Earnings Call Transcript - VLN Q2 2023

Operator, Operator

Good morning. My name is Yonie, and I will be your conference operator today. At this time, I would like to welcome everyone to Valens Semiconductor's Second Quarter 2023 Earnings Conference Call and Webcast. All participant lines have been placed in a listen-only mode. Opening remarks by Valens Semiconductor management will be followed by a question-and-answer session. I will now turn the call over to Daphna Golden, Vice President of Investor Relations for Valens Semiconductor. Please go ahead.

Daphna Golden, Vice President of Investor Relations

Thank you, and welcome, everyone, to Valens Semiconductor's second quarter 2023 earnings call. With me today are Gideon Ben-Zvi, Chief Executive Officer; and Dror Heldenberg, Chief Financial Officer. Earlier today, we issued a press release that is available on the Investor Relations section of our website under investors.valens.com. As a reminder, today's earnings call may include forward-looking statements and projections, which do not guarantee future events or performance. These statements are subject to the safe harbor language in today's press release. Please refer to our annual report on Form 20-F filed with the SEC on March 1, 2023, for a discussion of the factors that could cause actual results to differ materially from those expressed or implied. We do not undertake any duty to revise or update such statements to reflect new information, subsequent events, or changes in strategy. We will be discussing certain non-GAAP measures on this call, which we believe are relevant in assessing the financial performance of the business and you can find reconciliations of these metrics within our earnings release. In the coming weeks, we will be conducting investor conferences and meetings virtually and in Chicago and Tel Aviv. If you're interested in meeting with us, please e-mail me at investors@valens.com. With that, I will now turn the call over to Gideon.

