Synaptics Incorporated (SYNA) Earnings Call Transcript & Summary

And good morning for those out here on the West Coast. This is Marco Lagos. I'm a Managing director with Deutsche Bank. I run our semiconductor, electronics and IP business, but significantly more importantly, today, we have the folks from Synaptics with us. Synaptics is a emerging leader in IoT solutions in a company that's got a great story in trajectory over the last couple of years. With us, we have Michael Hurlston, who is the CEO of Synaptics and Dean Butler, who is the CFO of the company. We are going to be running this as a fireside Q&A chat. So for the investors online, there is a panel on the screen where you can ask questions. I can see some of those after they've been prescreened for [Indiscernible]. And we can go ahead and get started. So first off Michael and Dean, it's great to see both of you.

Marco, thanks for having us. It's -- we wish we could do it in person, but next best thing from our lovely conference room here. Pardon all the beer pictures behind us. This is not the most professional setup, but we'll take it as it comes, okay.

It is all good and I'm familiar with that conference room as well. So look, as I thought we could start sort of at a high level, would love to sort of get a flavor for the folks online about the trajectory you've been on over the last 2 years and kind of taken in pieces so they get sort of a summons for the magnitude of what you've done over the last couple of years here. So you both came to Synaptics about 2 years ago now in August 2019, I think [Indiscernible]. Over that period of time, there's been a lot that's happened. But I guess, take us to sort of the early days. When you guys both came in, you both will have perspectives from tremendous companies, Broadcom, Marvell, Finisar, Maxim and other sort of industry leaders. When you showed up, what did you see -- what were some of the things that you saw that you felt needed fixing and were issues? And then what were the things that you saw that were strengths that you felt that you could build on.

Yes. Maybe we'll take it Google first. I mean, I think, obviously, it's really obvious. I made a great hire as a CFO, probably the best thing that I've done since I got here. Dean's been a tremendous partner in building this business. And the reason that he was attractive was I think he and Matt Murphy did a terrific job partnering to get Marvell situated. And if you look at the turnaround job that Matt has done there, it was a lot of what we tried to apply here, a lot of portfolio management. And I think Dean was the one that partnered with Matt to kind of come up with the overall strategy. They shed some businesses, they added some businesses. And in that journey, I think they really did a great job turning Marvell around. So they -- that was what really attracted me to Dean, and I couldn't have had a better partner. I mean I think he's just done a great job here, managing the internal mechanisms to keep us in check. But to answer your question, obviously, when we got here, the company was actually trading. The market cap was below revenue. I think when we came in, it was about $900 million against a revenue of about 1.1. And to me, that didn't make sense from a semiconductor perspective, the gross margins were 38%. It has been capped at 38% for the last, I think, 4 years -- the prior 4 years. And again, that didn't make sense coming from Broadcom, you should be operating a semiconductor company, I would think, in the 50s. And I think we both saw an opportunity just on the fundamentals alone when -- I'll speak for myself, and I'll have Dean add color. When we got here, I think we were both surprised at the lack of rigor. There wasn't a lot of infrastructure to make decisions. There wasn't a lot of financial discipline. So we were able to put a lot of infrastructure in place that frankly, it's just now taking room. I mean it takes time for those things to play out, but we've got that infrastructure now, I think, in pretty good shape. And we're in a position finally to start growing the company. I mean a lot of it was teardown, shedding some bad businesses, making some decisions in the portfolio. Now we're finally in a position to start growing. And I think over the last couple of earnings calls, I think people are starting to catch up for that. We still have one of the lowest multiples in semis, as you know, Marco, but we've made some progress on that front, and hopefully, that will continue. Maybe I'll have Dean give his side of the story.

