Qorvo Inc (QRVO) — Q2 2023 Earnings Call Transcript

Thanks very much. Hello, everybody, and welcome to Qorvo's fiscal 2023 second quarter earnings conference call. This call will include forward-looking statements that involve risk factors that could cause our actual results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statements contained in the earnings release published today as well as risk factors associated with our business in our annual report on Form 10-K filed with the SEC because these risk factors may affect our operations and financial results. In today's release and on today's call, we provide both GAAP and non-GAAP financial results. We provide this supplemental information to enable investors to perform additional comparisons of operating results and to analyze financial performance without the impact of certain noncash expenses or other items that may obscure trends in our underlying performance. During our call, our comments and comparisons to income statement items will be based primarily on non-GAAP results. For a complete reconciliation of GAAP to non-GAAP financial measures, please refer to our earnings release issued earlier today available on our website at qorvo.com under Investors. Joining us today are Bob Bruggeworth, President and CEO; Grant Brown, CFO; and Dave Fullwood, Senior Vice President, Sales and Marketing; as well as other members of Qorvo's management team. And with that, I'll turn the call over to Bob.

Thanks, Doug, and welcome, everyone, to our call. Qorvo delivered fiscal second quarter revenue and EPS above the midpoint of the outlook provided during our August 3 earnings call. As we indicated on our call, Qorvo's business is now organized into three segments: high-performance analog, connectivity and sensors, and advanced cellular. In high-performance analog, revenue during the September quarter was broad-based with strength primarily in defense and higher power applications. In connectivity and sensors, headwinds in consumer markets and related inventory drawdowns impacted revenue as expected, even as favorable design activity was diversified across a growing list of customers and product categories. As a reminder, connectivity and sensors combine the previously split connectivity and sensors businesses between mobile and IDP. Lastly, in Advanced Cellular, we enjoyed a large customer ramp during the quarter. While unit volumes were weak in the Android ecosystem, we were encouraged by content and integration trends across our Android customer base in their 5G designs. With our new operating structure and global sales organization, Qorvo will capitalize more quickly on opportunities across markets and customers to support growth. We will leverage our core strengths in system solution design, semiconductor manufacturing, advanced packaging technologies, and deep relationships with customers and suppliers to help enable a world that is more efficient, more secure, and more connected. Now let's turn to some quarterly highlights. In our Performance Analog, Qorvo signed an agreement with SK Siltron for a long-term supply of silicon carbide wafers. Qorvo has achieved four consecutive quarters of sequential growth in our silicon carbide business. Our expanded relationship with SK Siltron will further diversify and strengthen our supply base and help support continued growth in our power device business. We released a portfolio of advanced fourth-generation silicon carbide surface mount FETs for applications requiring maximum efficiency and low loss. These include DC to DC converters, fast DC chargers, onboard chargers, industrial chargers, and IT server power supplies. New GaN product introductions included a 5-watt GaN PA module for massive MIMO cellular base stations and a GaN power module for upcoming DOCSIS 4.0 systems. For power management markets, we introduced a highly compact power management IC designed to enable reconfigurability and reduce our customers' time to market in space-constrained applications, including home automation and networking systems. In Connectivity and Sensing, we achieved Matter 1.0 certification and commenced shipments of matter development kits featuring concurrent connect technology to simplify the design of IoT gateway and connected devices. We broadened our smart home product portfolio, leveraging our ultra-wideband and matter system solutions, and we expanded our ultra-wideband