Silicon Laboratories Inc. (SLAB) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to Day 1 of Citi's 2021 Virtual Global Technology Conference. My name is Atif Malik. I cover U.S. semiconductors and equipment stocks here at Citi. It's my pleasure to welcome Tyson Tuttle, CEO; and John Hollister, CFO of Silicon Labs today. The format of our discussion is fireside chat. Tyson is going to make a few the prepared comments at the start. I'll start with my questions after that, and then we'll take your questions. [Operator Instructions] With that, I welcome Tyson and John.

All right. Atif, thank you for the introduction. Thank you, everyone, out there for tuning in to our fireside chat. It's exciting times for Silicon Labs. Last quarter, we announced to -- just prior to the quarter, we announced the divestiture, the completion of the divestiture of our Infrastructure and Automotive business to Skyworks Solutions, for $2.75 billion. And that was really the culmination of a 10-year transformation of the company from a diversified semiconductor component supplier to now a solution provider, silicon software and solutions, focused on the really huge and growing IoT opportunity. So we see the things within our lives and within our economy are getting connected at an ever-increasing pace. So basically everything outside of our handset and everything outside of our PC is becoming wirelessly connected. And we saw this trend about a decade ago, actually a little bit longer than that, and set out on a journey to focus the company around this growing opportunity. And so this involves some M&A. We did a number of acquisitions of companies and talent and technologies to add on to the capabilities that we had as a leading supplier of mixed signal and RF semiconductors with software and security and artificial intelligence, wireless protocols, development tools. And today, we're addressing about a $7 billion market opportunity, and that market opportunity has grown to $10 billion by 2023. So we see a high-teens CAGR in that market, and we've come out with -- had record revenue in IoT coming out of the second quarter. Very excited to see the progression of that market, receiving -- getting critical mass in that area and achieving escape velocity on our future growth. So we have a long-term CAGR of 20% or greater for the IoT business. And with the sale of I&A, we're now purely focused on this opportunity. So this goes into a broad variety of applications, thousands of applications, tens of thousands of customers across everything from home and life to industrial and commercial applications where we're providing an integrated SoC with microcontroller, wireless functionality, processing, battery management, everything else focused on low-power, highly integrated end nodes, which is -- there will be trillions of devices deployed here over the decades ahead. And we believe that we are in a fantastic position to address that market with our solutions. And Atif, great to talk to you. I'm excited to talk a little bit more about the opportunity and about a lot of the stuff that's been going on.

Sounds good, Tyson. I think there have been 3 major areas for investor focus this year on Silicon Labs, a lot of interest in the stock. The first one, as you highlighted was the divestiture of the I&A business. So let's start with that first. And how is the company focus going to shift now that the business is almost entirely IoT-driven?

I think -- so certainly, as a company, we are now moving to where we wake up every day thinking about how to succeed and win in IoT. And it's quite complex. You've got chips. You've got a whole suite of ships that you've got to do. There's all sorts of software and tools and enabling customers to get their products to market, ecosystems to support. And so that focus is going to be really important. We're also -- in terms -- we had 2 business units, and now we're moving to more of a functional organization within the company. We did an acquisition of Redpine Signals last year, brought in Wi-Fi. So we've got a lot of work on Wi-Fi and really accelerating our efforts to developing products, getting those to the market, getting customers into production. So we have purity of brand. Now we can talk -- investors, I think, will know exactly what we're doing in terms of we're all IoT. It's not a balance of all these different things. We have a clear financial model for the company. So we talked about the growth rate, 20%. We also have talked about the leverage that we're going to see as we grow up that curve on to the bottom line. So increasing levels of profitability over time, and we've committed to that both externally and internally, to be able to do that. But really, it's around this focus on IoT, and seeing that as just a huge opportunity, an exciting opportunity. It's one that internally, we're really excited about, and I think that we're seeing that with the pandemic, but just every year, more and more connected applications are now getting deeper into the economy to drive productivity enhancements, to drive cost savings, to improve people's lives. It's -- and this is something that's going to -- this doesn't just happen in a year. It happens over an extended period of time. So positioning the company now to really capitalize on this opportunity is really super exciting.

Great. And Tyson, IoT is a very broad term. And looking at your presentation, you're expecting home and commercial applications to be the strongest areas in IoT growth through 2023. And what are the applications in these markets? And what is Silicon Labs market share in these 2 markets?

