Nordic Semiconductor — Call Transcript 2019

Speaker 6: Good morning, and welcome to Nordic Semiconductor's second quarter presentation for 2019. It's like every quarterly presentation. I do a quick business update, Pål, our CFO, go through the numbers, and then I come back and do business outlook. To gather some highlights, what we will see when you look through the report is that we had a very strong backlog, and that's basically increased because of Tier one contribution, and it also impacted our revenue this quarter. Nordic Bluetooth design wins certification this quarter grew by 21% from 125 in Q2 2018 to 151 this quarter. Nordic design win market share was again at 43%. Strong market share. We have reported quite a few major design wins report during this quarter. The record high backlog was driven by new design wins with Tier one customers and is globally. We had a strong margin this quarter as a result of the investment we've done in supply chain. As you might recall, we got $100 million we raised in April last year. We bought test equipment to be faster to market with optimal yield, and that really shows on our margins today. We promised to release software for the cellular IoT products last quarter. We did so now in June. Also there has been some market uncertainty, and that's been impacting the willingness to keep inventory, and we have basically managed this adaption to current situation throughout this quarter. Our revenue was in line with the guidance, was $70.5 million, a decrease of 0.9%. The important thing is that Bluetooth had a increase of 7.1% year-on-year. If you look at the quarter, it was an increase of 50% quarter-on-quarter. We still are impacted by this market uncertainty. We keep our market share, which is very important. We had a down of 25.6% in proprietary, and that was basically due to inventory adjustment. I will say not PC, which is the biggest chunk of our business, PC accessories, but non-PC accessories contributed to this revenue decline. We sampled cellular IoT products for $200,000. It's not bad doing sampling. Back to the backlog, $112 million is a close to 40% growth year-on-year. Our gross margin, 51.2%, is an expansion of 2.2% year-on-year. We really get payback for the investment we did on supply chain on test equipment. This is the best margin we have had in four years. We see that the design wins that are contributing to revenue growth is the higher nRF52 family. It really shows that our new customer base, more or less the Tier one customers, they want advanced Bluetooth chips. EBITDA was at $9.8 million. If we adjust that for short range only, we have a EBITDA margin of 15.3%, which is 21.8%. That's basically the EBITDA on short range business from Nordic. Pål, I hand over to you and you do the numbers.

