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

Good evening, everyone. Welcome to day 1 of Citi Global Technology Conference. My name is Atif Malik. I cover U.S. semiconductors, semiconductor equipment and communication equipment stocks here at Citi. It's my pleasure to welcome Matt Johnson, President and CEO; and John Hollister, CFO of Silicon Labs. Silicon Labs is a pure-play leader in IoT devices, and they have software, hardware, wireless and security integrated platform across multiple end markets, industrial and commercial, home and life. Silicon Labs, recently late August hosted their development conference, and I'm going to start off asking Matt what he previewed on their next-generation Series 3 platform and also what he heard from some of the major customers like Amazon and Google Nest at the Development Forum, Matt?

Sure. Good morning, everyone. And yes, I mean maybe to give some context for anyone who's not familiar, our Works With is a developer conference that we host every year over the last 4 years. And it usually has a high virtual component, but sometimes there's also an in-person component as well. And we just had our Works With conference over the last few days. And we're really excited about it for a couple of reasons. One is record attendance, over 10,000 attendees, which is meaningful in our space and industry because it's really the only place that our industry has to come together for the IoT space. And it's not only Silicon Labs. Obviously, all of our partners are there as well across the industry, whether it's Amazon, Google and Samsung and many others. So the big deal at that conference was we had multiple announcements, but the biggest one was we gave the industry a sneak peek or preview of our next-generation platform. And a few reasons why that's so relevant. This next-generation platform called Series 3 is actually our fifth generation of wireless platform, really purpose-built for the IoT. And we're currently on our Series 2 platform, which has, honestly, 6, 7, 8 years of growth ahead of it. We're still right in the power cycle of that platform. But we also don't ever want to get complacent or too comfortable, we want to keep pushing the boundary for ourselves in the industry and give people that visibility and runway into what's going to be available down the road. So that was what the announcement with Series 3 was. And some of the highlights of Series 3, why it's such a big deal for our industry. One is we're really pushing the boundaries on all the things we've always excelled at as a company. We've always led the industry in terms of power consumption, security, wireless performance across tons of wireless protocols and ecosystems and Series 3 is going to take that to the next level. So longer battery life than anything that's been announced or existing in the industry, next level of security, which we already have the leading security platform in the industry. We're going to take that to the next click and even more wireless integration across multiple radios, multiple protocols, multiple bands. So that's the first piece of the announcement is really taking our historical strengths to the next level. The second is compute. We're taking compute from -- take 2 elements: general compute. Think of Arm Compute for our customers' applications. We're doing a 20-plus x increase in performance, which is very relevant because that allows a lot of our customers to integrate the stand-alone microcontrollers and their applications. And we're taking the machine learning or AI performance up significantly to over 100x our previous generation. So we already had the only integrated AI in a wireless SoC in the industry for what we do, and we just gave our customers a road map to 100x more performance and compute down the road. So that was a big announcement for our customer base. And then the third piece is scalability. We've really built this thing to scale at a much higher level for the industry. One of the biggest challenges in the IoT is interoperability, scalability for all these different protocols, ecosystems, products. And some of our customers have over 200 different IoT developments in house. So what we've done with Series 3 is a few things. We've given them the ability to scale much faster in software, scale much faster in terms of their development cycle time. And we've given them a road map where if they're developing on Series 2, which is the industry's leading platform. It's also going to be portable to Series 3. So if you're a developer, this is the best possible thing that could happen that the platform you're already relying on also gives you a road map to the next-gen platform. You can stay there, you have portability. You have scalability. And obviously, we addressed a lot of the industry supply concerns by giving them a road map to multiple foundries, multiple geos, which is also important. So big picture, if you step back, we have the platform that's already leading the industry, and we just gave them a road map to something that will allow even faster scaling and deployment of IoT devices. So it was a big moment for us and the industry over the last few days and pretty exciting.

Great. Matt, just staying on the product Series 3. Where are we in terms of adoption of Series 2. I mean how [indiscernible] you are on that?