Yes. So my observation, so walking in the door at Synaptics in the very beginning, the company was wholly focused on effectively wine market, mobile, right? And so it's actually very scary for our company, its management, its shareholders, its Board of Directors to shift away from sort of your core, right? I think that's the biggest portion of your revenue and we applied a strength in road strategy, which said, you're going to have to shrink your core business, mobile in order to grow something that's more attractive IoT, right, bigger market size, faster-growing market can contribute better gross margins and therefore, longer-term, better profitability potential. And so we sort of focused around this shrink-to-grow strategy. And then secondly, Michael said the gross margins were in the 30s early on, that's indicative of sort of a mobile commodity business. We focused the company on one core key unifying metric for really the broad employee base and that was gross margins, right? So we knew it if the company was going to focus on a new set of markets that had to be a higher gross margin market. We knew that the engineering talent of the company was really good that the talent was being wasted and not demonstrated via gross margins. And so it's a routing call to focus everyone gross margins, where can we take the products, where can we take the markets and that ended up being our guiding post sort of as we move through the shrink-to-grow phase of the company. And sort of now you see us an IoT leader and significantly higher margins, significantly better profitability position. And really, it's sort of many more doors sort of become opened once you get in that place.

Got it. And I think that was particularly sort of unique and differentiated about the way you did the restructuring here. In some ways, you guys timed the replacement of revenue with the shrinking of revenue and made it, in any way, sort of seamless transition into the Southeast space. Interesting to hear the philosophy around sort of how you manage the existing businesses. How did you think about the portfolio, right? Like -- and I understand sort of philosophically what you did on the restructuring side. But as you thought about the assets you were acquiring and bringing into the equation, how do you think about those?

Yes. I think Dean talked about it well. It is, again, the sort of shrink to grow. You're right. I mean we got lucky, I would say, to a certain extent, because almost every move we made to take something off the table, we were quickly able to backfill it. So in general, right, we made a big risky play to take our -- one of our larger businesses, which was our mobile TDI business off the board. We sold that in early 2020. And at that particular point in time, we didn't necessarily have line of sight to businesses that we could backfill but we knew we wanted to backfill with IoT. So the whole direction of the company was to swing it from a mobile-driven company to an IoT-driven company. And in so doing, we thought that would be a big benefit to the gross margin line. And so that's really what happened. We did 2 acquisitions, as you know, in 2020. One was this DisplayLink asset that gives us a great market position in the docking station market. And then we did a pretty creative deal with Broadcom around wireless, which is a really pretty sought-after asset, and we were able to bring that on board. And those 2 businesses have been fantastic for us. They've grown really well. That has -- that growth and that outsized growth has shifted the portfolio towards IoT. And now we're at this point where we've got 50% of our business being IoT, where when Dean and I started, it was probably 10% of the portfolio. Mobile was 2/3, about 65% of the business. Now Mobile is 25% of the portfolio. And our intention, and I think you've had some good strategic discussions with us on this is, look, we think Mobile is still important, but we want to operate that at 25% of the portfolio PC, which doesn't get a lot of airplay for us, also a good little business, 25% of the portfolio that then really drive growth. And our focus, our engineering investments on IoT. That's kind of our overall strategy, and it's played out really well. We got -- certainly got lucky. I mean our acquisitions have done better than we expected. Our latest acquisition, which is DSP Group. We expect that again to be a big positive surprise. We will see how it plays out. But we like a lot of things that we see under the covers there, and we think we can turn that into a third winter in our string of acquisitions.

Yes. That's terrific. Let's talk about IoT for a minute as a segment, right? I think depending on how you talk that the beauty of the IoT market really is that it's a capability, and it allows you to talk a lot of different end markets as you think about it. So from a technology standpoint and a technical product standpoint, what -- how did you choose what IoT capabilities you wanted to nurture that already existed? And which ones you wanted to sort of acquire? How did you think about which capabilities out of MCU, communication, all the different parts that you could think of around IT, you wanted to focus?

