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

All right. Welcome back to the Barclays Tech Conference. I'm Tom O'Malley, semi and semi-cap equipment analyst here. We're lucky enough to have Silicon Labs, Matt Johnson, Chief Executive Officer; and Giovanni Pacelli, Senior Director of Finance. So thank you both for being here today.

Thank you for having us.

Thanks for having us.

So I'm going to start with a topic that I've intro-ed with for multiple companies, which is just the current cycle. And I'd say that many here have seen cyclical downturns, but I think you guys have seen one that's very sudden and very steep. Can you just walk through what you guided to? Why was it so extreme? What were the first signals that you saw? And just give us some color on the progression from the time when things started to turn and kind of where they are today.

That's a big one. It would be good to hear from both of us on that. I think we were just mentioning earlier, one of the things that is definitely stand out for this cycle compared to all the other semi ones we've been through is the pandemic certainly injected different dynamics, and I think new-to-industry dynamics into the cycle. For us specifically, the biggest shift was going from this continued -- and by the way, we still see it, but this continued expectation of recovery and pretty aggressive recovery, to us really having to question that and the injection of massive amounts of end inventory because we've been through this before where the forecasts are wrong. That happens quite often every day, but to have it be so different from expectation, and at the same time, have so much inventory out there. The combination or confluence of those really set us on a reduction that was bigger than we ever would have expected and honestly caught us off guard as well. That being said, where we're at right now, we feel extremely good that we are working down all inventory as we go through this quarter. And for us, the internal inventory is very strategic and by design, we feel very good about that. Channel inventory doesn't scare us at the level, but we can bring it down some and that's going to happen. It's really the end inventory at our end customers that were way bigger than it should be. We're sitting on a quarter or so that needs to work down. And we see that happening. So that's what gives us confidence to say we don't see -- we're not calling the cycle bottom, but we definitely feel confident we can call our bottom and drive sequential growth from here.

Helpful. Do you want to comment as well?

Yes. What's been interesting is kind of the sectorial nature of the downturn, right? We've been seeing the signs in Home & Life for 4 or 5 quarters now. And industrial really was quite resilient even into the middle of this year. And as we got into later part of Q3, it just -- the fall was precipitous and just to the factors that Matt described, but the kind of this rolling nature is definitely notable.

One helpful way to think about it is 2 things, the confluence of, one, consumer had been hit for a long time. But I think there was a building view that consumer is starting to bottom. It would start to improve. That's what we were seeing in the forecast. And at the same time, industrial had been showing signs of weakness, but it's always more tamed and moderated. And for -- 2 things after, one, consumer wasn't done. And two, industrial took it way harder than we've ever seen industrial go down. So the combination of those 2 is definitely suppressed.

Is there a reason when you look at end markets correcting? More commodity industries like memory tend to bottom first and are more extreme. Consumer tends to be near that end of things as well. When you talk to your customers post this correction and they're sitting on a bunch of connected MCUs, do they say, "Oh, well, we got it wrong here because we were scared, we couldn't meet our order trends." Or do they get it wrong because they were really protecting themselves for 6 or 12 months?

Well, there's speculation on my answer, so -- but I think if you go up, up, you can definitely see that during the pandemic and supply chain crisis, people couldn't get what they wanted, and were doing anything and everything they could to build inventory, right? Take it -- just take it, which also put a lot of our industry in a position of managing and understanding their inventory at a level they've never had to do before. So that's really important for people to understand. I mean we have customers with more inventory and having to understand their supply chain in a level that never happened in the past. So I think that definitely hit. And then there was -- at the same time, take as much as you can. And then the other piece is, this prevailing view, it's going to get better. I mean how long have we been hearing next half, next half, next half, right? And the combination of those things really got us to, well, it's not getting better as quick as anyone wanted, and wow, we got a lot of inventory. And that hit the whole industry hard.

I think the prevailing view of the industry generally tends to be more positive as you start to see things slow down.