Speaker 5: Thank you, Svenn-Tore. I'll go through the financials now. It's good to be back on higher revenue. Last quarter, all our operational KPIs saw very negative variances compared to what we've historically shown. When we're back to $70 million in revenue, we see that the operational leverage gets our KPIs back to what we've seen as the historical trailing numbers. I'm going to go through this model now, as always. Just remember that the cost items here are the reported numbers, so we haven't adjusted for non-cash items. First of all, as Svenn-Tore said, revenue down 0.9%, good growth in Bluetooth, offset by the negative proprietary variance. Gross margins up 2.2 percentage points compared to last year. Positive contribution for cost improvements, and also a favorable customer and product mix compared to last year. If you look at our total cost for the quarter, it was 37.3% of revenue or $26.3 million. That's a 5.6% increase from the $24.9 million last year. That's actually down compared to last quarter, but that's the effect on salary pay that we always have in Q2. Total R&D, $23.8 million, up from $20.1 million last year. Included in this number is a capitalization of R&D of $3.8 million, slightly higher than last quarter's, but more or less the same number as last year. The difference in capitalization this quarter versus last quarter's, is that it's less cellular in this number now. This quarter it's only $2 million, so $1.8 million relates to the short-range business, which is then development of new products and new variants that we're coming with. Total cost for the cellular operation in the quarter was $5.6 million versus $3.4 million reported last year. However, the underlying cash cost is an increase from $6.8 million to $7.5 million, or about 10%. We're close to 200 people in Finland now. The 200 people is not only working on long range. Some of it is also short-range people. In total, 200 people. Finally, SG&A, $9.5 million versus $10.6 million last year. Actually, if you adjust for the IFRS 16 effect of $1 million, SG&A is more or less the same. In the challenging market, we are actually conserving costs while we, at the same time, are ramping business to sell the cellular business in next years. As Svenn-Tore mentioned, EBITDA margin of close to 14%, same as last year, above 20% for the first time, adjusted for the cellular business. We're going to jump to revenue per market. Nordic, after two quarters with negative growth, we have the first quarter where we have flat numbers, and that will, of course, be seen in the change in per market. You see all of them are more or less flat compared to last year and have a significant growth compared to last quarter. That's both the market improvement but also the seasonal effect, Q2 versus Q1. I'm now going to highlight the main items in each of the markets. If we start with consumer electronics, down 3.4% compared to last year. You remember proprietary is down 25%, and proprietary is to a large extent in consumer electronics. That means that the Bluetooth business in consumer electronics is pretty strong and showing a good growth. That growth is sort of a mix between a transition from proprietary to Bluetooth on some of the PC accessory products, but also some good designs that Svenn-Tore has mentioned previously. Most of them actually come in consumer electronics. Wearables, up 7.3%. $12.7 million is actually the strongest number we've had in wearables since Q4 2015 when our previous big customer in wearables was at its peak. We had a rebound in wearables. There's really two reasons for this increase or this good number. First of all, wearables was very weak in Q1, because wearables is the market that was hit most of the issues the ODMs had earlier this year due to the trade issue. Secondly, we do have quite a few of very good new design wins, both internationally and in China domestic market within the wearable market. A good number. Building and retail, more or less flat compared to last year. Really, the only big difference between last year is this RFID customer that we've had for ages, has had low numbers in this year compared to last year. Compared to last quarter, 16% increase. There's some really good smart home applications, and also beacon asset trackers in that number. Healthcare has been more or less flat for the last quarters. Also this quarter, up 1.5% versus last year. This is a market we're investing a lot and coming up with new products and new variants. We hope to gain attraction in this market because it's an important market in Bluetooth. Finally, others. Good contribution from all our module partners. Talk about gross margin. In 2016, when we experienced significant yield problems in connection with introduction of the 52, we had margin far down on the 50s. We started guiding on a target for 50% on gross margin. Since that date, we've been able to more or less constantly increase our gross margin. For the fourth consecutive quarter, we're above our 50% target. We've talked about this improvement many times. It comes a result of strong operational performance, where we now don't have all the waste when we introduce new products. We've had good wafer savings, and also we now have a much broader portfolio, we're able to sell the right product to the right price. Also, as Svenn-Tore mentioned, we've done investment in test equipment, when we ramp new products, scrap is much less than it was back in 2016, 2017. If you look at what it was last quarter, it's more or less flat. A little bit unfavorable customer mix, but a favorable product mix as there's still a pull for the more high-value Bluetooth products. We do anticipate quarter to quarter fluctuations and then also when cellular IoT starts ramping, you need to look at the total gross margin for the group. Cash OPEX. This number is adjusted for capitalization and equity compensation. As reported previously, we are continuing to ramp to capture future growth opportunities. We are increasing the number of employees. If you look at Q1 versus Q2, there's a small increase of 0.2% in cash cost. There's a reduction in salaries due to salary pay, holiday pay. There's an increase in other OPEX. That's mainly costs related to all the certification work where we're doing now with our cellular product. Compared to last year, there's a OPEX increase at around 5% or 8.8% if you adjust for IFRS 16. This increase is mainly driven by a 14% increase in employees. We're now 717 employees compared to 629 a year ago. The reason OPEX goes up less than the employee increase is that we do have a continued favorable effect in the accounts with the weakening of the NOK compared to last year. Final slide. On cash flow. Since Q2 represents the quarter where we're back to growth, we've had two quarters with decline in revenue. You will in Q2 always have a cash outflow due to the buildup of working capital. We've also seen this in Q2, so a negative cash of NOK 10 million in the quarter. This was compared to a negative cash of NOK 4 million the same quarter a year ago. If you look at the reduction in accounts receivable or the increase in accounts receivable of NOK 10 million, this is actually less than the USD 17 million in increase in revenue. It shows that we're able to keep the payment terms and the DSO with our customers even in a challenging market. I think that's good. If you look at CAPEX, NOK 4.1 million, slightly below the guided amount. It's taking time to build the lab equipment and then ramping the facilities we've talked about. This is more or less a delay into the next quarters, and Svenn-Tore will mention that on the guiding slide. Finally, we are continuing our disciplined cash strategy, and we do have a very tight cash management, and we're trying to optimize our cash generating ability. Okay, Svenn-Tore, I'll hand over to you again.