Yes. I mean, you really framed that question well. I think we have 3 core capabilities, Marco. We have audio, we have video, we have wireless. And if you look across that, for the most part, audio is an acquisition. That's the Conexant acquisition that we really have shored up. DSPG is going to play super well in that sector. We have video assets and the video assets really came from Marvell, actually deemed -- sold that business unit to us when it was still at Marvell. And then we have the wireless assets. And again, the wireless came from Broadcom, and we shore that up with the ULE coming from DSPG. So we feel like our IoT bent is largely multimedia. We have this direction to sort of take audio and video capability bring it to the edge of the network and do this have AI capability built into the circuits, whereby you can do make decisions at the edge of the network. Today, all of the processing happens in the data center. When you say, "Hello, Alexa, hello, Google, whatever, that audio command is understood, but passed back to the data center for decoding. What we want to do is we want to have a really low power processor at the edge of the network that has audio capability, that's the nice thing with the DSPG asset. But we think there's a huge emerging market for video capability to do things like people counting, like shelf monitoring, like asset tracking, where you need some visual sense of what's going on and having the audio capability, having the video capability. And of course, everything gets transmitted wirelessly. You got to have a really low power wireless technology to bring them back, the information back to some collection agent or another. Those are the capabilities that we focus on. And again, we short all those up with our acquisitions. DSPG has helped on both wireless and on audio. DisplayLink has helped to measure the part of that business that people don't understand is it's a video compression technology at the core. We're able to compress video down into small, small sizes, which, again, plays with this overall strategy. And then, of course, Broadcom has formed the base of our wireless. So we kind of got this saying that some people may think looks rather chaotic, but we're driving it to this vector that ultimately leads to processing at the edge of the network.

That's terrific. And obviously, as you think about those capabilities and processing at the edge, there is more value out there, higher ASPs, better margins. That generally falls in line with your philosophy of course. So I guess let's talk for a moment about competitive, right? Within IoT, maybe Dean, you frame and Michael, you heard -- you frame IoT as having sort of different compartments and market compartments within your business. Why don't we just for the audience that's less familiar with that piece of the business today? And how we talk about those end markets? Can you frame it for those folks talk about those end markets? And then who you compete with and how you differentiate in those end markets starting perhaps with auto?

Yes. I mean, one, I would say, we have a number of different technologies. They all have a different sort of competitive dynamic. For example, in automotive, we're doing infotainment. So these are interactive infotainment screens for the large part in automotive. That's a growing megatrend that actually in automotive used to sell it. Horsepower, exterior design, now it's being sold on software sensors and sort of infotainment inside the cockpit. So we think we're attached to sort of a mega sort of growing trend there. Now there are other people that do displays that are automotive-qualified, but there's really only a couple. We're sort of probably 1 of 3 that are servicing into that infotainment display market. In the other areas across the portfolio, obviously, wireless is one that sort of gets a lot of attention. There's a number of wireless vendors in the marketplace. But that's -- it's a large market ever been expanding market, and it seems our observation is a lot of people are focused on sort of different niche areas of wireless technology. Wireless technology for automotive is an application, the wireless technology for home gateways, wireless technologies for sort of IoT client devices, there's a good sort of array of different focuses. And then across sort of the portfolio is, you find the same sort of dynamic, audio processors, video processors, all have a little bit bigger dynamic. And the way we take it is we probably have one of the broader sets of portfolios on the set of technologies for the things that are around you and I and our everyday lives. So how do we experience sort of digital applications around us. We either visually identifying things, audio processing, interacting sort of touch screens and then now these things are becoming smarter and smarter every day. So the way we view our go-to-market is making the devices that are around us every day that we all experience, smarter and easier to interact with. So that's sort of the basis. And we compete with different people on different technology basis. But we think our breadth is probably top of the pack.

Yes. I think that's a very nice way to sort of marry the historical DNA of the company around human interface capabilities with where you want to take the business from an end market standpoint. So I guess question just digging into automotive since it gets so much attention, especially during the current environment. What -- how do you think about -- everybody talks about how -- it's a very attractive business because of -- on the back end, there's a long tail and it's sticky with the customers given how difficult the upfront part is. And so that's the part that people focus on is the difficult part, right? You guys have done it. You're in automotive production with a number of sort of design wins and different things. Can you talk a little bit about that sort of supply chain, the nature of your relationship with the Tier 1s and the OEMs, the investment required to actually win sockets there and so people get a sense for why it's important to the achieved in auto.