design engagements, serving enterprise applications including indoor navigation. We expanded connectivity and sensing design wins supporting top-tier automakers across a range of applications, including infotainment, connectivity, secure car access, and EV smart interiors. In WiFi, we secured a broad range of WiFi 6 and WiFi 6E design wins in support of 2023 platforms and launched 5 gigahertz and 6 gigahertz filters for European band WiFi 6E and WiFi 7 applications. In biosensors, we launched commercial trials of our COVID-19 diagnostic test platform with multiple retail healthcare outlets, and we began production of flu A/B cartridges for clinical trials in support of National Institutes of Health Initiatives. In Advanced Cellular, we increased shipments of Phase 7 LE solutions while securing additional design wins, including low-band, mid-high band, and ultra-high band integrated placements across multiple smartphone OEMs. We commenced our first production shipments of our high-performance MEMS-based antenna solutions, and we expanded our MEMS customer engagement to include top-tier smartphone OEMs. Qorvo's MEMS-based antenna solutions reduce friction loss and enable significantly improved system performance. At a Korea-based smartphone OEM, we expanded our content opportunity by securing our first Low-Band PAD win in their flagship smartphone. This win complements other content we have secured in support of their upcoming 2023 launch. Qorvo will supply integrated placement supporting the main and secondary transmit mid-high bands as well as antenna tuning and WiFi solutions. Lastly, we introduced a highly integrated Mid-High-Band PAD combining main path and diversity receive content. We will be sampling this product to customers in the first half of calendar '23, and we expect design wins to follow in support of future cellular architectures. Across Qorvo's business in high-performance analog, connectivity and sensors, and advanced cellular, Qorvo's markets are leveraged to multiyear secular trends like electrification, sustainability, and connectivity. We are at the forefront of advances in defense radar and communications, electric vehicles, battery power tools and appliances, wireless and wired infrastructure, smart home, automotive connectivity, precision location, and advanced cellular architectures. We are a technology leader, and we provide best-in-class products to a growing base of customers. In the near term, the Qorvo team is performing exceptionally well as we navigate ongoing weakness in our end markets. We are reducing factory loadings and bringing down our own inventories while helping customers to reduce inventory in the channel. At the same time, we are continuing to drive process and product development and have accelerated our efforts in support of future growth. Recent process development efforts include the introduction of Qorvo's next-generation SAW technology, which extends the range of our SAW filter portfolio to cover higher frequencies. Our newest SAW products will be complementary to our BAW products and will be featured in our most highly integrated placements that will be manufactured in our fab in North Carolina. Recent product developments also include our recently introduced mid-high band pad, combining main path and diversity receive content. This highly integrated solution leverages the reduced size and enhanced performance of our bar filters to integrate nearly 2x the BAW filter content in a smaller footprint than is currently available in mid-high band architectures with just the transmit functionality. As we have said previously, next-generation protocols continue to require higher performance content and customer architectures continue to favor higher levels of integration and functional density. We are launching new technologies and new products to fuel design wins and drive content in higher growth end markets. We expect these efforts to support growth as inventories adjust and volumes recover. We also expect to increase our growth rate and drive leverage as our investments play out in our higher-growth businesses. I want to thank the team for continued operational excellence. We are delighting customers with best-in-class products and technologies even as our markets undergo extraordinary events. We are adjusting quickly to supply and demand imbalances and positioning the company to drive sustainable long-term growth.