Speaker 6: Every quarter, we show some new Nordic Powered products. This time we pick a selection of products, I think very much representative of what we've been doing of design-in activity and where we do design-in activity. Logitech have just released a G703. It's a new gaming mouse. Logitech are doing very well on gaming if you look at the numbers, and Nordic is part of this gaming wave. We are continuing to winning the Brio products at Logitech. We are proud of that. Sikom is a Zigbee thermostat. We've been talking about Zigbee for many years. This is the first pure Zigbee application with Nordic inside. Who did we compete with? We compete with the guys that basically are pushing and selling Zigbee only. Our multiple platform product won against an optimized Zigbee product. We're proud of this design. We also see that energy measurement, this is basically a product you can put onto your power core and measure your electricity flow. Again, with the nRF52 series. Another meter is a water meter reader using Nordic again. We see that these meterings are getting more and more smart. They have to use either Zigbee or Bluetooth, or maybe even some of them use Thread. Remember, we have solutions for all those three protocols. This is a target market for Nordic. At the right end corner, you see Alps Alpine, which is a Japanese company using Nordic for asset tracking, both for short and long range. That's the first product we see. We combined the cellular long-range product with the nRF52 family. We spoke about that some years ago when we started doing the cellular, that we might see combinations in the same end product. If you look straight ahead, you see it. It's great. Every half year, we show this slide. How many design kits did we ship into the market? We ship close to 40,000 products into the market the first half. It's a new record. It's a 33% growth from first half 2019. What we see is that there's a significant contribution of the nRF52840. To remind you, the nRF52840 is the most complex BLE chip from Nordic Semiconductor. We believe that the applications we see now are getting more and more complex. You need CPU power. This is what we took the bet on four years back, and it was correct. Also, if you go under the numbers, you see that we ship 2,791 the long-range kit first half of this year. We still believe this is a leading indicator of the market growth. What we also see is there is a continuous strong diversification of applications where we get in. This is a leading indicator of our position, and we have an attractive and also a competitive solution. If I go back one slide, if you look at Sikom, we compete against the guys that are doing Zigbee. We won with our combined platform, the nRF52840. It was a record quarter for our certifications and product certification ended at 151. It's the largest number we have ever seen. It's a 21% growth year-on-year, and it's up 11% from last quarter. You see again that this red bar at the right-hand side, which is others, is contracting. We see that there is coming newcomers into the market every half year or every quarter, but still, you cannot have a sustainable place in this market with one or two or 10 design wins a quarter. Because investment to be able to give value to customers is not supported by companies doing one to five design wins a quarter. This will consolidate. Last quarter, I spoke about a segment called lighting. We believe that professional lighting will be smart. This quarter, we're talking about commercial asset tracking. You have all seen tags to make assets smarter. You see all the sensors out there. Nordic Semiconductor is reading those signs and obviously makes it easier for doing safety, inventory, and security. Usually, it's a relatively simple application where our low-end part, the nRF52810, fits in. Then you have more advanced parts where you do tracking and gateways, and these gateways do indoor location. They support mesh protocols, and some of them are using Bluetooth, Zigbee, and Thread. Is it familiar? It's what Nordic Semiconductor supports. Basically, one product, the nRF52840, supports all these three protocols, and we can enable these gateways to be built. If you want your data up to cloud, you can add on an nRF91 module and basically have a complete system built around our technology. This is a segment that's going to grow over the next years to come. Obviously, we have what we are familiar with today, the standalone asset tracking application. The nRF52810 can be used on low-cost consumer applications. Then we have the nRF9160, which is a GPS tracker. What we have showed you is pets, livestock, is application