Yes.

I guess you're saying channel is fine, end customer is not great. How about bookings? When you look at order patterns, you're saying you're confident in the bottom for yourself. What are you seeing that gives you that confidence from the booking side?

Sure. On the bookings side, it's been a long, slow thing. But we are seeing -- what I'd say is cautiously optimistic, patterns and behaviors there, one. So not getting worse, starting to improve, which is great. But then it's also -- you got to remember the level we're operating at, one; and two, that our run rate business is meaningfully above what we have for our Q4 guide. That's because we are working down that inventory. So the combination of the bookings, the actual run rate on our business while we worked on inventory and the strength of our design wins and ramps, that's what gives us the confidence to say we shouldn't call the cycle, but we definitely can call our growth going forward.

So we talked about inventory in the channel at end customers. What about your inventory on your balance sheet? What do you think the ideal -- I think days is a good metric in a time like this, because dollars is more difficult, especially as revenue is either ramping or coming down.

Well, it's a part of the channel, too, though. I mean we're -- our -- both are moving, right? If you look at us from a channel inventory perspective, the actual material and the channel hasn't meaningfully changed all year. But as the revenue comes down, DSI goes up, right? So for channel, what I'd definitely say is this, we've -- historically, people have expected us to be, I don't know, 40, 50 days. Is that...

45 to 55 is -- yes.

And I think that was too low. So we do plan to run at a higher level on a go-forward basis. We were, last quarter, I think, around 90. Too hot. So I think somewhere in there is what you'll see it moderate down to pretty quickly. And then there could be a quarter where the market recovers faster than we expect, where it will drop quick but we'll try to get that back to a level kind of in between those 2.

So perfect lead into my next question. So recoveries are all different. And I think that we saw on the way down this one was particularly different. But if you look at the recovery, you're not going to have perfect line of sight to this, but the question is meant to kind of understand your thoughts about the next years. Do you think that this recovery is linear because of how far you fell? Or do you think that it will also be lumpy? And by lumpy, I mean, do you see a couple of quarters of growth and then a small reset? I think that -- the reason I ask is, people will point to the fact that we've fallen so far that maybe you get some linearity in the early days of the recovery because you're so far below what the normal run rate of the business is? Any comments on that would be super helpful.

That's difficult to answer, I think. So what we know is, one, we're in extremely low level. A quick -- I'd just say, given the way you've described linearity and lumpiness, I bias towards linearity, but it won't be linear, right? But I do think we can drive growth every quarter moving forward, all things considered. And that's a confluence and combination of all those factors, including those ramps. If I didn't have the design win momentum and all those ramps happening, I'd be less confident to say that because the market would weigh heavier on that answer. Giovanni, anything you want to add?

No -- yes, I was just going to bring up ramps, but you caught that. That's a really important factor as we look into the first half of next year.

Yes. No, the intention was you see continued sequential growth quarter-over-quarter, which is what I was getting at. So I appreciate it.

Yes. Answer is yes.

So one area I want to dive in a bit more is ASPs. So I think most companies, including yourself, saw a substantial benefit. Where I look at prices were at the beginning of the upswing and where prices are today, how much higher are you on your average product? Or if you don't have a perfect answer on average, how much higher do you think you are for your products versus debt? Pre-upswing in the market.

So yes, that's a topic that's been, I believe, I'm going to use the word radically misunderstood, that -- the easy way to say it is prepandemic, pricing was what it was, then we had pricing increases out there. We haven't seen those prices go down either broadly in the industry. We also don't have a mechanism in our business to reduce prices on a daily, monthly, et cetera, basis. What most people don't realize, our business is vastly sole source, 95% sole source and most of it is a primary silicon and the end product that it's in. And we don't negotiate on that on an annual basis, quarterly basis. It only gets negotiated when it gets designed in. So that's important, one. But to answer your question, what I'd say we're seeing right now is, except for one company out there, all the other companies are doing exactly what you'd expect in a down market, and that's the typical behavior that you see. We do not see a step function or a cliff coming on pricing. Any resistance we're seeing right now is on mix or things like that or just our revenue being so low, we have to absorb more fixed cost.