Thanks, Bob, and good afternoon, everyone. As a reminder, our references today will be to our three new operating segments: High Performance Analog or HPA, Connectivity and Sensors Group, or CSG, and Advanced Cellular Group or ACG. In our upcoming 10-Q, we will provide historical financial information, which has been retrospectively adjusted to reflect these new operating segments. I'll now turn to our latest quarterly results. Revenue for the second quarter of fiscal 2023 was $1.158 billion, $8 million above the high end of our guidance. HPA revenue of $228 million was up 8% sequentially and 47% year-over-year, driven by strength in defense and non-consumer related power products, including silicon carbide. Connectivity and Sensors revenue of $143 million was down 6% sequentially and down 19% year-over-year due to weaker consumer electronics spend, primarily for WiFi-enabled products. Finally, advanced cellular revenue of $787 million was up 17% sequentially, representing a strong seasonal ramp and year-over-year growth at our largest customer, but down 15% year-over-year reflecting lower smartphone unit volumes within the Android ecosystem. On a non-GAAP basis, gross margin in the quarter was 49.2%. The quarter benefited from product mix effects offset by higher inventory-related charges and the beginning of planned reductions in factory utilization. Non-GAAP operating expenses in the quarter were $233 million, $7 million lower than our guidance due to OpEx discipline, the timing of product development spend, and lower employee-related expenses. Versus last year, operating expenses were up $10 million primarily related to additional headcount and higher design and development costs associated with our power management and ultra-wideband businesses. In total, non-GAAP operating income in the quarter was $338 million or 29.2% of sales. Breaking out operating income by each segment, HPA was the most profitable segment this quarter at 35%, followed closely by Advanced Cellular at 34%, and connectivity and sensors was negative 7%. Non-GAAP net income was $276 million, representing diluted earnings per share of $2.66. This was $0.11 above the midpoint of our guidance range. Free cash flow was $220 million. Capital expenditures were $47 million, and we repurchased $160 million worth of shares during the quarter. Today, we announced that our Board of Directors has authorized a $2 billion share repurchase. This authorization will replace the prior authorization, which had a remaining balance of approximately $350 million as of October 1. The rate and pace at which we repurchased shares is based on our long-term outlook, low leverage, alternative uses of cash, and other factors. Turning to the balance sheet. As of quarter end, we had approximately $2 billion of debt outstanding with no near-term maturities and $914 million of cash and equivalents. We modestly reduced our inventory balance in the quarter to $841 million despite seasonal product ramps in the macroeconomic environment. Now turning to our current quarter outlook. We expect quarterly revenue between $700 million and $750 million. Non-GAAP gross margin between 43% and 44%, and non-GAAP diluted earnings per share in the range of $0.50 to $0.75. Our current view of the second half of the fiscal year reflects ongoing weakness across end markets, primarily in consumer-related areas, as well as a more acute inventory correction at our Android smartphone customers than was previously predicted. We expect sales to China-based Android smartphone OEMs to represent approximately 10% of total revenue during the December quarter. We expect this will mark the low point in our Android-based customer revenue and in the March quarter, we continue to project Android base revenue will grow sequentially. At the volume levels assumed in our guidance, we expect our inventory position to remain elevated but improved by the end of the fiscal year as we undership normalized demand and reduced factory utilization. Simultaneously, we are cutting costs in our factories to offset the impact from lower volumes. Unabsorbed fixed costs will impact gross margin in the second half, and we currently expect non-GAAP gross margin for the full fiscal year to be approximately 47%. We project non-GAAP operating expenses in the December quarter will be down approximately $5 million to $7 million sequentially, reflecting continued cost discipline across the organization and lower variable compensation, offset by continued investment in growth areas. Below the operating income line, other expense will be approximately $15 million, reflecting the interest paid on our fixed-rate debt offset by increasing levels of interest income earned on our cash balances, along with other items. Our non-GAAP tax rate for the balance of the fiscal year is expected to be between 14.5% and 15% due to the absolute level and geographic mix of pretax profit, including FX-related gains within high tax jurisdictions as well as the impact of a U.S. tax law change related to R&D capitalization, among other factors. Turning to our operations. I'd like to highlight the great work our teams have been doing to improve productivity. As an example, in our Richardson facility, we have significantly increased the effective capacity of our BAW filters within the same factory footprint. This has been achieved across a number of initiatives spanning product development, filter design, process engineering, and manufacturing efficiencies. Successive generations of Qorvo's BAW technology have and will continue to meaningfully reduce die sizes and increase die per wafer. Manufacturing efficiencies such as the move from 6-inch to 8-inch wafer diameters as well as ongoing processing advancements will further increase effective output. The combined effects of these achievements will allow our Richardson facility to support significant revenue growth. Looking forward, we have the ability to approximately double our BAW output within our existing footprint in Richardson. Despite the macroeconomic challenges impacting customers, our long-term outlook remains positive. Product performance requirements continue to increase in our end markets and connectivity and electrification trends are accelerating. We have grown our opportunity set across markets, customers, and product categories while maintaining our commitment to technology leadership, portfolio management, productivity gains, and reduced capital intensity. This has supported strong financial performance during a challenging environment and positioned Qorvo exceptionally well for long-term increasingly diversified growth. At this time, please open the line for questions. Thank you.

