Synaptics Incorporated (SYNA) Earnings Call Transcript & Summary

Welcome to the third day of the Morgan Stanley TMT conference. My name is Craig Hettenbach, semiconductor analyst with Morgan Stanley. Very pleased to have with us today the CEO of Synaptics, Michael Hurlston; also have Jason Tsai in Investor Relations. Before I kick it over to them, I just want to remind investors that you can find research disclosures at www.morganstanley.com/research disclosures. And with that, Jason, I can turn it over to you for a minute.

Great. Thanks, Craig, for having us. Really appreciate the opportunity to come and present here. Before we get started, we'll be making some forward-looking statements here during this presentation. Please refer to our filings with the SEC for our full list of risks and uncertainties in investing in our securities. With that, we can kick it off, Craig.

Great. So Michael, just up top, just wanted to kind of set the tone. I mean you joined less than 2 years ago, and in that short period of time, there's already been a lot of change in Synaptics. But before we kick in there, I would just love to get your thoughts in terms of what initially attracted you to Synaptics as a starting point?

Well, first, Craig, good morning, and thanks for having us. It's really a pleasure to chat with you. When I came to Synaptics, I think 2 things were pretty surprising from the outside looking in. One, was the fact that the company actually was trading at a market cap below revenue, which is very, very unusual, I think you'd agree, for a semiconductor company. And then the second piece of it was that the gross margins were hanging around high 30s. They'd had real difficulty breaking 40% in terms of gross margin, which, again, is pretty unusual for a semiconductor company. So from the outside, looking in, I thought, okay, this doesn't make a lot of sense. There should be some opportunity to expand gross margin and thereby, increase the valuation of the company. And of course, both have happened, and we've been pretty pleased with the results that have happened here in the first 18 months or so of my tenure at the company.

Got it. And you did initiate a restructuring or taking out costs. And so why was that important? I mean you touched on low gross margins to address that. But just can you give us some of the backs up in terms of just that initiative in terms of improving costs is one way to get the margins up?

In general, Craig, I would say the company was chasing revenue almost for the sake of revenue for the previous couple of years before I arrived. There was a big move to top line growth, and that actually didn't succeed. There was a lot of effort to grow revenue. Actually, the revenue was going in the wrong direction. But what that resulted in was, a lot of different projects, programs, it had spend attached to it, and that spend really was commensurate with a company that would have $2 billion or $3 billion in revenue, not kind of $1.5 billion is when I intersected the company. So there was a lot of spending going on to try to chase projects that had really questionable return, if any. And so what we did over the first 6 months really was, evaluate where our spending was and try to consolidate on where the best bets would be and make cuts on things that we didn't think made sense or ultimately weren't going to bear fruit, and that was a really important part in the process, ultimately, I think, to impact operating margin. With respect to gross margin, and I think we'll talk about this as we go, 2 things were important for us. One was trying to get our supply chain under some control, and we had a pretty diffused supply chain. Frankly, we still do. And I think we're going to get into that later with some of your questions. But we really wanted to consolidate our bets a bit and work more with our suppliers on the fundamental underlying cost of our goods, which was out of whack when I came in. So we were able to work with our suppliers and get our costs, our variable costs under some more control. And then the second piece of it was really, portfolio and focusing our spend and focusing our investments on the highest and most profitable parts of the portfolio. In some cases, divesting, in some cases, just simply defocusing on parts of the portfolio that didn't have great gross margin and great return. So it's a long-winded answer. I think the restructuring ended in a better operating margin for the company, certainly a foundation to build a better operating margin for the company and then a better position on gross margin as well.

Got it. Well, I think that's a good segue in terms of just thinking about portfolio repositioning and some of the things you're doing organically. You've done some tuck-in acquisitions. So maybe we can start with the divestiture of kind of the low-margin mobile LCD touch business and just thought process there and what's that really meant for the company in the financials.