Yes, that's a super good question. I mean this one, frankly, is probably more difficult for Dean and I'd take credit for it. This Had started before we got here. That's the truth of that business. As you said, it was a good strategic investment made by the previous management team. The previous management team unfortunately, had overcalled when it was going to hit, right? I think that they had led investors to believe that there was going to be a relatively big hockey stick in 2018, 2019, 2020. We're really just seeing the tip of that now. And what's happened in that business, just to give some color, we competed historically with display drivers and discrete touch circuits, 2 pieces. And in that market, it's pretty clear. Cypress has a good position with their touch circuits. You've got some Taiwanese display driver guys in there, FocalTech, Novatek. But what Dean talked about is we have shifted the market to an integration of touch and display. We call it TDDI, Touch and Display Driver Circuit. And in so doing, we've narrowed the competitive landscape significantly. There may be one other competitor that's in there is that, we are winning the vast majority of the designs, but it's taken a lot of time for that to play through. In fact, a low portion of our mix today is TDDI. But when we talk about the growth that we forecast in this business, it's all coming from TDDI. Because we're a very unique player there, and we're winning the vast majority of sockets. But to your point, we actually have an additional degree of problem. We would typically sell into an automotive-qualified display company, JDI, Sharp or Guy's AUO Taiwan, who then sell under the Tier 1s, who then sell over the automotive OEMs. We have to call on all 3. And we often don't know which display guy is going to win the design at the Tier 1, that's ultimately going to get carried into an OEM. So we actually have to provide a lot of coverage and some of it's redundant where a design will drop off at, let's say, sharp that ends up being won by an AUO, but you don't know until the last minute that those sockets are actually competing for the same thing. So it has been a huge challenge for us to get automotive qualified to understand and properly cover and resource that supply chain. We've had to invest a ton to get that coverage, and we're in a good position now because of the investments that we made 5 years ago before Dean and I got here. So we are definitely the beneficiaries of some good decisions that was made -- that were made by the prior administration.

That's pretty clear, and thanks for that answer. So look, I think shifting we spent a good amount of time on the top line and what we saw there. Let's shift gears a little bit beyond the market opportunity on the top line side of things. Obviously, a lot of great work has been done on the P&L from the cost side over these last 2 years. Can you take us through the growth in the operating margin trajectory been, over the last couple of years? And what specific initiatives you've undertaken and are still going to undertake as you continue to achieve these gross margin targets you put out there?

Yes. Yes. Maybe so first on gross margin, I said earlier that's sort of one of the unifying calls to action we had. Approval across the employee base is engineering, its sales, its operations, supply chain managers. It's really everyone inside the company could contribute in some way to gross margins. Our primary focus is around in differentiated products, actually getting into differentiated products that we can make a difference in our customers' end products, and really selling the high-value engineering that we have. Part of that is one of the engineering that goes in. But two, actually also market selection. So this is where you sort of over-indexed toward IoT, you selected markets that actually have structural bearings, you more for higher gross margins relative to some of the historical decisions of the company in the past. So we continue to push toward selling our value, right? So we employ some of the top engineers, we expect that the value prop that they deliver comes with a commensurate gross margin. And as IoT has sort of grown and now it's 50% of the portfolio, you've seen that continue to expand. So that strength to grow actually the side that's grown is actually higher gross margin be a set of the portfolio. So that's sort of gross margin in a nutshell. We've also designed for gross margin. So it happens at the very beginning, new products, you're aimed toward higher gross margins. Operations teams have been looking at how do we simplify our supply base, how do we simplify logistics, how do we streamline test programs to just get the manufacturing side of the equation, the cost of goods sold down to something more competitive as well. So all these things have sort of come together on the gross margin side. On the operating expenses, that's sort of taken down some of the investment in the business. It really is around the pivot from the prior investment portfolio to sort of the new investment portfolio. In that, we sort of don't look at operating expenses sort of in a ratio form that most investors sort of might. We look at operating expenses in what is required to be successful in our technology road maps. So each has a different cadence. Some might be an annual or every 18 months design cycle. Some might be every 3- or 4-year design cycle. So what we're actually doing is resourcing the different technology types and road maps and trying to synchronize in between the gaps on where the design road map needs to go and what needs to be funded in resources to extract sort of growing top line, growing gross margin and ultimately, leadership in the technology areas. And so that's how we think about operationalizing what we're spending, where and why and that's how we sort of focus relative than just sort of an aggregate envelope, if you will. Marco, it looks like you are mute actually.