All right. So we talked about -- today, we're addressing about a $7 billion market opportunity. So we have about 10% share in the SAM that we're addressing, and that SAM is growing high-teens. There's -- we break it down into 2 main areas. There's the home and life area. So this is smart home and connected -- things that connect into your phone, things like portable medical devices, home automation, home security, residential lighting, health and fitness products. There's a wide variety, and that's about half of the business today. So we're at about that $700 million run rate, and that's about half of that business in the home and life category. We have leadership positions in the smart home and home security in the lighting markets and a growing position on the Bluetooth side with a lot of the connected devices that connected in to the phones. The other part of the business is really the industrial and commercial category. In that, we serve a broad application set. So this is everything from industrial automation, smart metering, retail automation, asset tracking, commercial lighting, many other applications within that category. And that's served with a variety of different wireless protocols, things from Bluetooth and Wi-Fi, but also you have mesh networking and you have a lot of proprietary protocols that companies use, and we've developed our platform so that you can run all of these protocols on a common silicon platform and a common software framework and be able to use those and evolve those over time. So we have over 100 different wireless protocols in the industrial and commercial category that customers use and optimize for their specific applications. And so -- and that, again, is about half of the overall business, and we see significant growth opportunities in both of those areas.

Great. And Silicon Labs has a somewhat of a unique approach to the market with products addressing hardware, software and connectivity. What advantage does this create versus your bigger competitors? Are customers increasingly looking for more of the platform approach? Or just one product set, whether it's hardware or connectivity?

Yes. I mean like we talked about the transformation going from a silicon component provider to really now more of a solution provider. So we're not just a silicon provider anymore. We're providing software that runs on our platform. And good design is at the core of this, but we're adding functionality and future-proofing our devices. We're adding the connectivity options and security all the way from the silicon to the cloud. We're adding intelligence and artificial intelligence and machine learning to our designs. And that's really increasing our level of differentiation in our product beyond just the silicon piece. And customers are really seeking out this kind of comprehensive product offering. And it's why we often draw premium in the market -- premium gross margin and are winning share versus our direct peers. So not -- we don't really sell software on a stand-alone basis, but we're monetizing the software and making that kind of a sticking point for our chips. And that's unlocking value, enhancing the differentiation through this complete solution all the way from the silicon to the cloud.

Great. Let me switch to John for a minute. John, you offered a modified Dutch offering recently. Was the 4 million share size you were expecting? And when do you intend to utilize the remaining $1.4 billion in cash from the sale of I&A business?

Yes. We're pleased with the results of the Dutch offering. As we analyzed the precedent transactions completed thus far this year, we find that the level of subscription on our Dutch offering was on the high end of what's been happening out in the market, just generally speaking. So good uptake overall in comparison on the Dutch. And where we go from here is subject to further discussion with the Board, the kinds of options available to us remain as we've discussed previously, whether that be in the form of additional share repurchases and/or special dividends with the full amount of $2 million being deployed still leaving us with about $1 billion of residual cash, which, as you've been tracking our stock for a long time, you know that's about 2x kind of the normal run rate of cash that we've had in the company. So that in and of itself is a good amount of dry powder for opportunistic M&A or even further capital deployment from that point. But the topic at hand is the remainder of the capital from the divestiture transaction, and that is something that we'll continue to look at and evaluate where to go from here. I will just highlight that we also re-upped our open market share repurchase at the time we completed the Dutch. So if you recall, that was $150 million, of which there's about $130 million remaining on that open market repurchase. So that is reactivated in the open market.

Great. And then gross margins are coming down post the sale of I&A from the peaks of around 61% in 2019 to a target of mid-50s. What are the puts and takes in the margin business for the IoT now? And is it even realistic to get back to those 60s numbers?

Yes, that level of performance was in the holdco with the mix of the I&A business being part of that. So now as a pure play IoT company as we had highlighted for a number of years, IoT was slightly below the corporate average. So that's not a surprise. Overall, we -- as Tyson was just indicating, we command a premium gross margin for the IoT market based on the features that we offer and the differentiation that we have. As the market evolves and the volumes continue to ramp, there may be some pressure on the gross margin. We've comprehended that in our longer-term model. But overall, we're pleased with the ability to sustain our gross margins in the current environment, in particular, with some input cost increases coming in. And we've had the ability to pass that on to our customer base in a constructive manner and sustain our gross margins. And like I said, even in the longer-term view, we see that as a premium to the overall IoT market and against the peers that we compete with.

John, supply constraints has been a topic of interest to investors. Every earnings call, I talked to you the backlog is going up. The book-to-bill is positive and you have kind of insights into even next year in terms of how your backlog is building. So can you help us understand where we are in terms of the normalization of supply. We're hearing some of the PMICs part are very short and ASPs are going up, that some of your foundries are raising pricing. And so how do you put it all together in terms of the impact to your business?

Yes. I guess I would say we are still sort of midstream through this time in the industry. You've seen a lot of investment beginning to be talked about and being implemented for the foundries to increase their overall capacity quite significantly. TSMC has talked about investing $100 billion in new foundry capacity. As you know, that will take some time to play out. And what we see, what we hear is by the end of next year, perhaps into the first half of 2023, we may begin to see the beneficial impact of some of these new investments, not to say everything will be normal by then. But hopefully, we'll begin to see some light at the end of the tunnel around that time frame. It's going to take some time. We believe we are in this mode for several quarters now.