I guess I had a question on your business in China. Can you kind of provide some context as to how significant your revenue in China was in the quarter? I think based on what you guys reported last quarter, China was about one-fourth of your business overall. How did you do in the September quarter? And what's the outlook going into December and in the March quarter?

Sure. Thanks for the question. I'll take that one. The China-based revenue in the quarter was down approximately 20% quarter-on-quarter and about 45% year-on-year, just to put it into perspective. Looking forward, as we commented in the prepared remarks, we're looking at that Android-based China revenue down to approximately 10% of the overall revenue for Qorvo. So a substantial decline both quarter-over-quarter and year-over-year.

Got it. And then as my follow-up on gross margins, probably for you, Grant. I guess based on your full-year commentary on that, will the implied gross margin trajectory into March is probably down a little bit off of that 43.5% guide you how should we think about the path to for you to get back to the 50% or 50% plus? I know you're going through a very sharp production, you're cutting utilization rates. But the pace and timing at which you can improve gross margins in calendar '23. If you could provide some context to that would be super helpful.

Sure. Related to gross margin, as you pointed out, it's heavily influenced by both mix and the utilization impact. Currently, the dominant headwind is the underutilization, which is generating over 700 basis points of headwind. So we have a clear path back to 50% gross margins beyond that utilization impact from the demand that we're seeing today. We don't typically report utilization by factory, but I think it would be a meaningful metric just to cover very quickly by location. As an example, for instance, if we look at utilization in Germany, it supports our broadband business, which has actually seen some strength. So the utilization there is doing okay and the migrations to the new DOCSIS standard are helping support that factory in the volumes. Alternatively, if you look at our North Carolina Gas fab, for instance, it's running very low levels of utilization, which impacts our margin in the WiFi business for CSG. Larger sites like Oregon and Texas are also underutilized given the unit volumes we're seeing from customers as they work through the inventories and the soft demand environment and similarly, our assembly and test operations in China remain underloaded as well. All of this underutilization creates costs that go unabsorbed into a higher inventory volume and negatively impacts the margin. I would expect that to resolve as volumes return, and we'll have a clear path back to 50% as that factory mix and volumes both return. In terms of margin, there's obviously a lot of moving parts there and other factors, but the underutilization is the primary one.

I want to pick up on the last line of questioning. And you seem to insinuate that there is a path back to 50% gross margin when these underutilization charges sort of work their way through. But is there a natural resolution or path to the situation or might management have to make some decisions on in terms of defensive realignment with the manufacturing footprint?

Sure. There's a number of opportunities for us to improve margin looking forward. We are reducing costs in the factory today, primarily variable costs. We can alternatively look at the utilization that we can bring down, which we've commented on previously. The underutilization, as we see it today, is something that will resolve as we're under shipping and under-building to what would be a more normalized demand environment. So as that returns to normalcy, I would expect the underutilization to leave itself. The other items in gross margin, and there are others, but they are much less significant. For instance, inflation is one where it might be running approximately 50 basis points to 100 basis points as a headwind today. But again, it pales in comparison to the utilization impact. There is pricing, which factors into it, but there's nothing that we're seeing there outside of what we expect in historical norms. So again, going back to utilization, it ultimately relates to the volumes we see and the volumes we're seeing right now from customers and the demand levels are intimately related to the macroeconomic effects we've talked about.

Sure. You're right. There is weakness beyond just Android. Both consumer and enterprise spending on our customers' end products have continued to be a challenge. Our customers have had to adjust their production to align with the lower levels of demand and the inventory they are carrying. This varies by end market. The inventory challenge in the Android ecosystem is likely the most significant, but we are also experiencing similar issues in our WiFi business. This includes access points, routers, power management products for power tools, and SSDs, which have also shown some weakness. Looking ahead, I expect these areas will follow similar patterns and that volumes will ultimately recover.

For the first point, you mentioned a 47% gross margin for the full year, which implies that March will have relatively flat sales and gross margin. Could you provide some clarification on that? Additionally, Bob, I'd like to know what the recovery looks like for Qorvo. Prior to the 5G cycle, your quarterly sales were in the $750 million to $800 million range. Recently, they've increased to 1.1 to 1.2 billion, which seems to have exceeded demand. Does the recovery suggest that sales will settle somewhere between your pre-5G levels and the recent peaks, or do you believe you can surpass the recent quarterly figures?

