Synaptics Incorporated (SYNA) Earnings Call Transcript & Summary

Good afternoon, and welcome to the second day of JPMorgan's 49th Annual TMC Conference. My name is Bill Peterson. I work in the semiconductor research team. We're pleased to have Michael Hurlston, Synaptics' CEO; and Dean Butler, Synaptics' CFO, with us today. Michael is going to spend a few minutes providing a quick overview of the company. And after that, I'll begin the fireside chat with a number of questions. In addition, please feel free to submit questions to me using the blue "ask a question button", under the video player, and I'll do my best to incorporate them into the session. So with that, gentlemen, thanks for joining, and we look forward to the fireside chat. Over to you.

All right, Bill. Thanks a lot, and thanks for the kind introduction. Synaptics is a company that's been around for quite some time, but we've gone under a pretty significant transformation over the last close to 2 years now. Dean Butler and I joined the company in late 2019, and we've embarked upon a plan to transform the company, and that's been characterized by a couple of things. First was, a relentless focus on our gross margins. And when we joined the company, the gross margins were in the high 30s and had been sitting there for the better part of 4 or 5 years. The previous administration had talked about bumping the gross margins above 40% as sort of an aspirational target. And Dean and I thought we could do better than that. So we focused on the gross margin line and lot of moving pieces under how we improved it. But needless to say, our guide for the next quarter at the midpoint is 56.5% gross margin. So we've made some pretty market strides on the gross margin line. The second thing that we've done is reshape the company. We have -- at the core, we're a semiconductor company, of course, but we kind of prosecute 3 different market segments. One is PC. One is a mobile segment. And perhaps the last is our IoT business. And what we've tried to do is, is focus a lot more on our IoT business, and we've tipped the weight of the company toward that. We -- historically, before Dean and I had got there, we were a mobile company first, with a PC sub headline and perhaps an IoT afterthought. And we've reshaped the company focusing on that IoT business. We're an IoT company first now, with a PC sub headline. And then opportunistically, as Dean likes to say, we prosecute in that mobile area. And that's really taken the seasonality out of our business. We were characterized by kind of a low watermark in this June quarter, followed by a pretty big spike in our September quarter, a slight up in our December quarter and then a big drop in our March quarter. And I think we've asked people to think about us in a more linear fashion now as we've gotten more focus on our IoT business. We sort of think of our business now progressing in a much more linear fashion across the base that we reported here, and we're guiding to on our June quarter, we think we can build sequentially from there. So 2 big things to point to, again, is the gross margin improvement, and the elimination of some of these troughs and valleys in a more sequential, predictable business.

Yes. That's a great overview. Kind of actually want to talk about the investment thesis. We see a clear sort of trend in let's say, gross margin -- gross margins go up, typically, the multiple investors are willing to subscribe to a company intends to go up -- you guys have driven a lot of earnings power, but the multiple, it seems fairly undervalued still relative to the sockets peer group, especially with some of the things you're doing in IoT and then in the margin profiles. I guess just at a high level, what do you think is holding back investors or people just maybe are not understanding about Synaptics.

Yes. I mean, to echo your thoughts. When Dean and I got to the company, the earnings per share were $2, the stock price was trading at $30. Now we're rolling up, consensus has is around $8 a share. So x4. And of course, the stock price is bouncing around at about $120. So we've seen almost no multiple expansion. And if you look at our peer set, I think we're the cheapest name out there in the semiconductor sector. And certainly, at 55%, 56% gross margin, companies that are posting 30% gross margin, have a higher multiple than we do. So we've been disappointed, frankly. And we think we've had a pretty big lag on our multiple story, and it's taken a while for people to catch up. I think there's 2 things there, Bill. One, I think that the company before Dean and I arrived, had a history of overpromising and under delivering. And I think people have long memories, and people are still ascribing that to Synaptics, a company that sort of over promises results and under delivers. And then I think, secondly, there is concern around our mobile business. It's probably reason #2. And to address that, I think we've washed away a lot of the uncertainty on mobile. You and I talked about in the last earnings call, one of the transitory issues was Apple and our touch business there. And we've said, "Hey, at least as we forecast it, we've taken that number out of our business." A second transitory effect that we had was Huawei and some of the restrictions around Huawei. We had a pretty big presence with Huawei in our Touch Controller again. And we've sort of taken that out of our thinking as well. So the 2 big uncertainties are out of our June guide, and we think we sort of hit a steady state with that business and have the opportunity to build. But again, it's sort of the sub headline for us as we think about our collective business going forward. It's something we're going to prosecute opportunistically when we see the ability to capture higher-than-average gross margins and higher-than-average growth, we'll get into it. But otherwise, we're going to manage that business within a pretty constrained investment envelope.

