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

All right. Great. Hi, I'm Joe Moore. I'm very happy to have the Executive Team at Silicon Labs here at our conference. Matt Johnson, CEO; John Hollister, CFO. Before going to questions, I have to read quickly, the safe harbor. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your sales rep. So with that out the way, welcome, guys. Thank you for joining us.

Thank you, Joe.

Maybe we could just start off with a big picture look at your strategy. It's really a unique set of capabilities you guys have, an orientation around kind of a broader end market like this, particularly since the divestiture that you guys did. Can you just talk about what the strategy is and where you guys feel like you are in the journey there.

Sure. So big picture, if you step back, we really see the opportunity for ourselves as a company to do what maybe Qualcomm did in cellular or NVIDIA has done in AI and GPUs. We see that opportunity in the IoT space, right? That no company has claimed that, and there's no company better positioned to do that. And the best proof point I can give you, the last couple of years, we've been able to double the size of the company's revenue during the supply chain crisis. And I think that's the headline that gets the most attention. But the bigger one is that we've been able to drive our design wins even greater than that during that same timeframe, more than doubled our design wins over that timeframe. So that positions us going into the next few years. And the question we get is how are we different? And the quick answer is there's no company in our space that has more breadth, more depth or focus on this IoT space, and that's what we're bringing to the market.

Okay. Great. Yes, I mean, the design win lifetime revenue up 50% last year versus '21, can you talk about maybe how you define that and how we should understand that in terms of interpreting it for our future revenue models.

Yes. Sure, Joe. So we have a fairly rigorous standard for scoring a design win. Our team identifies opportunities. And then once a customer takes at least $1,000 worth of product into that opportunity only then can we consider that a design win. So there's no human judgment there. It's not enough to have an award letter or an e-mail, you have to ship $1,000. And what that means for us is that, that's really the beginning of a ramp. And then for the next 3 to 4 years is when that opportunity will manifest the majority of this revenue. And some applications have a very long tail, call it, 7, 8 years, beyond that. But for the bulk of the revenue, it will show up in the first 3 to 4 years after we call it design win.

Okay. And you define that then the lifetime design win based on the number of years in the...

Correct. Exactly.

Okay. And then opportunity pipeline, you talked about $17 billion for a company doing $1 billion of revenue, that's a lot. Can you talk about how you define that and how we should think about that really?

It's similar to the -- it relates very much to the design wins. So when we see an opportunity we estimate the total lifetime revenue for that. And then when we add all of that up, that's the $17 billion lifetime revenue. If you take, again, the average of about 3 to 4 years for an opportunity, that's a $3 billion, $4 billion a year type opportunity, SAM, if you will, so then our $1 billion run rate is roughly 25%.

It's important to think of it, too, is that, that funnel -- those are opportunities that the sales team actually tracks or register. They're not incentivized in any way to make that number big. They're more incentivized to make those numbers that they convert to design wins. So in reality, that number is probably understated in terms of what's being captured. But think of the funnel as capturing the potential, but it only matters if we can convert it into business and design wins because that's the number that really speaks to what's going to come next for sure.

Yes. Yes. It seems like it's such a fragmented market that it would be hard to know how big the overall opportunities are, but those are actually opportunities that you guys see a...

Exactly.

And being able to compete for.

Yes, exactly. It's not a Gartner report or something like that. These are actual opportunities.

Yes. Okay. That's helpful. So industry conditions. On your most recent earnings announcement, you actually saw kind of a stabilization after maybe a little bit of a weaker quarter, the quarter before. Which, I think, was a positive surprise for people, people sort of see the first downtick is like -- and in a market like this, this is something that's going to snowball. And can you talk about, obviously, still mixed conditions, overall. Can you talk about the factors that are holding your business afloat in the tough time?

Holding in a flow? Yes. So yes, maybe start -- going way up to the top and big picture, first of all, it's impossible to know exactly how this environment is going to play out, right? But what we've said consistently is we see a path to growth and we see a path to definitely doing better than whatever the end market ends up being. And the reason for that is we know we've been gaining share, and we know that, that -- those ramps are going to help offset whatever is out there. So to answer your question directly, definitely still seeing strength in consumer, industrial -- I'm sorry, industrial commercial, seeing weakness in consumer. It's also worth pointing out that the consumer side is mostly the home, the smart home for us. The life and health piece of that has been more strong and robust than we expected. So we're still seeing growth there, while we're waiting for the consumer home side to recover. Yes. I think that diversity of business is really serving us well. And like we said, we do see a path to growing and outperforming whatever this year ends up being.