Thanks for the question, Vivek. This is Grant. Let me take the first part, and then I'll let Bob address your second question. I mean, first and foremost, we won't guide into March formally, but we did comment on the Android-based revenue, which we do expect to be up in the March quarter. And then in terms of our largest customer, seasonally, you would expect that to be down. So there's some offsetting effects there. We'll have to see how that plays out. The rest of the business, we expect to be approximately flat to slightly up in certain different areas.

This is Bob. Thank you for your question. Yes, you're right that there has been some inventory buildup, but I want to emphasize that we are far from the number of 5G phones we anticipated; our current figure is approaching 600, while at the beginning of the year, we expected it to be around 700 or more. This significant decrease has contributed to the inventory increase. However, we still aim to exceed our previous levels of $1.1 billion to $1.2 billion over time. We have numerous growth drivers across our portfolio today, including all our business segments. Regarding event cellular, we believe we can achieve mid- to upper single-digit growth and there is still potential for growth with our largest customer as well as considerable BAW content in the coming years. In the high-performance analog business, we have various growth drivers, with defense expected to be a strong segment for multiple years. Additionally, we are optimistic about the infrastructure market with our GaN modules. We are excited about the 5G rollout in India, which will primarily draw on our European customers. The power market mentioned by Grant is currently facing some challenges due to the data center market and electrical power tools, but we are expanding that product into multiple markets and anticipate significant growth. In our power device business, we recently formalized our agreement with SK Siltron as a valued supplier. This collaboration is yielding significant growth, and we continue to enhance our sales pipeline. Regarding connectivity and sensing, we believe this area will offer the highest growth potential. We've shared before about our success in ultra-wideband and our efforts with Matter and development kits. We anticipate Wi-Fi will rebound for both handsets and access points, so we remain committed to our long-term plans.

Very helpful. And maybe for my follow-up. I think on the last call, you had highlighted a $110 million charge, if I recall correctly. I was curious what happened to that? Was it paid? Was it negotiated? Any other charges we should be aware of? And is there any obsolescence risk on the inventory that you have?

Sure. Thanks for the question, Vivek. I'll take the silicon question from last quarter and then I'll roll it forward to this quarter. If you remember, there was a $110 million charge last quarter. In the K that we filed, there was $2.2 billion of total purchase commitment liabilities that we had of which $1.4 billion was related to this particular silicon agreement. It currently stands at approximately $800 million, which remains on that particular agreement. Given the demand that we are including in our guidance, looking forward, we were able to work with the supplier in that case in order to better match the supply coming in with the ultimate demand in our silicon. So overall, a very good story, very solid partnership in working through that particular agreement.

I wanted to maybe first start off with a question for either Bob or Eric. To what extent is Qorvo under-shipping demand in the December quarter, particularly in handsets? And related to that, clearly, volumes are impacting your utilization and margins. But I guess our ASPs on older generation devices coming down by a similar amount as we think about the December quarter guide?

Yes, thank you. This is Dave. I'm not sure how much we can disclose about the extent of our under-shipping demand. It's a mix of weak market demand, particularly in the Android ecosystem, along with the inventory that has built up in the channel and is being worked through. We don't believe pricing is a contributing factor; it primarily concerns the units and inventory levels.

Thank you for that. Again, we've got three different suppliers that supply us the raw wafers, and we've got even more that do the epitaxial, so this is a portion of that. We haven't disclosed even the baseline business, how large it is this year. All I can tell you is it's growing significantly, and we're very pleased with that acquisition. It's coming up on its first year anniversary and very pleased with how it's contributing to the overall performance on the top and bottom lines. But we're excited about the business. We've got a great product offering there. I ran through a number of the different applications we're in, and we just continue to add to the sales funnel on that business, and we just want to formalize with one of our suppliers in the longer-term agreement.

I just joined the call late and wanted to get an understanding of the situation in China. If you can share any insights beyond June, could you discuss how you see the inventory digestion progressing after December? Do you expect there will still be some residual effects in March, or will December be the peak of the issue?