Yes. I sense another area and maybe people with long memories, has to do with -- on your recent earnings calls about getting more aggressive and growing the business, maybe looking at some areas where your competitors have been raising prices and you didn't perhaps insert your health yourself and then gain some market opportunities. At the same time, you said that your margins are going to be basically pretty solid. So I think there may be some misconception or people misconstruing what's going on. But I guess, can you provide any additional color on the opportunities you're seeing, where you feel you could be aggressive while maintaining a great gross and operating margin performance?

Yes. I think and I'm glad you asked the question because I think some of the comments were taken out of context. I think what we had meant to signal, and perhaps it was our own language that caught us in a bit of a mixed message was that, the 56.5% guide on the gross margin line is not sustainable. We think here over the next, let's say, 3 to 4 quarters, we'd be happy with 55%. We think we're going to operate the business to what we printed in the March quarter, which is a 55% gross margin. There's a lot of reasons that the fourth quarter, our June quarter is animalistically high. But we think we're going to return and sustain sort of a 55% print, which is great. I mean I think, again, if you look at the landscape of companies that are in that mid-50s range, we're significantly undervalued on a relative basis. That being said, I think the thing that we've done well, we set out -- Dean set out some long-term guidance in our previous earning call, 50% gross margin, 30% operating margin and 8% to 10% top line revenue growth. If you look at the guide for the fourth quarter, arguably, we're there on 2 of the 3 lines. We're there on the gross margin and we're there on the operating margin, but we're certainly not -- we're flat. We're actually -- which, again, is good news because we've taken some of the seasonality out of it, but we haven't shown the upward growth. And what we meant to signal was, there are a couple of opportunities that we see that we think fuel a growth vector that are outside the sort of normal growth that everybody is seeing in the semiconductor business. And those 2 opportunities are Chromebooks that where we've enjoyed very little presence today on the touchpads. We have our first wins and our first revenue coming in from some Chromebook wins. And the second one is in display driver in the mobile business, where consistent with our thesis as to how to operate the mobile business. We see an opportunity for better-than-average gross margin and some nice growth. Now kind of tie all that together, those 2 opportunities do come at sort of lower than average gross margin, not meaningfully lower, but certainly lower than the 55%. So I think people kind of coupled all that together and said, oh, is this a return from the old Synaptics where you're trading gross margin for revenue growth. And that's not the case. I think we want to continue to be very, very mindful of earnings and gross margin as a proxy for those earnings is very, very important to us. But we do see an opportunity for us to expand the top line in Chromebook and in display driver.

Okay. That makes a lot of sense to me. One thing, of course, holding back top line growth has been just the chronic sort of supply sort of chain issues. And I was hoping you can update us on that matter. And especially, how does it impact each of your main segments or even within segments in the case of IoT? Some of -- some peers out there, semis have talked about demand exceeds supply by even 40% or so, in some cases. I guess how much demand is exceeding supply for some of these key markets, especially you talked about IoT, but IoT, PC and mobile products?