Gideon Ben-Zvi, CEO

Thanks, Daphna, and thank you all for joining our Q2 2023 call. In Q2 2023, Valens Semiconductor revenues reached a record of $24.2 million. We also achieved better than anticipated profitability metrics on our journey towards adjusted EBITDA breakeven by the end of this year. We continue to make progress executing against our long-term growth opportunities as well. As we further push the boundaries of connectivity with our advanced offering and enable our customers to bring to market new disruptive products to existing and untapped markets. We continue to track the current macroeconomic headwinds, the rise in inflation, interest rates and lower than anticipated inventory digestion. While these trends are driving some near-term uncertainty long-term trends for the semiconductor industry and Valens remain positive. I will start our second quarter business discussion with our audio-video business. The audio-video market is highly correlated to macroeconomic trends. We can now see indications for a recovery of the market, which we believe will start to improve at a relatively slow pace towards the end of 2023 and through the first half of 2024, and gain momentum into the second half of 2024. We have identified that one of the main contributors for the expected improvement is the increasing demand for high-performance USB peripherals. As such, Valens Semiconductor is driving adoption of the USB 3.2 standard globally across verticals. Valens Semiconductor's long-term vision is to accelerate the transformation of the video conferencing market with an extensive product portfolio. Our latest chipset, the VS6320, is the first single chip in the market for extension of high-performance. The target is growing market and can extend USB 3.2 peripherals at up to 100 meters or 328 feet. We recently received the first samples of the VS6320 from the successful payment executed in Q1 2023 and we remain on track to ship the first engineering samples to selected customers by Q4 of this year. We believe that revenues from the new products will start ramping up during the second half of 2024, as our customers will introduce their new products embedding the new chipset. The VS6320 chipset is ideal for connecting the many remote USB 3.2 peripherals required in video conferencing, industrial and medical applications. Each of these applications presents a large market. Multi-camera videoconferencing is one of the fastest-growing areas for audio-video equipment in the coming years, as more larger conferencing applications increasingly require a unified meeting room experience with flexible, efficient, and high-performance connectivity solutions. Many leading audio-video and PC manufacturers are investing in the development of advanced solutions for small, medium, and large meeting rooms. The video conferencing market is projected to essentially double from about $7 billion in 2022 to more than $14 billion in 2029, or an 11% to 12% CAGR according to research reported by business insights. We recently demonstrated how another one of our products, the VA7000 chipset family, was originally designed for automotive applications can be leveraged for multi-camera video conferencing applications. At Infocomm International in June, we announced our collaboration with iCatch Technology, a leading AI image processing funded semiconductor design company. The two companies are working together to develop a flexible, efficient, and high-performance multi-camera video conferencing solution that leverages our VA7000 chipset family and iCatch Technology's AI imaging system on a chip, also known as SoC. While deploying the solution, we will benefit from the ability to cover the entire room, enhancing the equity of both in-room and remote participants. Another benefit of this new solution is the ability to use smaller cameras that consume less power at reduced costs. During the many discussions held with customers about the VS6320 and the VA7000 chipset, it was clear that with these innovative solutions, Valens Semiconductor is once again at the forefront of the industry. Turning to automotive, first our symmetric automotive chips family, the VA6000. 2023 is the third year in which our VA6000 chipset is being broadly deployed in Mercedes-Benz S, C, and E Class models, including the electric vehicle EV model, the EQ series. As such, our annual sales in 2023 are expected to increase as a result of being deployed in more models than in prior years. We expect to stay in the same car models going forward. As such, beyond this year, the expected growth rate for our VA6000 chipsets should be correlated to Mercedes-Benz passenger car growth rates. In Q2, we recorded initial sales of the tractor-trailer revenue safety solutions we jointly developed with strong partnerships for the fleet operator customers. These customers are in the process of conducting pre-production extensive live on-road evaluations, and we expect this will result in ramping sales during the second half of 2024. Moving to the VA7000, our MIPI A-PHY non-symmetrical automotive chipset family for safety applications known as ADAS. There is a growing demand from automotive OEMs for ADAS, including vision-based systems, which are key enablers for ADAS, a 360-degree perception sensor for applications such as surround view, parking assist, and reverse assistance. The VA7000 perfectly fits vision-based systems, and over the past quarter, we grew the pipeline with automotive OEMs considering the deployment of the VA7000 in mass production. The ongoing discussions with the OEMs looking at potentially selecting the VA7000 give us confidence that we remain on track to announce our first design wins this year. As a reminder, it typically takes a few years following automotive design wins before generating initial revenues. To close out my opening remarks, I want to spend a moment discussing the plan we announced in June to improve the efficiency of our operations. In line with our focus on reaching profitability while maintaining our ability to meet our technological and business goals, we arranged our R&D and development infrastructure in a more efficient manner and streamlined our development platform. This enables us to operate a stronger and leaner organization for the benefit of Valens Semiconductor’s stakeholders. Dror will provide more details in his prepared remarks. I'll now turn it over to Dror Heldenberg, our CFO, to review our Q2 2023 financial results and provide our financial outlook.