Great. And then can you talk to the role of supply chain and lead times, have been sort of a challenging environment for everybody. You guys have navigated it pretty effectively. Can you talk about how you've seen those challenges?

Yes. We have navigated it well, and it's really based on the strength of our relationships with our suppliers and our posture as an IoT pure-play company. That pure-play status helps us with customers and suppliers, where suppliers are looking for exposure to this market, and we represent an outstanding opportunity for them.

The other thing I'd add to it is we get asked a lot, well, how do we know that -- how you're positioned from a supply perspective. The best testament we can give to our position is not just the growth we drove during the supply chain crisis, but the design wins we secured during the supply chain crisis. You can't grow design wins that fast if customers are worried about you in the future. And if they think you're not going to be able to support them, they'll go elsewhere. So our business has ramped incredibly fast in revenue and design wins because they have confidence we're going to be able to do it. So it's the best data point we have.

Yes. I mean, I don't think that's something we should take for granted given that it has been such a challenging supply chain environment. I know there are some small companies, I won't mention, that I cover, that have struggled with the supply chain issues and have struggled, not just with their own supply chain, but to give customers that conviction that they can deliver.

These -- when there's a crisis, relationships either get better or they get worse. And our supply relationships have gotten better. You don't hear us trashing any of our suppliers and our customer relationships have definitely gotten stronger as well, and we've gained a ton of market share. So that's exciting.

Okay. Great. And your visibility, right now, outside of the perturbations that you talked about in home surveillance. Seems like you have pretty good visibility, pretty long lead time still?

Yes, we do. Lead times are sitting at about 6 months right now, Joe. That's come in a bit. It was closer to a year, 6, 9 months ago. But all that said, that speaks to a portion of the quarterly revenue. We still rely on turns to build it out. So it's not perfect, but it is longer than it has been in the past.

And where do you want those lead times to get to?

I don't think we're going back to the old days where we were less than 1/4. So call it, 13, 15 weeks will be kind of the ideal state, overtime, but it's going to take us a while to get back there.

13, 15 weeks and still some ability to meet turns demand?

Absolutely.

Okay. Can you talk about distribution? I think over 80% of our revenue goes to distribution. You've talked about rising inventory in China a little bit. Can you just talk generally to your distribution strategy and what you guys are seeing there?

Yes. I was just going to say most people are aware that we have a large distribution percentage of our business, right, 80%. It's important that people understand within that, there's a large component that is fulfillment because we directly work, support and engage with those customers. And that's a valuable piece. And then there's another piece that's very valuable as well, which is the piece that we don't touch, that's demand created by our distributors. And that's not a business, we don't invest in. It requires a lot of investment to make that low or no touch, easy hands-off business for us, but that's really valuable business and higher-margin business. So we're very focused with our distributors on feeding and supporting both of those because our goal is to, overtime, continue to gain market share and be the undisputed leader in the space. We need both ends of that spectrum in order for that to happen, and that's where we're structured and the way we're executing.

Okay. And can you talk to the level of inventory that's at distribution?

Yes. We were stable in the fourth quarter at around 60 days. That's very reasonable, particularly as you compare us to larger peers in the industry. We could see that potentially coming up a bit in the first quarter with the business down ahead of ramps as we progress through the course of this year. But we monitor that carefully. We don't want to let that get too high, as we could have other demand that could benefit from that inventory availability.

Yes, that brings up -- it's a really important point for us that we're trying to be as responsible as we can in this market environment because there's a lot of uncertainty out there. But at the same time, we know the businesses we won, we know the ramps that are coming. And frankly speaking, our industry doesn't do a great job at handling these swings. We just keep going back and forth. So we're very focused on making sure we can support our customers' ramps on the other side of whatever this environment is because they're coming and they've been won, and they're going to ramp, and we cannot be short on supply to those ramps. So it's a tough balancing act in this environment to make sure we're doing both of those well.