It was a tough decision, Craig. I think it was a fairly high revenue part of our portfolio. And frankly, it was profitable. So there was profitability. There were earnings attached to it. But we never saw a path to get it to a reasonable level of gross margin. And having that big chunk of revenue was a relatively sizable chunk of revenue at a dilutive -- significantly dilutive gross margin. Even though it was making money and even though it was accretive on the EPS line, we felt like, if we were ever really going to make significant moves on the gross margin line, we had to shed that business. And that was a decision that myself, Dean Butler, Jason, a lot of people came around the table and deliberated that, because it just wasn't obvious. In the rearview mirror, it looks like, a really good move. But at the time, there was a lot of healthy debate around doing it. We just felt like we were never going to get the profitability of the company and really, on that one, I mean the gross margins to a level that was commensurate with our semiconductor peers and stay in that TDDI business. So we made the decision to sell it. And that did result in a pretty big step-up in our gross margin that we're pleased about. And I think it gives us a base now to operate from in the 50s on gross margin and trajectory, as you know, to a long-term model in the very high 50s, around 57%. So we think we've got line of sight to continue to build on our gross margin story, but the first step, I think, was taking away a pretty big drag on the gross margin line, which was that TDDI business.

Got it. And we'll come back to some of the things you're still doing in mobile and touch on OLED. But before doing so, I wanted to touch on 2 of the acquisitions that you did last year. Broadcom IoT, really, how much -- how important was the familiarity you had with that business in terms of the decision to say, we're going to buy this technology and try to leverage this in Synaptics going forward?

Yes. Craig, I think I'd put it differently. I think that without familiarity with the business, without familiarity with the people, you would have struggled making that deal. You really had to have some intimate knowledge. So it was not so much the operation of the business per se, but it was more around, how Broadcom thought about the business. There are obviously pitfalls in the deal because it's essentially a license and a manufacturing license to make these ICs. And of course, the question that has happened over and over again is, hey, they sold the business once to Cypress. They -- looks like the deal is relatively familiar in terms of selling it to you. What are the differences? And how are you sure that they're not going to sell it a third time? I think we were able to get a lot of comfort with the deal structure in terms of how Broadcom would act, how Broadcom would operate going forward. And that came from a huge familiarity, both with the management team over there and with how they think about their businesses. And I think without that, it would have been a very difficult deal for an outsider to execute.

Got it. And along with that, it comes with kind of a road map from a product development standpoint, which is important the next couple of years. And so can you maybe just touch on that? And then more broadly, just the growth expectations in some of the key vectors that you see driving that IoT Wi-Fi connectivity growth?

Yes. We're super excited about the business. And of course, back to your previous question, I know the business well, and I know the customers well. It's been great reengaging with some of the customers I know. I got a couple of e-mails this morning from customers in that sector. I think where we're -- we're super excited about the growth that, that business can bring. I think we've talked about on the earnings call, seeing it double over the next 18 months or so, and we really see a great trajectory. I know we're going to get to that later, but I think our limiter in that business is just our ability to supply. It's just been a business that has vastly exceeded our expectations in terms of the revenue pipeline and the design win pipeline, and we just couldn't be more excited about it. The thing that we saw and the thing that certainly I learned from going through a bit of the Cypress experience was, the challenge to prosecute a development road map, the challenge to execute on forward-looking projects. And so that learning incorporated and went into the deal with the Broadcom team. And having them actually develop with their development team, which in my opinion is, is the best in the world and their technology is the best in the world. Having them execute 2 chips, the first 2 chips on our road map gives us oxygen to develop our own engineering capabilities in-house, gives us a lot of runway to develop a lot of the systems that we need, both operationally from a test standpoint, from a development standpoint. And that's been -- that was really key to our -- into our thinking of the deal and solving for some of the problems that we saw in the previous transaction.

Great. Maybe we could segue to DisplayLink. I mean I look at that business, it looks like a gem of the business from a margin profile. Why did it fit well with Synaptics? And if that's the case, you buying it versus other companies in terms of how you got this business?

Yes. We feel really fortunate. I think we got a great asset at a very fair price, and it's turned out, again, much better than we expected. We think that we can take it in a number of new directions by combining our Broadcom asset. With it, we can get into wireless docking. We think that there's a lot of room in this whole work-from-home environment where people are bringing in docking stations into their home offices. So we've seen a really nice tailwind to that business. But getting back to your question, we already played in that market. We already had an understanding of the docking market. So we were sort of usually situated to appreciate the asset, to understand the customer base, to understand the technology. As you likely know, our business was in a kind of a one-to-one dock, where we would sell into enterprise-class docks built by Lenovo, built by Dell, built by HP to attach to their PCs. The DisplayLink asset is a universal dock that allows any kind of PC to dock to any sort of monitor. It's really a step-up from where we were in the market. And so we had competed with them in some measure. I mean we don't make a universal dock here, but we understood their position in the market because most customers are offering a one-to-one dock. And then above that, from a price point standpoint, they offer a universal dock. And so we had enough familiarity with the DisplayLink business to say, yes, this is something that we think adds to our portfolio and really completes our stack, our SKU stack at the high end of the docking station market.