Yes. There's no question. We're seeing some of that same phenomenon. And you were good enough to touch on that when we got together a few minutes before the call. No different to any of our peers. Our demand is outsized relative to our ability to supply into it. And we're probably particularly challenged in that. We have businesses that are new to us. I think everybody who's got a run rate business is seeing the normal growth where a word abnormal is for example, our WiFi business, which is new to us. And so we're forecasting new demand coming off a 0 base. And when that happens, I think it becomes particularly difficult to supply. Any business that's unforecast is a particular challenge because the -- all the foundries are sort of operating everybody on a run rate. They're doing the best they can to supply the run rate business. But when there are these perturbances, it becomes particularly difficult for them to catch up. So our WiFi business has been problematic. This display driver opportunity that we're talking about for mobile phones is also one that's -- it's going to be supply-constrained because we're coming off a 0-base, selling into a market where we had no meaningful presence before. And so our ability to capture these market opportunities is going to be driven by how we're able to handle the supply constraint.

I guess with that in mind, now almost everybody is now saying this is likely to even probably go into 2022. Do you guys basically see this as a kind of a first half '22 phenomenon?

Yes. I think so. I think that our demand -- Dean talked about on the call, we've stopped giving guide, we typically give what we're booked to relative to the next quarter, and it's just not a meaningful number anymore. So we've refrained from giving specifics around that. You can assume it's very high that our backlog is in excess of what we can supply. I've said we're entering our annual operating plan this year. And Dean drives a pretty rigorous process with the businesses. And I said -- I've told the business unit leaders, they have the easiest forecasting job in the world because all they have to do is walk down the hall to the operations guy and say, how much can you supply. And that becomes the forecast. So we're in pretty good shape. And I think we have some benefits in our supply chain that we've sort of locked into. And that is, you and I've talked about this as well. We have a pretty diffuse supply chain. We want to land and do what we see best as best practice and land on one partner, and we're driving to that. But at the moment, we do have some additional degrees of freedom because there's a long tail with this stuff. You can't shut off supply overnight. And the fact that we are dealing with a good number of foundries, some of which are smaller, has actually led to an outsized opportunity for us to supply. We've been able to craft deals with some of these smaller fabs and do some unusual things to help us supply to customer demand. So we actually think on the whole relative scale of things, we're in a bit better shape, mostly by luck rather than by choice.

Okay. Well, let's move on to some of the various businesses. I'd like to start with IoT. I think it's certainly some of the really attractive growth opportunities. It's been a little less than a year ago, you acquired 2 great businesses: DisplayLink of Broadcom; wireless IoT connectivity. You discussed that wireless IoT exceeding on track to double the quarterly revenue run rate, at that -- at the time of acquisition here in the current quarter, and now you have the DisplayLink, he's been doing very well. Seems to be benefiting from a hybrid model. I think you guys used the term hoteling. Almost 1 year-end, can you provide an update on these 2 acquisitions.

Yes. I think you got it right, Bill. The WiFi business has just exceeded our wildest expectations. You're correct in saying that the run rate this coming quarter is double the run rate at which we acquired it, and we see that continuing. We've just done remarkably well in that business. Our primary focus has been on high bandwidth WiFi applications, where an example is video, where you're trying to transfer a lot of data really quickly. We seem to be the chip of choice for that type of application, whether it be surveillance cameras, set-top boxes, over-the-top devices. We've done remarkably well. And again, our single problem there has been our ability to supply. We've done some things to create some redundancy in the supply chain to shift from one foundry to another that we think is a better long-term partner for us. So we've tried to affect some changes in that to better deliver to the demand. But we're really -- I mean that's probably the business that we're most excited about in the IoT portfolio in terms of growth. The second business, and you're right to call it out, is the DisplayLink business, and that, again, has exceeded our wildest expectation in terms of what we can deliver. It was already a business that was growing. Dean talked about it in one of the previous calls. It was accelerating when we bought it. A lot of people said that it was going to flatten out, that it was going to plateau. We've not seen that. And with the technology that it brings, there's 2 aspects to it. One is the universality, and you touched on that in your remark. The ability to set up a hoteling type of environment, where you can dock a Chromebook, you can dock a Macbook, you can dock a Windows PC to a docking station. That's been great for work from home, where you have a mixed-use environment. It's been great now as people are coming back to the enterprise in this hoteling environment. But the real beauty and DisplayLink is the software compression. It's able to -- and through the use of software, really compress video technology over a very thin pipe, and that leads to new applications like, wireless docking stations, wireless monitors and also into these in room, Zoom Room, Conference Rooms. So the DisplayLink business now has opened up from the traditional docking station market into a bunch of new vectors that we think we can capitalize here in the next handful of quarters.