Yes, that's a great point. I'd say we're still relatively early, just to frame it for everybody, we started ramping Series 2, let's call it, production shipments over the last few years. So an easy way to think about it, our company doubled its revenue over the last couple of years. That was primarily driven by Series 2. Our design win funnel -- I'm sorry, opportunity funnel is around $18 billion, over $18 billion now. That growth is all driven by Series 2. Our design wins, which are growing at a faster pace than our revenue over the last few years, that's being driven by Series 2. So it's really driving our current growth and it will drive our growth for the next few years to come. So we still have many more products coming out on Series 2. We'll be developing software on top of Series 2 for the next decade easily. These things don't go away. They last a long time. So the best way to think of it is Series 2 or Series 3 won't replace Series 2, it will complement it and build on top of it. It's not an instead of, it's in addition to.

And what is the availability for Series 3 timeline.

Series 3, so we're already engaged with multiple customers because we've been working on Series 3 for a while. But in terms of early access is general samples, that type of thing, that's early next year.

Okay. And then the next one, the top line growth and John, if you do jump in. You guys have seen your revenue double from 2020, 2022 last year, 25% year-over-year growth and outperforming the industry. This year, if we look at consensus numbers, somewhere down 11% to 12%. Obviously, macro is a big piece of that. You're dragging some of your end markets. So how should we think about your outperformance? How much was it the market driven? How much of it was the share gains because of the Series 2 products that you have talked about? How much of it was maybe the ASP is going up.

Yes. So particularly looking at '21 and '22, we had significant share gain activity. And it's really on the back of the Series 2 early progress and success that we had. Also, the supply chain situation where Silicon Labs really shown in that whole last couple of years of having more available supply, being able to address the middle part of the market, frankly, better than some of our competitors and that's a very durable business. Those were trends that will stick with us for a long time. But it's really on the back of the strength of the Series 2 products themselves. If you just think about the BG22, our new Bluetooth device, that has done really well in the market, and we have definitely gained significant share from that. Yes, in '22, there were some ASP lift because of supply chain cost inflation. But really share gain has been a very material component of our growth success for the last couple of years.

And John, looking into next year, I know -- I'm not asking for a guidance, but again, [ street ] is modeling you guys up [ 7%, 8% ] year-over-year. Are we just looking at things like PMI indicators and stuff like that to see a rebound in the overall market and then layer your outperformance based on your product cycle.

Yes. Simply put, yes. We are in a down cycle right now. No question about it. It will recover. It's just a question of when and how strongly, but we feel very good about the company's longer-term growth horizon. We maintain our 20% CAGR goal, and we think that's very achievable for the company over a mid- and long-term basis. And the one -- additional thing I want to point out is while the revenue is behind this year, the design wins are on track. We year-to-date are on our annual plan for design win momentum. That's a really good sign for longer-term growth on the company. That also bodes well that the IoT customer base is not pulling back in terms of investing in their own new product development.

Yes. I think that's really important, John, because none of the fundamentals have changed, right, that the need for wireless connectivity and connecting devices at the edge, that's only accelerated over the last few years, and that outlook over the next decade couldn't be better. And our position and ability to capture that has only improved over the last few years with Series 2, the strength of that platform and now Series 3. So we're obviously not excited about the current market environment, but very excited about the next few years on the other side of that. given that positioning and that market outlook.

Great. And John, just staying on the cycle, if you can remind us what your lead times were pre-COVID, where the lead times are now and also the backlog kind of coming down? And if you're seeing any signs of stability.

You bet. So pre-pandemic, we were operating with fairly tight lead times. You can think of it as 7 to 8 weeks. So we would enter a quarter roughly half booked for the quarter with turns to go to account for the other half. In the height of the pandemic and the supply crunch, those extended way out. And we had a lot of backlog accumulate. We're now getting more back to normal, but with also some high variability in the lead time experience. Some customers are continuing to put fairly long lead times on their orders. Other customers are really short, well within a month of lead time. So it's kind of a mixed bag. That does affect our visibility to a certain extent. But over time, I think we're looking at more like 12 to 14 weeks as a more normalized level. I don't think we're going back to the prepandemic lead time experience as this thing settles out.