Great. Let's shift gears to the supply chain dynamics today, which is topical across the whole industry and is hitting many different markets. And so love to get your thoughts in terms of the impact that it's having on your business and how you're managing through this backdrop.

Yes. It's -- no doubt, it's a very, very difficult situation. It's probably the most -- I'm going to date myself now, but it's the most difficult situation I've seen in 30-plus years in the industry. It really is very tough. We got a little bit lucky in that. We were already entering a growth phase. You talked about in your questions, we had done a set of divestitures. We'd taken some businesses off the table. We'd sort of gotten the company down to its raw foundation. And we -- as we were entering 2020, we were planning on a growth phase of the business. And so we got a little bit lucky in that, our forecasts were higher than our normal base business that's given us some oxygen as we go into the supply chain challenge. Where we're finding particular problems, if we don't have -- if we had not forecast growth for example, the wireless business that you talked about a second ago is new, in situations where we have new businesses or new upside to a business, that's where we're hitting particular headroom, particular -- hitting a ceiling. So our ability, I think, to service a lot of upside is going to be restricted. It's going to be very difficult for us to do that. And again, in that wireless business, I think you had asked some good questions in the prep. We think we could be doing a lot better there, had we had unlimited supply. But right now, because that business is new for us, a lot of the wafer starts were unforecast as we embarked upon this, our degrees of freedom are a little bit more restricted.

Understood. And how about from a customer perspective as they manage through the situation, are you noticing any changes in terms of inventory behavior or buffering of things that they're trying to do to make sure that they have enough supply?

Yes. They're scrambling. We don't see things like double ordering. We've been worried about that, that people are going for land grabs and basically double and triple ordering. We're not seeing that. I mean I was on a call yesterday with one of our most strategic customers who reported, hey, lines are down because of our ability to get semiconductor components. And of course, you see that in automotive and elsewhere, people's lines are going down because they simply can't procure the right pieces. I just think you have a situation, as you know, you and I have had this discussion, where every single sector of the semiconductor market is hitting, and we're the beneficiary of that in a couple of areas. You've got more semiconductor content going into autos. You've got more semiconductor content going into IoT, and we've been beneficiaries of both of those. You've got PC that's abnormally high and sort of unforecast, I think, because of the work from home. And then in the cellular market, even though the cellular market is largely flat, you have more content going into 5G phones than you did in 4G. So each major sector of the market, auto, IoT, PC, cellular, has had some inherent growth driver, and you're now selling into a market or you're trying to get capacity to market that, it hasn't been invested in. The semiconductor suppliers haven't spent on CapEx at these trailing nodes for quite some time. So it's just the law of supply and demand. Demand is way up. Supply has been constrained by the fact that the semiconductor suppliers haven't spent on CapEx.

Got it. And when we think about this from a longer-term perspective, you said earlier on in terms of when you came in, even from your supply chain foundries, you're looking at ways to kind of be more efficient. How important is that strategically on a longer-term basis? I know this is kind of the crux of it today, but just how much does that kind of shed light on what you want to do with your own kind of manufacturing footprint, looking out in time?

Yes. I mean it's -- I would say the same is true for our customers, and that's the message we've preached upstream. There's virtue to second and third sourcing until you get into a supply crunch like this. And I think, our customers have to pick their partners and who can ultimately supply and deliver to them and playing multi-sourcing games doesn't help. Our problem one step down is that we had a very diffused bet. We had -- and have 10 different foundry partners. We're not necessarily meaningful to a good number of those foundry partners. And so our challenge has been all the greater because, they look at our spend, and they're making decisions based on how much we spend in that particular foundry. And our challenge has been magnified pretty significantly by the fact that, in 7, 8, 9 of the foundries, our spend is relatively low. So we've had to do a lot more gyrations, I think, than anybody else. And I think as we look forward in this whole supply chain, the idea of second, third sourcing, it just doesn't work. I think you got to pick your bets with your partners, place those bets, operate with them strategically, and I think the -- some of the tension will be eased in the market. That's certainly our challenge. As we go forward, we've indicated to 1 or 2 of our foundry partners, in particular, that our bet is going to be placed with you, and we're going to try to work through some of the supply chain. It takes time, as you know. This is a long -- a very long cycle time, but we will streamline our operational -- our operations over the course of the next couple of years.