Dror Heldenberg, CFO

Thank you, Gideon. I'll start with our second quarter results and then provide our outlook for the third quarter and the full year 2023. Starting with our second quarter '23 results. We achieved record quarterly revenue of $24.2 million, an increase of $1.7 million or 7.5% from the second quarter of 2022, and an increase of 1.2% from Q1 2023. Second quarter 2023 gross profit was $14.9 million, with a gross margin of 61.8%, compared to $15.8 million or 70.2% gross margin in Q2 2022. Non-GAAP gross margin reached 63.1%, compared to 71% in Q2 2022. The change compared to Q2 last year was mainly driven by substantial growth from automotive as we doubled the portion of revenue coming from this business, which incurs a lower gross margin than our audio-video business. Before referring to OpEx, as Gideon stated, during the second quarter, we implemented our plan to improve efficiency. The annual savings of this plan is expected to be $9 million, as previously announced. The additional charge incurred in Q2 specifically was $250,000, coming mainly from R&D. Operating expenses in Q2 2023 totaled $20.1 million, down from $23.7 million in Q2 2022. Research and development accounted for approximately 60% of Q2 2023 OpEx coming in at $12.2 million, lower than $14.9 million in Q2 2022, mainly due to the purchasing of IP in the amount of $2 million in Q2 2022. We also benefited from the strong U.S. dollar versus the Israeli shekel. SG&A expenses were $8 million down from $8.8 million in Q2 2022 mainly due to a $0.6 million reduction in D&O insurance premiums, as well as positive foreign-exchange-related impact. Turning to net loss and adjusted EBITDA. Q2 2023 GAAP net loss was $4.6 million, substantially better than the $10 million net loss recorded in Q2 2022. And adjusted EBITDA in Q2 2023 was a loss of $0.8 million, also significantly better than the $4.5 million loss in Q2 2022. The better-than-guided adjusted EBITDA loss in Q2 2023 was mainly due to two factors: risk scheduling of certain IP purchases for a new product we are developing, which is now planned for Q3 2023, and the strength of the U.S. dollar in Q2 2023 compared with the company's estimates. This had a positive impact on expenses paid in Israeli shekel, mainly for compensation to employees based in Israel. GAAP loss per share for Q2 2023 was $0.05 compared to $0.10 in Q2 2022. Non-GAAP earnings per share reached breakeven in Q2 2023 compared with a loss per share of $0.08 in Q2 last year. Excluding the stock-based compensation of $4 million was the main reason for the delta between GAAP loss per share and the non-GAAP earnings per share breakeven in Q2 2023. Turning to our balance sheet. We ended Q2 2023 with a strong balance sheet, which is a clear indication of the current and future strength of the company as we expect to reach adjusted EBITDA breakeven towards the end of 2023. Our sound cash position provides us with operational flexibility to grow our business. Cash, cash equivalents, and short-term deposits totaled $138 million and we had no debt. This compares to $139.7 million at the end of Q1 2023. In Q2 2023, we generated $0.4 million from operating activities, compared to $4.3 million cash used in Q2 2022. Q2 2023 was the first quarter in which the company's cash from operating activities was positive. While in the short term we might face some quarters with negative cash flow from operating activities, all in all, we expect that the improvement in our profitability will support a positive trend of cash generation on an annual basis. Our working capital as we ended the quarter was $160.8 million compared to $161.4 million at the end of Q1 2023. This difference is mainly triggered by the purchase of fixed assets during Q2 2023. As expected, our inventory balance as of June 30, 2023, was substantially lower than at the end of March 2023, reaching $90 million, down from $123.6 million. This approximately 20% reduction reflects the fact that the company is returning to a more balanced supply-demand inventory management. As part of our inventory planning, we assume shorter lead times from our vendors. Yet, we have not yet seen them or formally announced a change in their lead times policies. While we expect continuous improvement in our inventory balance, we are still seeing our inventory levels impacted by a few factors that have been evident in the past couple of quarters through today. The macro environment is still negatively impacting our customer demand and sales. This is leading to inventory digestion that is taking longer than many have originally anticipated. We expect the recovery to continue at least through the end of the first half of 2024, which implies a modest pace of recovery in the short term. Second, higher interest rates are driving the cost of inventories up, which means that customers are more cautious in placing orders and stocking up their warehouses with new inventory. To sum up this point, we expect our inventories to continue to go down in Q3 2023, but at a slower pace. Now I would like to provide our guidance. For the third quarter of 2023, we reaffirm our expectation for revenues in the range of $14 million to $14.2 million. As we have shared with you previously, we anticipate that the third quarter will be the lowest quarter of the year. We expect Q3 gross margins to be in the range of 57.6% to 58%, reflecting on one hand, the projected product mix, with a higher portion of Audio-Video revenues, which incur higher gross margins, and on the other hand, the negative impact of fixed operation expenses on the lower Q3 2023 revenues. Adjusted EBITDA loss in the third quarter is expected to be in the range of $12.2 million to $11.9 million. As of June 30, 2023, shares outstanding totaled 101.8 million, excluding of course approximately 1 million shares that are subject to future transactions. For the full year 2023, we are reaffirming that revenues are expected to range between $83.8 million and $84.2 million. Automotive revenues are expected to approximate 30% of total revenues. Full year 2023 gross margins are now expected to be in the range of 62.2% to 62.5%. We are improving our adjusted EBITDA guidance for the full year, and it is now expected to be a loss in the range of $16.2 million to $15.6 million. We reiterate our expectation to reach adjusted EBITDA breakeven by the end of 2023, which means that in 2024, we expect to be cash flow positive. I'll now turn the call back to Gideon for his closing remarks before opening the call for Q&A.