that's already out there. We see again, asset tracking really fits the Nordic technology. Our customer tells us, too. Tive, one of the leading companies within trackers and Sikom. He has actually had a press release and toured around the world saying how important it is for Tile to get part of the Nordic infrastructure. We are building an infrastructure that these partners want to hook up with. That's our, I would say, secondary strength. The first strength is obviously the parts itself, but when you do have your infrastructure built out there and most customers are using the Nordic, then basically others want to hook onto the same infrastructure. Consumer is Tile. On industrial, it's a company called KUKA, which some of you might know of. It's doing the same but more for industrial applications. We have a company called H&D Wireless, which are basically using a combined solution again. It just proves that the combination of short and long range makes new segments open for Nordic. We have now qualified Amazon FreeRTOS for nRF52840, so it's available now. Basically you can go to AWS and use the software and use the Nordic chips. We are not the first, but we're there, and it's a new opportunity for everybody using the AWS. A quarter ago, we talked about production status for nRF91, and we said they're going to be delivered in June. We did so. nRF9160 SiP is all now in production. We are finally getting certification in place both for LTE-M and Narrowband IoT. It has taken some time, a little bit longer than we had anticipated, but now it's coming, and obviously it is impacting the time to revenue for us, but we are there at the moment. We support all LTE bands, both LTE-M, all the bands, Narrowband IoT, all the bands. We're certified by GCF, PTCRB, CE, FCC, ISED, and we are very close to get the Verizon certification out, and we expect that to happen now in July. Guys, if you have a project in your room at home, you can start buying modules from Nordic. If you're working in a large corporation and you want to have a secure and good LTE connection, again, you can contact us and we deliver. I have to say, there is a lot of good and smart engineers in Norway also. This is a product which a company called Telespor is doing. I call it a radiobjella. For you that listen on the webcast and doesn't know Norwegian, it's a product that you stick around the neck for sheeps. It's out there in the market today. These sheeps are walking around with this orange radiobjella today in the west coast of Norway. It reports GPS position at different intervals. You can define what you want. Tagging is a two-way device. You can set alarms. For example, when there is no movement, you think that the sheep, it doesn't move for a day, must be something wrong. If you know, currently there is a lot of legal requirement for livestock, and this help the farmers to fulfill a legal responsibility. If you see here on the left side, in the bottom, this is the actual size. This is a product that we see. We have shown you one more similar product, was livestock in Finland. That is reindeer. Now we see sheep. We all know that there is a couple of sheep, for example, in New Zealand. This market is relatively significant for Nordic. If you look at our guidance now for 2019 Q3, we have a range between $78 million and $83 million. We have a strong backlog, and we are certainly back to growth in Bluetooth. We think that within $78 million- $83 million is a good range to expect. When it comes to gross margin, we are going to have a continued strong gross margin. If you look at our backlog, it is strong. Was $112 million. We said that there are Tier one customers that contribute to this backlog. That is why we want to set the expectations that it is not going to be another 2.2% growth in margin, but we are going to keep it around 50%. We know that we will use around $4 million to $5 million in CAPEX to continue, expand and accelerate the nRF9160 product to the market. Also, we need to ensure we have test capacity to ship out this $112 million that is going to be increasing over time. Just a brief poll at the end. We want to have a capital markets day. It is going to be following the Q3 presentation on October 22nd. We are going to deep dive into sales model, go-to-market strategy for both short and long range. We will have an update on the progress with long range certification and design wins. We are going to be more open with our technology and R&D roadmap. We will send that detailed information to you guys in September. This concludes the presentation and the Q&A. We have some questions here. Can you get the microphone, please?