Understood. Let's touch on the target mile. You recently increased your long-term targets to 8% to 10% revenue growth, 57% gross margin, 30% operating margin. Can you just touch on the path to those targets? What does it look like -- I know IoT, which will feed some additional questions here, is the big driver, but what does it look like from where you are today to kind of get to those long-term targets?

Yes. I think your question is, again, really well stated and on point. The whole thing is a tip toward IoT. So we see IoT in our portfolio, which had historically been a smaller part. We have 3 pieces that you and I have talked about several times. The PC, you've got IoT and you've got mobile. And I think historically, we were a mobile company with sub headlines around PC and IoT. And I think we've transformed the company or certainly, we want to head along the vector that says IoT is the headline with a sub headline of PC. And then operate mobile within an envelope, a restricted envelope, where we're going to be much more opportunistic about our bets in mobile. So if we take that as an assumption that IoT is going to be a much larger part of our long-term mix, we think the growth rate in IoT -- our intention is to outgrow the growth rates of the IoT market, which if you simply do the math, I think the numbers there are somewhere around 15%. We tend to outgrow that. If that's half of our portfolio, you get to a pretty high growth rate for the company overall. IoT does better for us on a gross margin basis. So as we tip the company toward IoT, we think our average gross margin goes up. And then as I said, I think PC, which has been a real nice business for us, we're going to continue to focus there. And then mobile, we'll operate as intelligently as we can. I don't think the revenue goes down there. But I think by operating it and sort of restricting our spend and being much more intelligent around our investments, we have an opportunity to improve gross margins from where they are without impacting top line and seeing maybe single digits type of growth even in the mobile area.

And let me add real quick here. I think if you take a look at just the overall market growth, we're not assuming a whole lot of growth beyond the market, right? And IoT market is growing at 15%, we'll do a little bit better than that. But to get to that 8% to 10% revenue growth, we're assuming relatively flat growth out of our mobile and PC business as well. So the 8% to 10% growth and then the 57% gross margin is really a very straightforward calculation that gets us from where we are today to where our long-term target looks like. And then on the op margin side of 30%, it's really just being much more diligent, continuing to be diligent on where we focus our spend. Like Michael said at the beginning of the meeting here is that, we just need to be much more -- continue to be much more focused on where we invest.

Yes. Got it. Within IoT, it can certainly be a catch-all. It means different things to different companies. For Synaptics specifically, what are some of the kind of differentiated products that you're leveraging to kind of drive growth in that segment?