Yes. These are 2 really good businesses. And hopefully, the supply constraints, especially the WiFi side start to mitigate. I think you guys also got some Bluetooth and combo chip capability. What are the other areas you've seen the most design win activity? Or do you see a lot in the combo space? Or is it primarily on the WiFi side at this stage?

Yes. Almost all the chips we do, Bill, are combos. So we've -- applications, let's say, in a video environment, you've got the high bandwidth transmission, that's really our hallmark, but you might operate a Bluetooth remote. So the received side, the channel side of the remote control is what we pick up and do channel changes and things of that nature. The other area that we don't talk about much is wearables. We acquired a GPS asset with Broadcom and we're one of the very few companies that has a wearable class GPS asset. You think about QUALCOMM, you think about Broadcom, they're trying to apply that GPS asset to mobile and less so to things like wearables. So we seem to have had the run to the field, being able to bundle our GPS with our WiFi Bluetooth combo and create a pretty elegant, a wearable type of connectivity package. So we've also done really well there. As we think going forward, the nice thing about the partnership with Broadcom, as you know, there are future chips that we get in our road map, and Broadcom is actually going to include some additional wireless technologies in those combo chips. So we're going to create an even bigger, more integrated combo chip than we have today, and we'll be in a position to talk about those as we start launching and ramping those at end of this year, or early next calendar year, we'll be in a better position to start talking about the additional wireless capability that we get.

Other exciting parts to the IoT segment, earlier in the edge-SOCs, you kind of repurpose some of your technology in the auto. You've given some growth metrics around that. Kind of just starting off in low power AI. I guess if we just sort of think holistically, what -- how should we think about growth of these other parts of your IoT business by their own rights, have some nice potential tailwinds or potential customer interest behind them?

Yes. Let me talk about 3 areas, and you touched on 2, and I'll add 1/3. Our organic IoT business has also done really well. So it's not just been the acquisitions that have boosted that business. It's actually been the organic business has done really well, too. And to highlight 3 areas: audio, we have a set of active noise canceling, far-field voice chips that have done really well. They've done well on sort of a work-from-home metric as they're incorporated into these over-ear wired headsets. And of course, those have done super well. You see all these Zoom calls, with people with the captain style, headsets on. Those are more often than not employ our technology. So that's been great. The second sub piece of that business is a set of new applications, where, as I'm doing now, you're talking into your PC, to enhance the audio quality of that. People are looking for better far-field voice, better noise canceling, and people are taking our audio chips and incorporating those into laptops, into tablets for better video conferencing type experience. And then the third area that's a really interesting one for us that's further out is to redeploy that audio technology into an Edge AI capability, where we take advantage of the low-power that we'd already built into the audio solution in addition to the neural networks that are already there by virtue of when you [ an over-ear ]active noise canceling, you're doing a little bit of learning and training. We're able to employ that now into a bunch of really interesting used cases that actually take advantage of video. And you have a situation where you're trying to do simple people counting going into rooms, for example, and now training on what most people are doing is facial recognition. We're actually trying to train on the top of people's heads, which have been an interesting thing. And having people with baseball hats, having somebody's hairdo looks like yours as it compared to mine is an interesting application for our data scientists, and they've had to do all sorts of things to go train on that. But we see that as a big market for us on a go-forward basis, something that's going to be shipping in a year, but we're invested pretty heavily in that, and it takes advantage of some of our best-in-class capability. 2 other quick areas to touch on is automotive. You touched on that in your question. That's been great for us because we had a presence in our automotive, almost all the automotive revenue that we report today. That's sort of in the tens of millions, has been on discrete touch and discrete display going into these automotive displays, the infotainment displays. What's happened is, you've had a shift to TDDI, a touch and display integrated chip. And as that market has shifted to an integrated solution, we've gotten outsized market share. So far, that's been a small business for us. It's just now turning on. The first car is rolled off the lines with TDDI in Q4 of last year, but we see that business ramping, and we've characterized $100 million business for us in the next couple of years. And again, that's actually turning on faster than we expected and doing better than we expected. The other phenomenon to talk about in that business is you think about larger displays, we tend to do better. So if it's a small, tiny 6x8 display, it's a little more competitive. But as these displays get into these larger form factors, we do really well. The last business to talk about is the other part of our video protocol business, and that's the one that we had before we acquired DisplayLink. Couple of drivers there. We've, of course, got the same phenomenon in the docking station business, where you've got one-to-one docks that have done really, really well. When HP bundles up a docking station to go with their laptops, that's a different family of chips to us than the DisplayLink chips. The DisplayLink enabled this universal experience. But the new growth driver for us has come from these lower position chips that are derivatives of the docking station that enable protocol converters when you go from let's say, display port to an HDMI output or from USB to HDMI. These one-to-one conversion chips we're just turning those chips on now. We've announced our first wins. Back in the first quarter, we issued a set of press releases around some products that are shipping. But we see that being a new segment that's opened up for us to drive some additional growth this back half of this year and into next year. So sorry for the long answer, but a lot of detail in that business. And hopefully, that gives some flavor to the question you asked.