Speaker 4: Thank you. Henriette Trondsen, Arctic. Good to see that you are now back onto Bluetooth Smart growth this quarter. First, your order backlog was quite solid this quarter. You write in your presentation that you have increased your Tier 1 contribution in your backlog. Firstly, could you give some more color on the customer concentration, the backlog, how much of your backlog is from Tier one customer or your top five customers, for instance?

Speaker 6: We are not commenting on whether it's tier 1 or each customer, but obviously to have this jump of 40%, it must be some larger companies in the backlog. We are going to see a shift in our current top 10 customers as a result of invoicing the backlog this coming quarter.

Speaker 5: The top 10 has been around 30%, 35%.

Speaker 6: Yeah.

Speaker 5: It's probably going to increase, but it's not a huge increase.

Speaker 6: It will gradually increase as more than one product from each customer starts going to production.

Speaker 4: Okay. Your Q3 guidance, could you give some more color on the split between Bluetooth Smart and proprietary? Because on Bluetooth Smart, you are now back to growth and you have easier year-over-year comps and also may be supported by Okay. Last one, on cellular. You mentioned that you expect cellular growth to pick up in the second half of 2019. Could you quantify this somewhat more? Also for 2020, do you still expect the cellular segment to break even during next year? If you could remind us-

Speaker 6: Next year.

Speaker 4: I know next year, maybe. If you could quantify what that implies in revenues for 2020?

Speaker 6: Yes. Let's take each question. If you look at cellular, we have had some great progress lately. We're starting to get certified globally. A lot of good things have happened. It's been a slower certification process than we expected. This will be a stretch goal to reach the break even, but we still believe that it's absolutely possible, and it's another 18 months before we end 2020. We are positive, optimistic, and believe that the goal is still achievable. You wanted to know more about Bluetooth contribution in Q3. That's going to be strong. The other part of your question, Henriette?

Speaker 4: You wrote that cellular revenues will pick up during.

Speaker 6: Yeah

Speaker 4: The second half. If you could quantify this?

Speaker 6: No, we cannot quantify. We are not guiding on each product line. We see that we have been shipping around 200K samples in Q2, and there will be some of this customer that will go to production in end of 2019.

Speaker 5: 19

Speaker 6: As we have said. We are not going to split it out.

Speaker 4: Okay. Thank you.

Speaker 5: You're welcome.

Speaker 4: Thank you.

Speaker 3: Christoffer here from DNB Markets. Just to clarify on the guidance for proprietary, you did some commentary on it in the Q3 report and said it was going to be down single digit, if I remember correctly. Was that incorrect, or do you expect it to be down single digit year-over-year in Q3?

Speaker 6: More than single digit.

Speaker 5: More than single digit, I think. We're talking about this report. We said more than single digit.

Speaker 3: Okay.

Speaker 5: Yeah.

Speaker 6: In Q2 report, we wrote that we have strong comparables in Q3, and we expect to be more than single digit in Q3.

Speaker 3: Okay.

Speaker 6: Second half is a different answer, but we come back to that in the capital markets day.

Speaker 3: Sure. Is that based on, you wrote that you had some issues, like you said, with the smaller customers in the proprietary business when you have the guidance for more than single-digit decline. Is that assuming that these guys will still be out of the picture? Or

Speaker 6: Yes. You can say yes.

Speaker 3: Yes? Great. Then, just as a follow-up on Henriette's question on the cellular business in the second half. Can you just give some more color on what recent events give you confidence that you will see revenues ramp?

Speaker 6: We've been shipping samples already from Q1 this year, and it takes some time to build the end product, but when it's built, when we've been certified, the whole infrastructure is ready to go. We very much depend on our customers' initial production rate, but we will get some customers into production this year.

Speaker 3: Yeah. Okay. Final one from me is on headcount. Could you say anything about how much you expect headcount to increase year-over-year in 2019?

Speaker 5: We haven't exactly said that. You look at what I've said previous quarters is that the growth will be more or less at the same pace, at least not more. Around the average we've had the last quarters.

Speaker 3: Okay. Thank you.

Speaker 6: I think we have to turn that question a little bit around. We have to look at opportunities we have and the means to be able to fulfill those opportunities. As we are getting more into new segments, and I would say a new customer base, we have larger opportunities, and we have to deliver faster, and we are not restricting headcount.

Speaker 3: I just remembered another one. There was news out, I think it was yesterday or the day before that keyboards from Logitech and mice and presenters have been found to be exposed to some security vulnerabilities, and these are products where you supply the only chipset in there. I'm not asking you to comment on Logitech in particular, because you can't do that. In general, how do you usually handle these kind of situations? How does it progress?

Speaker 6: First-

Speaker 3: Is it possible that you could lose a customer, or will you just do a firmware update, or how does it work?

Speaker 6: First of all, we never comment on individual customers. Secondly, any MCU or any radio can be hacked. Obviously, if such a situation occurs, we will work with our customer and ensure that they get the optimal security. It's a case that will happen in the future also, and we are working tight with all customers to ensure not to reoccur.

Speaker 3: Thank you.

Speaker 6: Okay.