Sorry about that. It's the line of the last 18 months, right? So guys, I guess sticking to sort of the cost side of things and just from taking a big step back, looking at sort of macro environment, right, we are in a really unique situation from a supply chain semiconductor standpoint today, right? You guys are a fabulous company. And in a normalized market, that provides a tremendous amount of flexibility, right? And that helps you with profitability, CapEx, all the other good side. The flip side, which has been a discussion topic for a lot of companies today is supply chain, your foundry partners have sort of decisions to make. They've sort of done certain things to sort of manage through the current environment. What have you guys done to manage your foundry relationships to ensure that you're getting the volumes that you're getting today sort of keep this good momentum of. Have you had to make any economic concessions? What kinds of things have to happen. And then bigger picture, when you think about the current sort of potential management of inventory across the supply chain, and availability of wafers, et cetera, et cetera, how long do you think these effects will last more broadly in the sort of the broader ecosystem?

Yes. I mean our supply chain has been an area of a lot of focus, and it's had some positive points and some negative points. So we came in, Dean and I together recognized that the supply chain was way too diffused. We worked and it's actually still work with 9 different foundry partners. Most of those are coming by virtue of some acquisitions. But then you also had a set of decisions that were made prior to us joining that were really arbitrary where you have engineers driving foundry road map. They're not really partnering with operations in the degree that he should. So we had made statements and those statements still are true that one of our underlying goals is to consolidate our foundry partners down to really, one, we like to be very, very strategic and meaningful with one. So that's the direction that we've been driving. But in that process, we still have 9. So we still have to manage 9 different relationships. In some instances, having such a diffuse supply base has worked to our advantage because we do have the ability to move supply around between supply partners, and we've been able to maneuver a little bit more than I think most have in that regard. In some, it's really worked against us because we're not a meaningful customer. So the price increases that are well documented have probably hit us harder than many because to some of the major suppliers, we're simply not all that meaningful. So they have hit us pretty hard with these cost increases, we've been relatively successful in being able to pass those through. We've been able to use the diffusion of the supply chain to our advantages in certain cases to get share because we're in some foundries like PSMC, like [Indiscernible] that are more flexible in the supply-constrained environment. So on balance, I would say we probably would give ourselves B plus. It's mostly been a positive having this relatively diffused supply chain, but there are no doubt there have been instances that we've received a pretty harsh penalty as a result of something we knew, something that we really wanted to haste in consolidating our supply chain as quickly as we can. Because when you're spending money with 9 guys, again, you're not meaningful to any of them. and you're just not going to get preferential treatment if they don't have to give it.

That's right. That makes a lot of sense. And then I guess, Dean, for your question to you, I guess, and these effects on sort of the P&L. Are those sort of factored into your guidance already? And how long, if you guys have to -- and I know you don't want to -- we don't put company-specific forecasts out there longer term. But from a sector step, how long do you think this sort of dynamic is going to last?