And Matt, you talked about your long-term goals, 15%-plus component growth rate for industrial and commercial [ person ] for Home & Life. Can you talk about which end markets within these segments, whether it's smart lighting are you guys most excited about?

In the overall?

In the overall IoT, because IoT is such a broad team.

Yes. And everyone defines IoT differently, I think, depending on -- yes, sure. So if you step back, maybe an easy way to do it is break it out by the way we are structured and look at it internally. So we have our Home & Life business, which home typically covers a lot of the spaces and applications. I think people are more familiar with, whether it's lighting or panels or smart speakers or security systems or any of the devices that you might see in your day to day. Life is more indexed to something you might wear health care, your quality, your lifestyle, medical. So that space, we've seen really kind of accelerate over the last few years. And everything indicates that has really strong secular growth capability over the next decade. And easy ways to think about it are during the pandemic, telehealth took off, and that seems to be durable. And the need to connect devices as part of that, whether it's a -- think about it a blood pressure cuff, a pulse oximeter, a thermometer or just wearables for health type tracking your day-to-day preventive -- all these monitoring blood glucose, all of these are taking off as long-term trends. And we've been focused on that space for a long time. So that's an area where we see long-term durable growth in addition to the traditional spaces in Home & Life. And then if you go over to the other side of the house with industrial commercial, I think that space has really kind of hit its stride over the last few years. And what I mean by that is the economics are -- the financials are just strong. Our customers are seeing returns under 12 months for a lot of different applications and deployments, which is a real key or trigger for them to deploy and accelerate adoption. And the software maturity, technology maturities also hit its stride. So easy examples would be metering. We see that across the globe, whether it's gas, water, electric and with very fast returns for those applications. We talk about shelf labels or digital labels, again, very fast returns for the commercial and retail environment, so deployments accelerating. And it just goes on and on across each of those spaces where in a factory, just wire replacement, just awesome opportunity to simplify the cost structure, improve the upgradability, you could put that under the industry 4.0 bucket. But those are a few examples that really have strong long-term growth and deployment outside of the traditional understanding of what the IoT is, maybe as a quick answer.

Great. And I still get asked about your secret sauce versus some of your bigger competitors, whether it's TI or ADI or ST Micro. I would say, maybe some of it is software, but can you just talk about what drives your kind of penetration on the IoT market and what keeps the gross margin so high? And the barriers to entry.

Yes, sure. I mean quick answer is depth, breadth and focus, right? There's no other company in the world that has the breadth of what we do across multiple generations, the depth in terms of what we can do in terms of -- we can take a watch battery and make it run for 10 years over a mile for our customers, right, with high security, interoperability and the focus that this is all that we do. And if you take that to the next level, most companies trying to do what they do and push that into our space. What we do is custom purpose-built for this space, which is really important. We're not trying to just say, "oh, it's an adjacent SAM expander". It doesn't work that way. And that's one of the reasons we're successful. Multiple generations of focus, really important. We have domain expertise, understanding relationships trust. And just look at the supply chain crisis over the last couple of years, as a company, we were able to double our business during that crisis. And we saw a lot of our competitors stumble where they either focused on other areas, they weren't able to prioritize it, they weren't able to execute. And the last piece that is worth mentioning wireless and RF is hard. It's not something that you just say, "Hey, I've decided strategically, that's cool. I'm going to go do that." And trust me, you look at any company that says they want to get into it, they have to acquire their way in. You don't home grow your way in. And once you acquire, it takes years to integrate that. I mean, simply said, it's a lot easier to integrate digital in RF that integrate RF into digital. And we see a lot of our competition struggle with that on a day-to-day basis. So simply said, that's why we've been able to grow faster than our competition. And if anything, given our design win momentum, we see the ability to grow even faster in the coming years because of the execution of the platform and the confluence of all those things. So definitely a lot of competition out there. But because of that, we feel extremely good about how we're positioned.

Yes. And I just want to quickly add on the depth concept. We have been doing this for a long time. We have been 15 years really in this market.

5 generations now.

Yes.

John, just going back to the cycle question that keeps on coming up is China, your sales. I think your comments for China was maybe 10% of first half sales. Can you just talk about -- are you seeing the weakness at least in the near term across all regions or China, the main driver?