Yes. No, it's just -- so many -- again so many great things going on IoT. You kind of alluded to it earlier, and there has been some fears that at some point, the PC market and the Notebook market could rollover. But on the other hand, your TAM is expanding, too, right? I mean, you're able to address some parts of the consumer segment you haven't been able to maybe perhaps address before. So I guess, how should we think about PC growth over the next -- your PC growth over the next few years when we overlay the market dynamics, coupled with your TAM expansion?

Yes. You got it right again, Bill, I think you understand the dynamics of our business quite well. If I was being honest, I would say, I'm a little disappointed in our PC business over the last year. We've grown and we've grown pretty significantly. But I'd say we've undergrown the market, quite frankly. The growth in the market has been everywhere, but it's been dominated by Chromebook, and it's probably -- the second pole has been Consumer. And our exposure in those 2 subsegments is lower than our commercial exposure. Our commercial exposure is quite high. So although we've seen pretty good growth, I would say we've undergrown the market as a whole. You characterized it correctly. I think the way we think about the business is you had a big inflection, a reset in 1 PC per household going to 1 PC per person. We think that continues, but I definitely think there's going to be some leakage in the business for us to anticipate continued growth is probably overaggressive. We would probably anticipate some leakage from this point forward. But we think, in our case, we more than offset that by our renewed focus on Chrome and our renewed focus on Consumer. And we sort of -- I think, other people have used the supply situation to reset pricing and things like that. In our PC business, it's harder to do. You're dealing with some pretty monolithic buyers. We've used the opportunity rather than to sort of reset pricing levels, we've asked for additional share. And so I think as you think about our business over the next couple of years, we think we can sustain the gross margin in that business, but we think we're going to breathe some new life into the revenue line as we go out because we're using that supply issue to a share advantage. And we also think we've repositioned our business to better capture the Consumer and Chromebook opportunities.

Yes. Makes sense. Shifting to mobile, and it's -- I think the strategy is very sound here, certainly to diversify the revenue base and so forth, make it less -- this overall raw business is well less cyclical. You did guide the June quarter to be kind of a bottom. I guess what gives you confidence that you can see this business returning to growth? And I mean, how should we -- should we think of it relatively flat quarter-to-quarter. Or just less seasonality. More muted seasonality. How should we think about the business from here?