Yes. Atif, just real quick. In terms of our overall philosophy on this is, first of all, to the extent that there are cost increases and those may be transitory, but they are also structural. John talked about all the capital being invested in mainstream technology. And in the past, we just built new cutting-edge fabs, and that emptied out all of the other nodes. And then that's where -- we're kind of a fast follower on Moore's Law. And so we would jump into a new node, and there would be plenty of capacity. And we've got to the point now where we're kind of reaching an inflection point on Moore's Law, where things get harder and more expensive. And that's kind of jammed up stuff back into the mainstream technology. So they're having to build new mainstream fabs, and now those fabs are not fully depreciated. So everyone is seeing the fact that we're having to build some new capacity and there's going to be a cost to that, which is long-term structural. Our philosophy around this is that as a supplier, we can't get caught in the middle. We've got to make this at least neutral to our gross margin and to be able to pass on those costs to customers. And we want to do that in a few ways. One, you've got to be equitable about it, both in terms of your allocation of the supply that you have, but also the cost increases that come along. You also, in the process, can select a little bit where you're going to emphasize and focus on things that are maybe more long-term sustainable and higher quality type of revenue. And you also want to make sure that you are not creating headwinds in the future. You don't want to damage your customer relationship. We're all in this together. You're partnering with your customers, and we are trying to -- certainly, we're seeing increases that's got to be passed along, but we are also partnering together. And we don't want to have something to where -- we have tremendous pricing pressure -- or power right now. Our customers would pay anything to get additional parts. But you can take advantage of that short term and then you'll create a headwind long term, and you'll also damage those customer relationships. And if you're truly partners, we're in this together. Everybody knows it's a tough time, and we're trying to handle ourselves in a -- as equitable and ethical way as possible while also keeping our eye on the long game here. Because this is a long game, and those customer relationships are really, really important, and we want to make sure that we operate through this, while not getting squeezed in the middle. And that's, of course, going to have some -- there will be a little bit of -- that doesn't line up perfectly when those cost increases happen and when things happen. And so there will be a little bit of turbulence in the middle, but our goal overall when we come out of this is to be able to maintain our gross margin and not get squeezed, while at the same time making sure that we're well positioned long term.

Yes, makes sense. And Tyson, the third important event for Silicon Labs this year has been the CEO transition. We talked about I&A sale and the Dutch modified offering and share repurchases. At the end of July, you announced your retirement and the election of Matt Johnson to the CEO position. Can you talk a little bit about the transition and your expectations for Matt once he takes over?

Absolutely. I mean very excited for Matt. And Matt came in about 3 years ago, a very strong background in software and in microcontrollers and connected devices and this sort of stuff. He joined us from Freescale NXP, and he's a great leader. And he's been running our IoT business over this last 3 years. And like I said, we had 2 different business units. And now as we've sold this I&A business, it's -- I've been with the company 24 years. I just had a 54th birthday and a daughter getting -- graduating college and getting engaged. And I think we've now transformed the company into an IoT company. And Matt was running that, and he's absolutely ready. He's going to be a great leader for the company and out in the industry, and that gives me a chance to step back onto the Technical Board. I've got a technical background, and I'm looking forward to that. But also the time to kind of reflect on -- there's a lot of stuff out in the world and you don't have to do the same thing your whole life. So I view this as a good time to pass the torch, and I'll be finishing out through the year here. So I'll finish out '21, and Matt will take the torch and drive the growth. In terms of expectations for Matt. It's really to execute on the strategy to optimize around the IoT opportunity and to carry that torch forward. We've got -- with the Wi-Fi, we've got to accelerate our efforts there. We've got to continue to scale our efforts throughout the channel and broaden the customer base and execute on our Series 3 platform and continue to drive differentiation and build the culture within the company. And so I feel really, really proud of what we've been able to achieve as a company, both in terms of the core founding principles and techniques that we had to really be leaders on the silicon side. But also now as a solution provider for IoT well positioned in a great market, being able to control our destiny and our integration path and strive for market leadership. So I think the company is well positioned for that. And I think that the -- overall, I think the transition is going to be seamless. My goal is to make sure that the company is well positioned and to cheer from the sidelines here as I go out and figure out what's next.

Good luck. And this is either for you or John. On the M&A, historically, Silicon Labs was very acquisitive in the IoT market and was able to utilize higher cash generation from I&A business to fund some of those acquisitions. How does your M&A strategy change today? And will Silicon Labs continue to be a consolidator in the IoT space?