Yes. China has been a key driver of market weakness. And unfortunately, we just haven't seen signs of China taking off or really recovering in a robust way. We have seen this cycle really globally at this point across business units, across the various end markets that we serve. We're navigating it. We're looking at our own internal spending, et cetera. But unfortunately, China situation has been quite weak for about a year now.

All right. Another one on the competition. Are you seeing any kind of domestic the Chinese fabless companies coming up in this market?

I mean certainly, there are some, Atif, and they have had some degree of success there. But back to the design win comment, what is interesting is while our China revenue is really an all-time low at 10% of our global revenue. The China design win mix is stronger than that. It's around 20%. And that is what one would typically think of as a normal level for a design win in China. And that really tells us that, number one, China customers are still designing new products, and they are continuing to opt for best-of-breed technologies. But for sure, over time, in the mid and long term, the domestic threat will persist and likely accelerate.

We don't want to sugarcoat it, right? I mean, there's literally hundreds of companies locally in China trying to do what we do. And we've always only been selected if we have something that there's no other viable alternative, right? I mean, almost everything we do is sole sourced by a long shot. So that dynamic hasn't changed. We expect it to continue to get even more challenging over time. But very few of those companies have achieved whatever you want to call it, escape velocity. And the one thing that has changed is their headwinds are outside of China have increased. And that's new. There was always a headwind in China. But outside of China now, we see so many companies who don't want Chinese silicon, especially big brand companies. So we're seeing -- and it's not even, "Hey, in our design cycle, we want to remove it." They want to remove it ahead of the natural design cycle. So that's new. We haven't had that as much in the last decade. So it will be interesting to see how that plays out moving forward.

Great. Let me pause here and see if there are any questions in the audience. If you have a question, you can raise your hand and we'll pass the microphone to you. Yes.

As a follow-up question for John. If lead times pre-COVID, were [ 7, 8, ] but they're only going to recceed back to [ 12 to 14 ] arithmetically, that would suggest that every quarter is basically based on the backlog you had entering. I'm sure you have turns or book and ship business in the quarter. But how does that change the management if you look at how you run the company post-COVID versus how you were doing it before? How does it change your visibility? And what are the implications for variability in your business post recovery.

Yes. Thanks, Chip. It's not -- I wouldn't say it would meaningfully change how we operate. In theory, this should give us better visibility into customer order patterns. But even within these average type comments, there's a lot of mix. And customers do not uniformly conform to quoted lead times. So even with our [ 12 to 14 ], if that's where we land, you'll continue to see aberrations longer or shorter over time. But in theory, it should improve visibility.

Yes, 100%. And honestly, there's just not much incentive to have the shorter lead times. I mean, it's an easy way to summarize it, right? You have less visibility. The natural cycle to develop the parts is much longer or manufacturing is much longer. So it will help net-net, but it won't be transformational.

Yes. So this will put us more in line with market is the other way to think about that with competitors.

Do you think your booking ship business over time in recovery still stage way well below the 50% that it might have been recorded.

Yes. We'll have to see how that shakes out. One would logically expect that to be the case. The magnitude of it, we'll have to see, whether it's 10 or 20 points less, we'll have to see how that shakes up. The question was whether the turns will be less than that were the case pre-COVID.

It also depends on the end markets in terms of demand, how strong the demand cycle is for overall macro. And I also think where people's heads out on supply. That was a massive topic for the industry that's kind of gone quiet, hasn't gone away. So I think we'll see as the environment right now is not awesome, it's going to change, demand is going to be strong and supply will be back in people's minds. So I think there'll be more people lean in on their ordering patterns more than they had historically as a result.

Questions. Okay. John, in terms of your gross margins, you have a best-in-class premium gross margins versus some of your peers, and you have the same expectations continuing for longer term. But you have mentioned a modest gross margin erosion on the last earnings call. Could you elaborate on that? And when will it normalize?