Yes. I mean I think that our old business was characterized by these pretty monolithic events. We may or may not have discussed this, but our Huawei situation in the very early part of our fiscal year was a pretty big headwind. We've entered the market while in OLED touch and had done really, really well because we have a very, very differentiated solution, but we were really only supplying to Huawei. So we saw a big up and down in that business. And then our large North American customer, again, OneTouch win, had a nice Q1 and Q2 of this fiscal year. And that's been very muted in Q3 and Q4. And as we've said, we've sort of taken it out of the guide going forward. So we've been characterized by these lumpy kind of monolithic events. What we have now, sort of from our Q4 and as we go forward is a much more diffused business where we've got wins with all the Chinese handset makers. We've got wins in Korea. So we've got a much bigger base of business, a much more diffuse business, and we think all of that is much more sustainable. I mean barring any sort of political calamity, with either South Korea or with China, we think that, that business now is a growth business that is much more sustainable. And then layer into that, whatever opportunities we see in the Display Driver going into the second half of our fiscal year, we feel better about our business because it's just much more -- it's not concentrated. It's not 1 customer sort of driving the activity. It's a whole set of customers and a whole set of design wins that drive the business on a go-forward basis.

And to be clear with that last part on Display Driver, you're speaking about OLED Display Driver.

Yes. Sorry, the OLED. Yes. The LCD display driver, we still have a nice level of business on that with a large North American customer. And we think that's sort of a kind of a steady run rate. I think we think they're going to continue to supply lower cost phones. They've done really well in that segment. And so we think that, that's going to be a baseline that sort of bubbles along for us for the foreseeable future.

Okay. I don't know if this is for you or for Dean. But this gross margin -- I mean, I personally have never seen gross margins improve over, say, a six-quarter time frame. And you already said its kind of taking it as somewhat flattish over the next few quarters. Taking into account the seasonality or lack thereof of a mobile, continued COVID headwinds, maybe expedite fees that you might have, well offset maybe by pricing, the mix of business, updates, your productivity initiatives, I mean, how should we think about the gross margin as we look into really in the next fiscal year and beyond?

Dean, you want to take it?

Yes, I'll take that one, Bill. So one, just -- I do think the team has done a phenomenal job in improving the gross margin over the last 2 years. 1,600 basis points is really quite remarkable. And we're actually really confident in sort of running at this 55% for the foreseeable next several quarters. Now if you start to think about a couple of years out, where should we think about the company, we continue to drive the 57%. So we think there's upside from here. And really, 55%, 57% in that range, it's going to be about executing new products, delivering into the marketplace. It's going to be executing on our product mix, right? Continuing to win across all 3 areas, but as IoT continues to grow and expand up above 50%, that's going to be key to us going forward. But longer term, it's going to continue to be a high 50s gross margin business, and we're confident we can keep it there.

In terms of capital allocation, you have -- there's converts, I think you guys are not shy on M&A. I've asked you this in the past, too and you have a great wireless franchise, but there's certainly more protocols. I'm curious, how would you say, do you have any missing parts of the business that could be of interest? Or balancing that versus debt pay down? How should we think about the use of cash?

Yes. Just on capital allocation. So one, we do have a convert that's outstanding. It's due in sort of roughly 12 months from now, June of 2022. So we will look to probably settle that at some point, right, between now and 12 months from now. I think our first priority, [ borrowing ] that first item is to redeploy inorganically. I think there's a lot of opportunities out there, specifically in the IoT sphere that can help accelerate our growth, add technologies or new build of materials that we're already into the marketplace. In borrowing we're unsuccessful in inorganic means. We continue to invest in ourselves, right? Back into our business, continue to accelerate. And then through a third order, right, unsuccessful in inorganic, unsuccessful in organic or due to excess cash flow, then we'll probably look to do some sort of shareholder returns. But I do think inorganic means is, is probably our priority right now.

Sure. Well, with that, I do believe we're out of time. This has been a great discussion. Michael and Dean, thanks for your time, and I would say we're going to following the progress and hope the supply constraints don't hold back some of these initiatives you have going on.

Bill, thanks for your understanding of our business. I mean you've come up to speed remarkably fast. I think it shows how much time you've invested in understanding us, and I can't appreciate it more. We like folks that understand the business, plus or minus, right. If -- but your investment in understanding us is second to none. We really appreciate that.

Thanks for that. Okay, guys...

Thank you so much, Bill.

Thank you.