I just want to add on clearly that, Joe. So I mean it's monitoring and managing that distributor inventory on the organic in-house inventory, making sure that we're well positioned for growth, heading into later this year and into next year. So that balance is coming up. It doubled in 2022, see it coming up again in the first quarter, and we'll continue to build reserve inventory. But that's in DI bank form, which is almost like raw material that we can then build out and submit these for SKUs, ready to put -- part numbers.

Okay. And then talking about a difficult balancing act, China, we've got -- talking to people at this conference, numerous reports that continues to be slow. On the other hand, it seems pretty obvious that it's going to start to speed up. So how do you prepare yourself for economic re-acceleration after such dormancy in that economy, and how do you prepare yourself for that without overextending?

It's great setup. So we had 24% China mix in fiscal '21. That was down 10 points in '22 to 14%. That's pretty low, and to your point, I think there's more upside opportunity than further downside risk, given how kind of bad it's been in the Chinese economy. So we're just -- the same strategy, is making sure we have enough inventory on hand, making sure we're working carefully with our distribution partners who serve that market, and we're just kind of waiting to see if the recovery will begin. I haven't seen it yet, to be fair.

And as we've said publicly, we haven't predicated our plan on a recovery in China 2023, it would be great, but we're not assuming that will happen. The other thing that's worth mentioning is we've always had headwinds in China to growth there, right? There's a lot of local incentives to use local suppliers. There's the non-A strategy, all these things. And those have just been business as usual. We will only get designed in if we have a meaningfully better solution than any local alternative. So we're at peace with that. The dynamic that's relatively new over the last couple of years, is the Chinese semiconductor suppliers are having a more difficult time getting designs in the West, in particular, in the U.S. and Europe. So we're seeing a lot of places where those suppliers are going to be designed out in favor of our solutions because they don't want Chinese silicon in those sockets. And that's new. That wasn't a strong dynamic even just a couple of years ago.

Yes. Okay. Okay. Maybe shifting towards the annual outlook. The most recent earnings, you talked about this year being more like calendar '21, where the growth is kind of more unit driven, less ASP driven. But you have the product cycle, design win pipeline that you talked about. Maybe ASPs could continue to be kind of a mix-related strength. So can you just talk about the balance of those things?

Yes. Yes, that's right. I mean that commentary really is about specific price increases. We had some limited price increases. But -- your point is a good one, is that the customer mix, product mix can still positively benefit our ASPs and revenue momentum. And at the same time, we see a lot of unit growth ahead over the next, call it, few years as we have major programs ramping out in the market.

We talk about our current generation of product is Series 2, which is not the best name because it's our fourth generation, right? And what matters about it is each of these generations we're getting better and better at addressing and serving this marketplace. Every generation, we learn something and things that are incredibly valuable and help us be more competitive. And last generation Series 1, we released 4 wireless SoCs. This generation, we've already released 6 on Series 2 with that many, if not more to come after that. And it's not just about the quantity, they're just hitting in the marketplace. Each one of these products is setting records for us that we've never seen before in terms of the adoption, the opportunity, the design wins just the potential for each of these, which is incredibly exciting for us to have this product cycle be so strong right now, and it's helping drive that design win number I've talked about, helping drive that future growth that we're talking about. And of course, we're already working on the next generation as well, but we want to make the most of this because we've just hit it. We've hit it hard and right, and we want to make the most of that and grab as much land as we can.

Okay. Makes a lot of sense. In terms of the price increases that you were passing through from your foundry suppliers. Is there a point where that reverses? It's a question I've asked everybody, but nobody seems to really see that happening, but is it -- the foundry price, I know it reverses at some point, does that mean you end up passing through price declines to some of your customers?

Potentially. We'll see what comes. And I agree with the first part of your comment, we really haven't seen that yet in a meaningful way. But the marketplace will take over and normalize things, probably and hopefully, actually. So we could see some moderation in our pricing, overtime, that is possible.

Right. But it doesn't seem like the customers are really asking for it. At this point, the customers are still focused on supply chain...

Every customer like better pricing all the time. So I don't want to ignore that. The way we've tried to approach it with our customers is with just transparency, integrity and being very open with them that we're passing it along. And if it goes the other way, we'll pass it back. What we have confidence in is our ability not to get stuck in the middle and that we can navigate it either way. And I think we have a good track record of doing that. I think where we've taken some heat is when the margins have gone up more than expected, we've been asked, why aren't you resetting your model? You don't reset your model in an atypical market environment. And pricing pressure, market forces they will prevail. They always do. It's just a function of time, but we're confident we can navigate it.