Yes. It really doesn't change out of -- it's very similar. We look for opportunities that are a strong strategic fit to what we're doing with strong teams that can add to the talent pool that we have at the company and opportunities that make sense for us financially, both in terms of the metrics and the deal parameters. So that remains a core focus. I think we'll continue to look for those types of opportunities. And as we were talking about a few minutes ago, with the residual cash that we intend to maintain, that will enable us a good amount of liquidity to execute on that.

Yes. I'd just say that on the M&A side, we've now got -- the organic growth story is very powerful. We've got a complete portfolio and a full suite of wireless technology. There's always more stuff to do, but this concept of focus when we -- the big rationale for selling our Infrastructure and Automotive business was focus and accelerating our execution in the IoT market. And we've got all of the pieces that we need. It doesn't mean that there's not more. But so from an M&A standpoint, there's not some urgency. We don't have some big gap to fill. We've got -- you certainly want to look if something makes sense, you want to have the wherewithal to do it. But executing on the strategy and the organic path, like we've talked about getting our next-gen silicon platform out, getting the next releases of software out and continuing to drive the business is a powerful lever.

Great. Let's move to an audience question. The question is, you guide for flattish revenues driven by supply tightness. What are you seeing in the market today? And is the supply tightness leading to lost revenue opportunities and increased competition?

Yes. So I guess I'll just start, Tyson, you can add on. But the guide that we put out for the third quarter is in the low 30% year-on-year growth. So sequentially, I understand the point, but we're still looking at very strong year-on-year growth for the guidance that we have, and that's really how we're measuring our long-term CAGR on that basis. We are supply limited, Atif. There's no 2 ways about it. We could ship a lot more this quarter if we had additional supply, and that's something that we're continuously working on improving as we round out this year and head into next year.

And I think just on the competition side, I mean, I think that we are doing very well from a competitive standpoint out in the market in terms of design wins and in terms of revenue achievement. Certainly, if we could get more wafers, I think that right now, everybody wants more wafers, we can do a heck of a lot more revenue. But I don't think that there's -- I think that if anything, when we come out of this, our share will be somewhat higher than it was before.

And one on the operating margins for you, John. The target model shows the ability to return operating margins to the 20% range? And what are the puts and takes here? And how do operating margins return to prior levels on lower gross margins?

Yes. It's really about scaling the business, and that's a core mission for Matt and the executive team now moving forward here. We've got -- the growth opportunity is there. We have identified that and secured that in terms of opportunity pipeline and good design win momentum. For us now, the imperative is to ramp our OpEx at a lower rate of growth than revenue, mindful of the potential pressure on gross margin at the same time. And we believe it's doable. We have an OpEx frame that is oriented around an operation that's larger -- a revenue base that's larger than we're currently serving. That's with intention, given the enormous size of the market that we're serving. We've put in place the building blocks necessary to attack that opportunity, and that's what we're going after. So make it -- and the final point is continuing to make progress in the ease of use on the products themselves and the ability for customers to design us in with less efforts over time. That remains a core focus. We think we're differentiated in the market today, but it's a journey, and we're not at the destination. We've got more work to do there to make the IoT more simple to implement.

Okay. And then another one, do you sell software on a stand-alone basis? And how big are software sales off the total sales?

No. We really don't. There's a small amount of that, but the -- we're a semiconductor company sort of in the core of our revenue generation, but it is a solution still. So the software is inherent in that and that's how we monetize, is through product sales.

And one more. Are you still seeing an impact from U.S.-China trade tensions in your business?

Indirectly. You see some pressure for domestic sources from the China market, for example. But I'll say this, it's less significant -- it's a less significant element to how we operate than was previously the case.

Great. I think those are all the questions that I had. Tyson, if you have any closing remarks for the investors, feel free.

Yes. Well, I think I got most of that out upfront. I think we covered a lot of ground here in terms of the rationale for the divestiture, the capital return strategy and the M&A strategy going forward. I think it's really important to understand that we've put out a financial model around the growth of the IoT markets and then the growth of the company long term on this 20% CAGR. And we also put out, basically, the operating income of the company versus revenue. And the faster we can move along that trajectory, the faster we can gain that leverage on the bottom line. But there is no question that these markets are growing. We are extremely well positioned in terms of having the right portfolio, the right partners, the right market traction, the design win pipeline, the right road map to be able to continue to drive that growth and scale the company from what -- in that $700 million level now past the $1 billion -- past $2 billion. This is a unique opportunity to invest in an emerging market in semiconductors with a pure play focus and a really strong team that has a track record of execution and the leadership in place to take that forward. So I just appreciate everybody's time. And Atif, I know that you cover us, you and Amanda cover us, and you'll be keeping an eye on our progress here every quarter.

Thank you, guys, for coming to the Citi conference and good luck, Tyson.

All right. Thank you.

Very good. Thank you.