You bet. So we do, we do deliver premium gross margin to the IoT space. If you look at our pure-play competitors or the embedded IoT operations in some of our larger competitors, as we see larger customers ramp as we see more mix in our revenue of open standards-based technologies like Bluetooth and Wi-Fi, we do expect some modest erosion in the gross margin performance over time. we don't think it will be aggressive. We think that will be modest in terms of that trajectory. And if you look at our model, that would call for margins in the mid-50s to upper 50s, that's the range. We're at the upper end of that range, we may see that trajectory moderate to more of the midpoint or lower end of that range. But an important point about that is the trade with that is superior top line growth and ramping EBIT margins. That's really the model. That's the play. We will accept some modest erosion in gross margin for top line growth and for ramping our EBIT margin over time. And the proof in that has been the last few years. This year is a tough time. But if you look at the progression from the company as a pure play company from 2020 to 2022, we ramped EBIT margins even more than we expected, and that is a trend that we expect over time to continue to take place.

100%. And there's nothing in there that changes that stands a position that our gross margins will be at a premium relative to our competition. We don't see anything changing that dynamic just as we go from our goal to get from $1 billion to $2 billion to $3 billion over time, long term, we expect that gross margin will come closer to our original target. But we'll always be at a premium. And if the industry drives higher gross margins, we'll be at the top of that.

I know you didn't ask this, Atif, but it's we're continuing to work down the P&L as we ramp EBIT margins, we expect even greater leverage on EPS and given the capital deployment progress that we've made, we've returned over $2 billion to our shareholders and lowered our share count to an all-time low. Our share count today is roughly where it was right before the company went public in 2000. That's a fairly dramatic change in our share count.

Yes, that's where I was going to go next, John, in terms of capital allocation. I feel like you guys were fairly acquisitive maybe before you divested Industrial and Auto business to Skyworks. But I think more recently, you guys are less acquisitive and returning more cash to shareholders in terms of buybacks. So could you just walk us through where we are in terms of using that $2 billion buyback and then how much kind of gunpowder is left?

For sure. First point is we remain very interested in strategic M&A that can further our progress, particularly in the Wi-Fi and Bluetooth space, areas where we are already competing. If there are opportunities to double down, accelerate, gain scale faster, et cetera, we're very, very interested and open to that. Capital return has always been part of our capital deployment strategy, and we had returned a fair amount of capital through share repurchases over the last decade, 15 years or so before the divestiture transaction. The divestiture allowed us a very large amount of capital to accelerate that and really move that needle in an unusual and really meaningful way. So we took advantage of that opportunity. And we're able to return over $2 billion. That's really largely complete now, not to say that we are not going to continue share repurchases. We will but the unusual amount of capital that was in the balance sheet has been really deployed at this point.

It's worth mentioning because I'm not sure how well this is understood or how broadly known. I mean the -- as John said, we've been in this space for well over 15 years now, but the last decade was really about acquiring. We acquired a company almost every year, and it was really about acquiring the requisite technologies to do what we do. And you could think of that simplistically as kind of SAM expansion. Now we're in a position where we have the requisite technologies and capabilities. This is not something that we need. There's incredible opportunity in the markets we're in and the ones we're serving. So we want to go and maximize that gain as much share as we can. So from an M&A perspective, we're certainly open to it, but we'd be looking for things to accelerate within our SAM, not expand our SAM. And that's a smaller list, and that's where we're at.

John, in terms of your distribution, can you remind us how much you direct and how much you use the distribution channels? And if you're thinking of you doing something different given the supply chain disruption from COVID in the future?

Sure. So we run about 80% of the business through distribution. Within that, there's a mix. You've got some business that's more fulfillment-oriented and some that's true demand generated by the distribution partners. Our distribution partners are very tight with us. That's a long-time relationships. We conduct training with their FAE teams. It's really a force multiplier in the market, strong relationships going back decades, and they're a very important part of our business. I also want to mention that we have clear visibility into what's going on in the distribution channels. We get weekly reports on point of sale, as well as inventory levels. So it's very much a partnership in the go-to-market with our distribution partners, and we don't really expect that to change.

Your design win funnels about $18 billion, 2 or 3 years ago, it was about $12 billion to $13 billion. Do you think that continue to grow at that rate. And within that funnel, what's the kind of mix between Tier 1 customers and...