Speaker 1: Yes. Good morning. Aksel from ABG. First, a question on backlog, no guidance methodology. You say that the uncertainty in the market that endured in Q2 will also prevail in Q3. How does that impact your guidance range? Is it such that you put in a safety margin and lower the guidance range, or do you make a wider guidance range? How do you approach market uncertainty in the guidance range?

Speaker 6: If you look at the percentage, it's not increased, we don't increase the range. If you look at the general conditions, there is parameters outside Nordic control. I think based on the company's history, it's better to be very realistic when you do guiding.

Speaker 5: Also the backlog is, since there's more inflow of bigger customers, the range or the timeline is increasing. It's going into 2020 also.

Speaker 1: Okay.

Speaker 5: Which it makes from quarter to quarter.

Speaker 1: better safe than sorry. Is that a correct interpretation?

Speaker 6: I think any company that are guiding today is more conservative than aggressive when you know what current state you are in.

Speaker 1: All right. One more question on the proprietary sales. You mentioned the channel effect, then you mentioned weak PC.

Speaker 6: No, we did not. We said it was weakness outside PC.

Speaker 1: Weakness outside PC. Yes. Is it possible to split those two effects?

Speaker 6: It is. We basically did. We say that the PC peripheral business has not been as affected as medium-sized, smaller customers that are in a lot of other applications.

Speaker 5: Your question is really, can you split between inventory and non-PC weakness? I think it's more or less a double dip, because if there's weak in other, there will also be inventory adjustments because there's a weak market. I would say that these two are linked and are probably similar.

Speaker 1: All right.

Speaker 6: We can be even more specific. What we see is that our distributors' channel are basically limited by inventory, holding of inventory. It's an effect that have been on all semiconductor companies. As we are growing relatively strong on Bluetooth Low Energy, most of the inventory we are shipping to our disti partners has to reflect what's going to be the fast-growing product.

Speaker 1: Okay, just a final one following up on previous questions on cellular revenue towards the end of the year. What would make you pleased being able to ship out? What kind of volume in, say, Q4 would make you very happy as we stand now?

Speaker 6: I think we are not looking at cellular proprietary or BLE separately, only to make us happy. What we are making us happy is that we achieve the goals we set. We've been working for many years now to be the leader of BLE. We want to ensure that we get those Tier one customer contribute to the revenue growth that Nordic, as a company, need. We know we've been doing a lot of good things. Things are starting to happen on long range with cellular. We will be disappointed if we don't see revenue end of this year. We haven't put a range of where we are going to disappoint or where we're going to be happy. We know that we have a goal is to try to get breakeven in 2020. That's the first milestone where we're going to be happy or not happy.

Speaker 1: Just remind me, the implied revenue to breakeven in 2020, what kind of run rate revenue would that be?

Speaker 6: It depends on margin, currently we look around NOK 65.

Speaker 1: All right. Thank you.

Speaker 2: Andreas Bertheussen, Kepler Cheuvreux. Two quick ones if I may. You reported revenue growth in Bluetooth better than expected. I guess, can you help us get comfortable that the 7% increase in year-on-year on Bluetooth was driven by actual new growth in Bluetooth and not sort of a cannibalization of the proprietary business, which was again then weaker than expected?

Speaker 6: Yeah. Quick answer is yes.

Speaker 2: Okay.

Speaker 6: This is new application using Bluetooth and not really taking over proprietary.

Speaker 2: Okay. You haven't really changed the way.

Speaker 6: No

Speaker 2: you do this. Okay. Thanks. Second question, there is of course now becoming a mismatch between the backlog and the guidance for Q3 in terms of size. Can you help us understand what your customers are telling you when they place these big orders? Of course, it's as you say, out in 2020, but what are they feeling right now? Are they saying that, "Yes, we are hopeful for 2020," or, "We will buy this in 2020, but we of course won't buy now because things are uncertain"?

Speaker 6: Obviously, we have customers that have production plans and plans, and we also go in and replace existing or other products in existing end product that is keep running. This is a more stable production. We know exactly when to ship, and we have dates on all backlog. This is not a hopeful orders. This is real orders that are going to be affected on real dates.

Speaker 2: Thanks.

Speaker 6: Cool.

Speaker 2: Okay.

Speaker 6: Thanks a lot for your questions. You guys have a good day and.