We did cover the China revenue, the percent of sales and the percentage that it will be down both quarter-on-quarter and year-on-year, which are substantial. In terms of the inventory and the time it will take to process through the inventory, we haven't made a formal statement about that, but we have commented that Android-based revenue in China is expected to be up in the March quarter. We haven't provided formal guidance, but we do expect to see some increase in March.

I want to discuss the mid-high band that integrates the transmit and the DRx into a single module with a smaller footprint than what we previously had for the mid-high band. I assume your performance improvements have allowed you to reduce the size and add some other features. Is this the new Phase 7E module that many of your Android customers have been requesting to help reduce both the footprint and possibly their costs for the RFFE, or was this developed for a specific customer? Any insights you can share on how widely appealing that part might be would be appreciated, and then I have a follow-up.

Yes, Ed, this is Dave. The Phase 7 LE is a different solution. So we talked about that earlier this year, and we've ramped that with Honor. We've got a lot of new customers, POs in hand, we'll start shipping more in the beginning of next year. The product you referred to that combines the mid-high-band, main and diversity path, that's a new product that will ramp probably in 2024. So that's more targeting high-performance, small form factor applications, really leverages Qorvo's strength, optimized size and performance. And so we're working with some leading customers on helping them define that architecture and drive that solution.

Great. And then a follow-up. I mean, your inventory problems appeared last year at this time pretty much. And I know it's impossible to tell, it's difficult to even understand how much inventory relative to demand seems to have happened subsequently to that to make things worse. But we've now gone for 12 months and it's not getting better, it's getting worse. So what point or is there a point where you start writing off some of this inventory? Or is it all standard product. They'll sell just as well in the 2024 phones as it did or targeted for last year's and this year's fall. So I'm just trying to get a grasp of how long you're going to go with it before or is it just selling through?

Thanks for the question, Ed. In terms of inventory and what we're writing off or reserving against, it is up significantly. So that will be in our gross margin in our non-GAAP gross margin. So we are seeing that today. If we believe anything was excess or obsolete, we would have included it in that. So there's no expectation that there was something we missed. I would also point out that we're doing the things that we can do to help manage that by reducing utilization in the factories. We're working with customers and suppliers. We're ordering less raw materials, for example, and being selective about where we choose to add value to inventory looking forward, I tend to look at finished goods, and it's about 20% of our total now. It typically runs higher than that. So that tells me that we're doing a good job. At least on a historical basis of managing the situation tightly and in terms of what we choose to build knowing that we're going to make sure there's demand to consume it. So we're taking the steps that we need to take today and we're reserving against the excess and obsolete as we see it.

I apologize if this question was asked earlier since I joined late. I am interested in understanding the perspective of Chinese handset customers regarding what a recovery year looks like in 2023. Given that phone designs are typically planned six to nine months in advance, I'm curious if you could share any insights on what a recovery year might look like in 2023 considering the 600 million expected for the 5G market this year.

I think what's important, and it's a good question, and if I could answer that, I know a lot of you would be super impressed if I was actually accurate. I think what we focused on is the design activity, to your point, that we've been working on. And we're quite encouraged by the number of new phones and obviously, our design wins that are there and the amount of content that they're putting into their phones. It's just what you're really asking is the number of units, and let's just go through their markets. The China consumer is at an all-time low right now. Everybody had hoped after President, she was elected to his next term, they'll back away from the Zero COVID policy. We haven't seen that yet. So what's the China market going to look like? They're a major export market. A lot of that is Eastern Europe. The war in Ukraine doesn't look like it's slowing down. So we have to factor that in. And then you put in place, they're strong in Europe as well, you look at inflation and what they're seeing over there. So until a lot of those things get under control, they're not leaning forward, okay? What they are doing is continue to design new phones. We work with them on that. We get those wins. Many of those are some of the same products we're shipping today. Many are some of the new products that we've also talked about. So very difficult to project '23. What we feel good about is our design wins, our market share is consistent or higher as we go forward. The number of units, we'll just have to wait and see. We want to thank everyone for joining us today. We look forward to speaking with you again at upcoming investor events. Thanks again, and hope you have a good night.