Gideon Ben-Zvi, CEO

Thank you, Dror. In light of the ongoing macroeconomy and semiconductor sector-specific headwinds that have continued to impact most of our end markets, we remain focused on elements in our control and our progress towards profitability. Our main targets in the second half of the year are: first, to secure design wins from automotive OEMs for our VA7000 chipset family. This is a major milestone we all have been marching towards. Second, to further enhance our profitable Audio-Video business with our new offerings. Our strong balance sheet provides the foundation for us to execute our long-term growth strategy and pursue the promising opportunities that will deliver value for all our stakeholders. I would like to close by thanking our employees for their commitment and ongoing dedication to the company's success and for the support of all our stakeholders. Operator, I would now like to open the call for questions.

Operator, Operator

Thank you. Ladies and gentlemen, we will now start the question-and-answer session. The first question is from Rick Schafer of Oppenheimer. Please go ahead.

Rick Schafer, Analyst

Good morning, good afternoon. Great job navigating a challenging macro environment. I have two questions. First, could you provide more details on channel inventory, especially since it seems to be primarily in Pro AV? Dror, I believe I heard your comment correctly. How much do you think you're undershipping consumption, and when do you anticipate the channel will return to normal? I think I missed some information you shared about this during the call.

Dror Heldenberg, CFO

Hi, Rick. It's great to connect with you again, and I appreciate your question. You're right in your observation. The audio-video business is largely affected by the slower inventory digestion. Currently, I would break this situation down into three phases. The first phase is the quarter we are currently in, and I believe this is where the audio-video business will reach its lowest point. Based on our recent guidance, we anticipate audio-video and alternative revenue to be around $40 million this quarter. The second phase indicates that we are beginning to notice improvement in the fourth quarter, with better demand from our customers and more inventory being digested throughout the channel. Finally, according to our discussions with customers, we expect to see a modest rebound in the first half of 2024. As we have mentioned earlier, we believe this positive momentum will continue to strengthen in the latter half of 2024.

Rick Schafer, Analyst

Thank you for the information. For my second question, I understand you mentioned being on track to announce at least one new customer in the automotive sector. Could you provide more details on that? Additionally, are customers in the automotive industry taking longer to launch new products? We've heard similar feedback from a few of your automotive and component peers. Are you observing any changes in order patterns or the velocity of product launches within the automotive sector?

Dror Heldenberg, CFO

Okay. As in the past, we cannot be more specific about the opportunities we currently have in the automotive sector. I can say that we are seeing increasing demand for our VA7000-based connectivity solutions for various vision-based applications, such as surrounding systems. Regarding the second part of your question, if there's a slowdown or it takes customers longer to make decisions, that's typical in this market, where players often take their time. It's not unexpected. As we mentioned, we anticipate seeing some initial design wins before the end of this year, and at this time, we are confident in our ability to provide service.

Suji Desilva, Analyst

Hi, Suji Desilva of Roth MKM. Hi, Gideon, Dror. So maybe to follow up on Rick's question. The pipeline closure for auto, what are the drivers for the auto customers for the time frame of those closures? And I guess because you may see one by the end of the year and more in 2024. What's driving their time frame at this point? Are they sampling the chip and testing it, or what are the factors there? Thanks.

Gideon Ben-Zvi, CEO

Hi, Suji this is Gideon. Thank you for your question. The process with the automotive players, the OEMs, is a shift. They are shifting from the old systems that they use to new systems and they have their own learning curve about what is needed to understand the need for newer bandwidth for newer and for more information in order to predict an accident or to predict if something is going to happen. This is a process that actually they are doing their own shift of understanding new needs in the market. Some of it is not predictable for us to know how long it takes, but we see that actually, the learning curve for most of them happens. We see and hear a growing pipeline of companies that comprehend that for the next generation of ADAS and the next generation of understanding what happens on the road, they will need to cope with higher resolutions, higher bandwidth, and our solutions exist today with superiority. Yes, it takes time, and some of the time is their own learning curve of the new world of the new demands. But we see that actually, for most of them, they come to very similar conclusions, and we hope that this will yield to a design win that we'll be able to achieve this year.

Suji Desilva, Analyst

Okay. Thanks, Gideon. And then perhaps a follow-up there as they compare your solution to perhaps better offerings like Ethernet and so forth, what are the one or two key factors you think are standing out that would be compelling to a customer toward the balance of the VA solution?

