Nordic Semiconductor

We previously wrote about rising inventories at Nordic Semiconductor in October last year. We argued that, in spite of the profit warning, the market was underestimating the risk associated with the inventory overhang.

Nordic released Q4 results on February 6, and the level of inventory now looks even more alarming. Even as sales continue to decline, the inventory is growing in absolute terms. As a result DSI has grown from 216 days in Q3 to 287 days in Q4. At the current level of sales, this would take over 9 months to clear down.

Management’s commentary on the increase seems to massively understate the extent of the problem. In a slowing environment we think it makes little sense to keep building inventory simply to “support future growth ambitions”, particularly in an environment where “visibility continues to be low”. Below is an extract from the Q4 earnings call on February 6 (our emphasis added):

“Net working capital in percent of revenue increased to 41%, so on the high side and is a result of higher working capital and lower revenue. The increase in working capital is partly explained by higher inventory. Nordic no longer sees any supply constraints given the current demand and supply outlook. Nordic has made a strategic decision to increase inventory to support future growth ambitions.”

Pal Elstad, CFO

Nordic Semiconductor is a “fabless manufacturer”, which means that production of semiconductors is carried out offsite, by a third party. The increase in inventory has us wondering if this is being driven by certain volume commitments? We note that, in Q1 23, the company made a prepayment of $100m in order to “strengthen supply resilience and diversification” (see extract from Q1 report below). No further details are provided, but if this was part of a deal to secure manufacturing capacity it may also have been tied to a requirement to take on a certain amount of future volume.

Note that $94m of that prepayment still sits on the balance sheet as a “long term asset”. While the company does not explicitly state what they “prepaid” we think it’s reasonable to assume that much of this will convert into inventory. We expect to get further details on this arrangement with the annual report when it is published on March 20.

As mentioned in our previous note, the company are also liable to issue rebates to certain distributors in the event that the distributor sells the product to end customers at a lower price than the price at which the distributor purchased the product (see extract from annual report below).

We don’t have the full terms of these “ship and debit” agreements, but in an environment of high channel inventories and weak pricing, it would seem to create an incentive for distributors to dump their stock on the market at low prices (knowing they can recoup any difference). Indeed this might feel like a very attractive option to a distributor struggling with cash flow in a weak environment.

The new CEO (Vegard Wollan) only joined on 1st January so we expect he’s only just had time to settle in, let alone get to grips with the balance sheet and the intricacies of Nordic’s supply agreements. The change in CEO creates a risk that the company will take a “big bath” on the accounts in the next few months — writing off inventory and/or recognising higher provisions for rebates. We now await the annual report for more detail on the above risks.