You bet. Question is on the opportunity pipeline and whether that can continue to have strong growth looking ahead and what's the mix of that. Short answer is yes. We do see that continuing to grow. And we measure that on the basis of lifetime revenue. So $18 billion is for the full life of the opportunities that we are surfacing it's roughly split between the 2 business units. We see a lot of great traction on the industrial and commercial side. Matt was mentioning that, given the ROI that's activated by the adoption of wireless sensor networks, we see a ton of new design activity in the Home & Life side as well. Looking at Life in particular, we have made a major push into the medical space, and we're starting to see the fruits of that now. and we'll see that business is already ramping today, and it will be ramping over time here even more as some of those designs come to full production.

Yes. I mean very, very equal across the end segments. Maybe a bias towards the growth over those years was driven by Series 2, as I said, really strong growth in their Wi-Fi and Bluetooth. We said a few years ago, we were going to go accelerate Bluetooth. It's exactly what we've done, far from done. And now we've said we're going to do the same in Wi-Fi. The funnel is there, design win momentum is there. We're going to do the same thing. So if you wanted to tease out some trends in there, definitely a Series 2 equal across the BUs, increasing Wi-Fi and Bluetooth as you'd expect. And we have to start incentivizing that funnel thing because that's just all natural organic funnel growth that's in there. It will continue to grow. But we're going to have to start focusing on it more is what we really focus on is design wins, right? And the funnel just naturally grows on its own. And then it's convert as much of that as we can to design wins. We might want to start increasing the focus on the other side because we talk about it so much. So we'll have to figure that out.

In terms of that $12 billion to $13 billion funnel starting to [indiscernible] 2 years ago because I think it calls it was kind Q3, Q4 really that concerns.

So it's rolling. The question is how soon is the opportunity pipeline manifest in revenue, things roll in and roll out, it just builds over time. But the reality is there is ramping business inside our revenue base today and that will continue to grow over time here.

Questions? Matt, your comment that Series 3 has 20x more compute kind of caught my attention. And I feel like you guys have been a bit further along in terms of introducing ML, AI on the edge and through your microcontrollers and devices. And there's a big kind of debate going on at what pace or some of these not large language models, but maybe the mini models proliferate on the edge away from cloud. Can you just talk about what you're seeing in the market in terms of AI, ML on the edge.

Sure. Yes. So our current generation Series 2 does support not large language model or generative AI, it supports machine learning on the edge. So what we mean when we say that we have a dedicated compute and accelerators built in to process machine learning inference way more efficiently than you could with the general purpose core. That's the intent. Because when you're running out of battery, if you're not running that efficiently, your battery will die very quickly. You won't be able to use it for useful things. And Series 3, we will take that to the next level. To answer your question, industry is still pretty early phase. You go through the cycles of hype and then value despair and all that. And I think -- right now, what we have is the foundation for our industry to start taking advantage of machine learning at the edge. And it's already starting to happen, but it's still relatively early days in that journey. And the easiest way I can give you a compare is if you went back 5 or 6 years ago, we were putting levels of security in our products that people didn't understand why we were doing it. And it's because we wanted that foundation out there and capability. And now we win a ton of business because of the security capabilities that we put in we bled almost every standard and measure that the industry has on security, we've been the first. And that served us incredibly well now because it's becoming more mainstream, machine learning at the edge is going to be the same thing. We're putting -- we're way ahead of what the industry needs today, but we're putting that foundation out there, and it will continue to accelerate. And I think some of the biggest challenges are really for our customers, them collecting the data, making sense of the data, training the data and then easily getting that data on to what they've learned in those models on to our devices. So that's where we're putting a lot of time because as a company, we excel at not only the hardware, but we do more software than hardware and more development tools for our customers than any other. So we're going to bring that same approach to AI at the edge Silicon software tools, domain expertise, that will help our customers get there faster. But quick answer, it's early days, but the foundation is out there.

Awesome. Almost out of time. Matt and John, thank you for coming to the Citi Conference.

Thank you, Atif, for having us. We appreciate it.

Thanks, everybody. Appreciate it.