Gideon Ben-Zvi, CEO

Well, the explanation is technological. The higher the bandwidth, the more exposure to electromagnetic influence you have. This is not a linear thing. Like if you have a camera of 8 megabits versus 4 megabits, it's not double the exposure. It's far more than that. This is the reason that the need for electromagnetic compatibility (EMC) becomes such a serious consideration. The second is the total cost of ownership. In our technology, we allow them to use unshielded cables, which actually reduces the total system cost because we enable using cheaper cables and connectors and actually cheaper labor because it's unshielded; a lot of things can be done automatically. Additionally, there is a lot less depreciation over the years of what's called aging cables. So these are the key factors: EMC, total system cost, and bandwidth—that's the three key parameters.

Blake Friedman, Analyst

Hi, this is Blake Friedman on behalf of Vivek. Thanks for taking my question. Just wanted to focus on kind of the full-year guide, specifically Q4. I know you only guide one quarter out and really discussing Q4 specifically. But just taking the full-year guide kind of implies a pretty steep sequential growth in December. So, I'm just curious what you're seeing, maybe from kind of a customer perspective that's giving you confidence in that strong ramp-up, just because you've heard across the ecosystem. Maybe some continued digestion for a couple of quarters, whether it be across industrial or consumer in a variety of other markets. Just any clarity there would be helpful.

Dror Heldenberg, CFO

So, first of all, good to hear from you again, Blake. The guidance—first of all, we are not providing guidance today for Q4; basically, it's only for Q3 and for the full year. But given the fact that we've already provided the first half and we gave the third quarter, it's not that complicated to calculate the Q4. I think that the confidence that we have in the Q4 numbers is based on the fact that we know our customer products and based on what they are telling us. But on top of that, it's based on backlog and we see that the level of bookings that we already have with them. I think that given that fact that we know what they're expecting and what they see in front of the end customers, and the fact that we already received the backlog, this is the reason why we foresee this correction in terms of the Q3 versus Q4. Okay. So, in a way, Q3 is kind of an exception. It's an exception because it's a kind of a perfect storm. We see, as we just mentioned, that we see audio-video reaching a bottom, which means that we do not enjoy the gross margin that we usually see. The fact that we reported lower revenue at the level of about $40 million means that the impact of the fixed operating expenses in this calculation of gross margin is going to be more dominant. So, Q3, in a way, is kind of an exception. It's not something that serves as a good reference. Going forward, when we return to the right proportion between audio-video and automotive, I think it’s fair to anticipate at this point that we should continue to expand gross margins, which will be north of 60%.

Brian Dobson, Analyst

Hi, good morning. Just a quick follow-up on your commentary. You did a good job laying out the near-term headwinds for the business and the sector. As you look at the industries of your end users, which are impacted the most currently, and which are in the best position to recover in 2024?

Gideon Ben-Zvi, CEO

Yeah. Hi Dobson, thank you for the question and nice to hear from you. We are a strong player in the Audio-Video world. In the Audio-Video sector, we traditionally work with quite high-end chips and quite high-end customers. With the new chip, the VS6320, we expect to reach a broader market which represents a shift from very large conference rooms to medium, small, and even huddle rooms, which are far larger markets and aur more expansive contexts for us. Another growing engine is the increased demand for Industry 4.0, which is an adjacent market to Audio-Video; it's Audio-Video technology used not for conference rooms but for different applications. And these are some of the growing engines of the AV sector. In automotive, we see the same trajectory; we are pursuing ADAS and autonomous vehicles. This is where our strength lies, and additionally, we have an increasing interest in surround view solutions in automotive. These are where we see growing opportunities in the industry. However, in terms of cash flow, it is the Audio-Video segment because in Automotive, any design take time before yielding cash and revenue.

Operator, Operator

There are no further questions at this time. Mr. Ben-Zvi, would you like to make your concluding statement?

Gideon Ben-Zvi, CEO

First, I want to thank everyone. I would like to thank you for joining us today for our Q2 2023 call and for your continued support and interest in Valens Semiconductor. Have a great day. Thank you, and goodbye.

Operator, Operator

Thank you. This concludes the Valens Semiconductor Second Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.