Yes. I mean it's definitely a catch-all for us, Craig. We had a good discussion the other day about it, and you can see it's a pretty decent basket. I think the good news there is, that it gives us some diversity as we think about the market, because we're servicing a lot of different end markets. All of those end markets have IoT flavor to them. But we have a pretty big basket of products that we sell in. I mean let me start with some of the things that you'd asked about in pre questions. Wireless is obviously our headline. We expect to grow very aggressively in wireless. Our best play in wireless turns out, it's sort of moving video around the home. And whether it's a surveillance camera, whether it's a streamer, a video streamer an over-the-top streamer, our wireless solution, our Wi-Fi solution, in particular, is very, very well suited to that. So we expect to see pretty high growth on that. Of course, we have a pretty creative model in Wi-Fi, where we're partnering with module manufacturers, leveraging their breadth and their sales channel to go and resell our Wi-Fi solution into a diversity of end markets. We just don't have the sales force to get after e-bikes and golf balls, some of these other things that we're getting into, but are -- we're able to leverage these module partners and really penetrate a pretty big footprint in wireless, but it starts with moving video. The second part of the business that we're excited, again, we touched on it, is docking stations. We classify that as IoT because, you're moving some video around, you're moving video from a PC to a monitor. There are also other applications with the technology in terms of video conferencing, moving it into industrial applications. So there's a nice IoT flavor to that, and we've seen a great expansion going from a traditional dock into video conferencing and into industrial end applications. The third area that we should touch on is, our automotive business. And in our TDDI, our touch and display, we're selling into the automotive end market, primarily for infotainment. But of course, you can also get into the cluster. We think we can actually sell the same technology into cluster. And we had historically been selling discrete touch and discrete display drivers into that automotive market, which is very, very competitive. By moving to a TDDI solution, we think we've got differentiation, and we've been able to drive a nice growth vector on our automotive business. The final 2 areas to really just touch on quickly. Audio, we have a set of audio codecs that go into headsets; gaming headsets; conference room headsets, meaning, with call centers and things like that. So it's a really high demand, high fidelity type of audio product. Not the true wireless, the -- sort of the very consumer Bluetooth-enabled buds that you might see from Apple or Samsung or somebody else. But more of the very, very high-fidelity, high-end audio solutions. That business has done very well for us. And then finally, our video business, and that's in set-top boxes, our lead segment there is, operator set-top box that we've been able to take the same technology and deploy it to soundbars, to consumer video conferencing devices where you have a portable screen that you're sharing amongst people and your family. So we've been able to do quite a bit with technology that maybe was purpose-built, like our docking station or like our set-top box asset, and then redeploy it to a wider range of end markets and end applications, and that's been part of the success story over the last 9 to 12 months.

Got it. Okay. And in the last minute or 2, I want to finish with mobile. I mean that tends to generate the most debate in terms of as a market and high-profile customers. How do we think about what you're doing today in OLED? And importantly, if you divested the LCD piece, kind of what's differentiated? Can that sustain? And again, I guess, in the context of you're really saying this market is kind of flattish, how you think about the mobile market as you go forward?

Yes. I mean I think we have 2 interesting plays, Craig. One that Jason's talked about time and time again is our, OLED touch solution. And so for Y-OCTA flexible panels, we think we have a state-of-the-art solution that's led to really grind the table in China with all the major handset manufacturers. We talked about on the last call a set of wins with a large Korean handset manufacturer. So we've really been able to extend a footprint, given the technology that we have. It's a high-precision analog. Whenever you're really talking about a touch solution, you need a really high-precision analog circuit at the front end, and we've been able to bring that high precision and develop a solution that we think has a lot of legs for that market. You touched on the second piece of it, which is for display drivers. That's the other big part of our portfolio, our display drivers. There, what we found in LCD was, it was getting very, very commoditized. That's why the gross margins were relatively low. We do see a window of opportunity in OLED, which has a much higher demand on refresh rates, which is how fast the screen is refreshing. Some of the gamma correction, it's a technical term to highlight how much you're correcting for imprecisions in the screen, we think we have some differentiation there. Particularly as the market moves away from a kind of a Samsung captive. So Samsung display had almost the entire market, and they attach to their solution, their own display driver, their own in-house display driver. It was almost a bundled solution. That market is starting to shift. You start to see more of the Chinese display manufacturers get in, BOE, Tianma, and others. And as that's happened, the landscape has opened up for us. And we don't know how long that landscape is opening up, but we certainly see an opportunity here in the near term for us to sell display drivers into that Chinese piece of the display market and do so at gross margins that we find relatively attractive. So that's been a market that we pulled back from, that we see a window of opportunity. And it's kind of consistent with this philosophy, Craig, of operating within a window. We see sort of a near-term chance for us to make a difference in that market and do so in a differentiated way. We'll jump in. How sustainable that is over a 5- year horizon? I'm not sure. But our -- we absolutely believe that in that horizon, there'll be other opportunities that we can use our technology for. We were pivoting toward VR glasses, which has been a huge surprise for us, the display drivers, pivoting toward games, again, sort of more IoT-type applications. And taking that same core technology and moving it within the mobile portfolio into areas that look more IoT-ish, I think longer-term is somewhere we think we're going to have some success.

That's great. All right. I think we are running up on time here. So both Michael and Jason, really appreciate your time today. It was great to kind of dig into some of these growth drivers that you have and the transformation of the company. And with that, I hope everyone has a great day.

Craig, thank you. Great questions. Really appreciate it.

Thank you, Craig.

Great. Thanks so much.