Yes. On the first question, we sort of factored that into how we think about the company. From what I can tell, sort of from my seat, it doesn't seem like there's any particular event that says there's light at the end of the tunnel, there's to be a big sort of relief valve coming. It does seem like these constraints continue to persist. I don't think many people have a view past calendar 2022. There's certainly a lot of conversations about calendar 2022. And I don't think the environment gets materially different in calendar '22, either to the positive or negative, if anything, I think the economic shift between customer circuit designer, fabricator is actually likely to shift around. I do think sort of some of the input prices continue to change. I would suspect that continues to change probably into calendar '22. And so you're going to see some dynamics between those 3 endpoints on how that moves going forward. And I don't think anyone really has a forecast on sort of what happens, but I think everybody in the industry is likely keeping an eye on that. And then fundamentally, what does that do to elasticity of demand. So demand couldn't be higher today at semiconductors, why everything around us sort of uses semiconductors now with more and more content in just about everything. So the demand, as you might imagine, is really the highest level it's ever been. And I don't think if the macro that's likely to change. But as these inflationary processes happen, how does that have an effect on the elasticity of sort of end-to-end demand, and so that's yet to be seen. And I think that's probably going to end up being a story of 2022, 2023, how does the industry evolve from here.

Got it. And I've got a quick investor question I want to squeeze in here. So you look at your P&L, we talked about rationalizing the OpEx side and making smart decisions. R&D specifically, right, the story basically around most of the time is you squeeze R&D punish growth. How do you guys manage that dynamic so that you continue to grow through that and we'll continue to grow despite your sort of rationalization?

Yes. So I would say, I mean the way that we manage R&D is actually by technology area, what's required for those roadmaps. And we feel pretty confident that we're resourcing our roadmaps appropriately. We're actually putting, for example, more effort into our wireless devices now. I think we have more and more opportunities in that technology area. We're sort of developing more and have an expanding road map. But at the same time, we're also managing a shift from some of the legacy markets that we have been. We talked earlier about mobile and PC and how the company has historically focused there. So think about the whole pie that we're investing in from our R&D budget. It once was in those 2 areas almost solely, now we've sort of reaggregated that all the same aggregate bucket actually into a different set of opportunities. So we manage it as individual roadmaps and technology proliferations. And we think we actually are resourcing appropriately and where we have more opportunities to grow faster, and we certainly put more in behind those technology development areas. And so that's sort of how we think about the operating expenses. Michael, I don't know if you want to add anything?

No. Perfect.

Super. So we got about a minute left here. I just want to make sure we hit on a pretty important topic here, which is your balance sheet and how you think about sort of capital allocation what is sort of the strategy for capital allocation going forward, if you have to sort of think about a mix of M&A reinvestment versus shareholder returns, which, by the way, your stock price has done a great job of already giving the shareholders, what -- how do you think about that? How should folks think about that?

Yes. So one, we've sort of been clear, I think, over the last few quarters on what our priorities are One is reinvesting back into ourselves. So that's been a big driver of the outperformance of the equity price over the last couple of years. Second priority is inorganic means of growth. And I think that's been another contributing factor. So between those 2 factors, we think that's the highest return for our capital deployment. The third is actually managing sort of our debt maturities. We recently made some changes in our capital structure, where we retired previous convertible notes that we have on our balance sheet. We actually retired that completely white that equity linkage off of our balance sheet from account structure, and then put on a little bit of permanent debt in a high-yield set of notes in fixed coupon that we did earlier this year in the spring, which really sets the guidepost of sort of 1x sort of leverage, applying some ability to leverage into the business to continue to reinvest, continue to grow. At this time, we're probably looking in these 3 categories, organic, inorganic debt management. And then to the extent that the first 2 are unsuccessful, we have limited ability to reinvest or we don't find M&A opportunities that look attractive. At that point, only would we look at is share buyback programs. And then finally, which I think is completely off the table at this point would be a dividend program at this point. So that's sort of the rank order of priority.

That's terrific. That's a detailed answer. Look, we're up on down here. I want to thank you both, again. We appreciate the partnership. Thank you guys for joining our conference and certainly elevates our conference to have you in it. We hope to see you again next year, and thanks to everybody online paying attention to.

Marco, thanks to you. Really appreciate it. Great to see you.

Thank you.