Yes. No, I think you guys have done a really good job of keeping those expectations in check, helping us to understand how all that flows through. Maybe we could talk a little bit about the consumer mix that you referenced, maybe, first, starting with the part of it that's weak. Any visibility into why the smart home business, I mean, it seems like still a pretty compelling product cycle, really exciting products, heavily promoted at the holiday period. What is the prognosis for that? What do you see needing to have a to see that business start to grow?

Yes, I don't think the fundamentals of that space have changed at all. I think it's just a victim to the environment we're in, where expectations were high, higher than reality, people built inventory, now they're trying to work that down. If you look at the marketplace itself for the smart home, the adoption is high as it's ever been. No expectation will slow down. And there's some things out there that are going to help, right? There's standards like Matter, which are going to make it easier for consumers, easier for developers, which will accelerate wireless adoption in the home and in the industry, overall. Same on Amazon Sidewalk, right? I mean these massive initiatives exist for no other purpose than to accelerate wireless adoption. So those are all going to help the smart home, but they got to work through the inventory that's there right now before we see the -- on the other side.

Yes. I mean it seems like even the end demand from what some of the customers have said is still quite good.

It's -- yes, I think a lot of customers are very quick to remind us -- they still have good demand. It's just not as strong as they thought it would be, but it's still strong.

Yes. Okay. And then the parts of your consumer business, which are stronger, health care and stuff like that. Can you talk about the drivers of that strength?

Yes. So think of the smart home as a space that we've got a leadership position for a long time. We've been focused on for a long time, and we just covered what's going on in the market there. If you take health care, which we call life, that's a space that we have not historically had a strong position in or any position. And going back 4 or 5 years ago, we decided that would be a good strategic thrust for vector for us to double down, triple down because you can see it coming, that the need is there and the opportunity is there. And I would never call the pandemic lucky, but our -- we were fortunate that we were so focused on that space. And then with the pandemic, it just accelerated the need and adoption for wireless connectivity across so many devices, whether it's on the non-FDA side or the FDA side for wireless connectivity. So we've seen strength, independent of what's going on in the overall environment because we're seeing new applications and we're seeing share gains, and that combination, I think, will serve us well for years. So I think you're going to be hearing a lot from us over the years to come about our position in health care and the growth potential there. And it's cool because it's good products that are also making a difference in helping people, which everyone loves.

Right. Right. Okay. And then on the more industrial side of your business, can you talk about some of the most important growth drivers there?

Sure. Industrial is always tough because you love the dynamics of it, but it's very diffused in terms of all the different applications. But a couple of things. Growth drivers at a high level, then I'll talk about specifics. At a high level, it's hit its mark, right? It's -- the technology is ready and easy enough to deploy and the returns are fantastic, right? Our customers are seeing returns in 9, 12, 18 months, and they're also seeing a competitive dynamic where people don't -- it's almost FOMO where people don't want to be left behind. So the adoption is accelerating clearly. But it's still early days. So you're looking at a good decade or 2 of growth in that space, which is awesome. Easy examples that we've talked about metering, always had a strong position there, gas, water, electric has always been kind of big in Europe and the U.S. Now you're seeing India and Asia explode with adoption. South America, I mean, it's just fantastic. And our position there is good in most cases, no matter who wins or shelf labels. Another example we've talked about, the digital labels has really accelerated in terms of global adoption. And whether you're going -- a lot of people in the U.S. will have seen them at maybe Whole Foods or Best Buy or Home Depot, but those devices can automatically update the price to price -- what's available online, manage for perishable inventory. You don't have to update all the time. And it works for dynamic pricing and the returns are great. So those are a couple of examples of specifics within that massive market of all those different applications.

So inflation helps you.

It's just taken off.

Yes. You can change the price of eggs every...

As much as you want.

Okay. Great. So I guess when you think about the revenue growth, at the Analyst Day, I think you talked to a 20% CAGR. But you've also about your design win lifetime revenue going up a lot more than that. I guess how do you -- is that conservatism? Is that -- it just takes time to bring these ramps up. Just how should we think about those 2 numbers?

Yes. Fundamentally, Joe, it's looking at our best view of the SAM rate, which is in the mid-teens overtime. Again, like Matt was saying earlier, it's been atypical environment in the past couple of years. Overtime, we see the market growing in the mid-teens, we think, as we have been doing, we can continue to grow our share of that market ahead of that growth, and that's what we're targeting the 20% CAGR on.

Okay. And you get -- I mean, there is still the pricing lift of Series 2 and things like that, it's part of that as well.

Yes. I mean, easy way to think about it is our commitment to that model is what drives us and our goal is to always do better than that. And we've done better than that the last couple of years, but we honestly don't see any signs of that slowing down, given the design win momentum. It will be lumpy, how it comes in, like years in environments like this, but the absolute opportunity and trend is the strongest it's ever been. And I think even in this environment that we're in right now, which is uncertain. Most of our discussions have been around, yes, we got to be responsible, but how do we capture and maximize all this opportunity that's coming in. I think as we've kind of gotten to the size that we are and clarity of message and focus, we just keep getting looks. People approach us who have never used wireless technology before and say, how might we do this? How might we partner? And obviously, our goal is to support that. And they don't even talk to anyone else. I mean, it's really exciting. So we feel good about it. We're just -- market is huge and growing, best position possible, just got to put 2 and 2 together and make the most of that.

So one more question, and then I'll open it to the audience. The building blocks that you have, I mean, obviously, you have the highest breadth of communication standards for IoT, you have software offerings to sort of help people do designs. Where are you in terms of that? Do you -- are there capabilities that you still want to build out from kind of a broad capability standpoint?

Yes. I mean it's never done because it's always evolving. But big picture, if you look at it, we spent really the last 10 years acquiring almost a company a year, when most of that was really about adding capabilities to our portfolio. We're at a point now where we have the requisite capabilities that we want and need. And our focus now is just about maximizing and driving share within that. That's not to say if we need a technology overtime, we'll make it or buy it. But right now, we're just trying to maximize the opportunities in front of us, and we're not feeling short on any capability or technology, which is one of the reasons why I think we're just seeing that flywheel effect and acceleration that we're seeing.

And do you see the bigger competitors taking on your approach? Or is it still there selling point products in like Zigbee and Bluetooth and things like that?

I mean we should always be hyper-paranoid, about all our competitors. But what we're seeing right now is -- the biggest companies, it's a challenge for them, right? They have core businesses that they have to protect and focus on, that served us really well during the supply chain crisis because they all retrenched, and that helped us gain some share. Also, when you have a big core business, the tendency is to try to apply that model to the new model, right? And it's important that people realize, the IoT space is unlike any space, the semiconductor industry has ever seen, right? Think of the volumes of handsets or PCs, which are big and they have been globally game-changing for the way we live and work. The IoT volumes are dwarfing those already, right? You're talking tens of billions of annual units going to probably 100 billion units over the next decade, you cannot take approach that worked at one of those other markets and say, I'm just going to apply it to this market. It doesn't work, and you can see that. Everything we've done has been custom, homegrown, made for the IoT across 4 generations. And that's why we're able to do what we're doing because it's made for it. We're not trying to repurpose it and reapply it. So we always have to be watching all our competition. But until they really start working to focus on the market and serve what the market needs versus just reapplying what exists against that market will be relatively well positioned.

Great. Let me pause there and see if we do have questions from the audience.

I'd be so disappointed, Jack. Come on Jack. Maybe I don't want to know what question is it.

Maybe then we could talk about some of the financial issues, I guess. On the most recent earnings announcement, you talked about another $200 million available for share repurchase. You look for a cash buffer of $1 billion. Can you talk about the trade-offs in terms of your cash balance.

Sure. Yes. So Joe, we're looking at returning capital to shareholders in a responsible way. We've done a good job of that. I would say, since the divestiture, we've deployed more than $2 billion as was our commitment. And part of what we're looking at is what's the right amount of cash to retain on hand, what's the right amount of leverage to keep in the model, if any, as we move forward here, we are evaluating that as well. And just ensuring that we have good capacity on hand to be strategic in the event that an M&A opportunity or other cash need of that nature arises. So that's the balancing. But continuing to return capital to shareholders as we generate cash flow. This is an ongoing thing that we see in the future.

Yes. Okay. Great. I think we'll wrap it up there. Thank you so much.

Okay. Really appreciate it.

Thank you.