I think you guys have mentioned it's where you're negotiating new contracts that you're seeing some pushback. So it's not a cliff, but would you say that it's -- I guess, in your best read of the market, are you going to start working back to where you were? Or do you think that there is some pricing bump that you've gotten through this period of time that never gets given back?

I think there's some piece that never gets given back unless you see the entire supply chain reset their price basis. Think about it, if the fabs all drop and they are doing everything they can to hold on to that as well, right? And so, so far in the cycle, they've been able to manage through that. And their expectation is when the market recovers, this will become less of an issue. So that's what's going on out there. But if that were to happen, we feel obligated to give some of that back to our customers. And the easiest summary I can give you, our commitment is to our model and our gross margin target which we've been consistent on this throughout our entire journey that, yes, our margins went up as we were in this. We didn't say we're resetting our model to these new margins. Everyone is saying, well, you're crazy. Reset your margins. We said, no, we're holding to this because we expect it will come back down to our normal model between 55 and 60, and that's what we're holding to.

It's almost unfair because historically, SLAB was always below that margin model and people are like, is it ever going to get there? And now we've gone above and I guess it is in the perfect range. But I would say that's exactly where I wanted to go, is you have pricing impacts on margin and you've seen this big reset on that side as well. You sound like you're maintaining the same range that you did before. Other than pricing, is there anything that I should be thinking about that would impact the range that you guys have kind of put out in that report?

Absolutely. Our platform, our new products. So our portfolio is the strongest it's ever been. It's in -- I don't have the right words other than a power cycle in the sense that our Series 2 is hitting the mark with end customers. It's what's driving our design growth, which is phenomenal and allowing us to gain share. So as you would expect, it would defy logic for us to be having such portfolio strength and to not be in a position to maintain industry-leading margins for our applications. So we don't see that changing. So commitment to our model, commitment to being at the high end versus competition because of what we do. And that's first order driven by our portfolio products and that strength, not by the costs we're getting from our suppliers.

Helpful. And you bring up competition, and I think this is a key area that people don't talk about enough. Can you just remind us who are your biggest competitors that you see on a socket-by-socket, design win basis. And two, have you seen any change in behavior from them? Because you guys are saying, "Look, we're not going to pass down cost until the foundries cut down -- cut costs too." And that makes total sense. But I can see other guys who are more opportunistic taking that pricing down earlier. Are you seeing any of that in the markets you're in?

I'm seeing 1 semi company out there being more aggressive than atypical, but they don't have much crossover to us, literally 1 or 2 parts. So of our portfolio of hundreds of parts, it's not going to change what you see in terms of top line, bottom line. But to answer your question directly, this is one of the things that is difficult for people to understand because there's a lot of competition, and it varies. We cover the entire wireless spectrum for IoT applications. Majority of our competition do not. So where we see competition depends on what the application is and what the sockets are and what the wireless technologies are. So to be specific, Bluetooth, biggest competitor has been and continues to be Nordic. We are taking share from Nordic. That has been consistent for the last few years, and we see that accelerating, not slowing down, which is a big statement in Bluetooth because they've historically been strong there and historically outperformed us in Bluetooth. But we decided to double, triple down a few years ago. It's worked. We're making big progress and we see a path to continuing that. Subgig. Really only 2 or 3 companies in the world do subgig for our space. TI is the biggest other one. And I think TI really took a step back in subgig during the supply chain crisis because they retrenched to protect other markets. So that was actually beneficial for us as well. And then when you get into 15.4, we're the leader by a long shot. There's a lot of other little companies out there, but no strong one other to even name, which, just for those who are unaware, that's Zigbee, that's Thread and one of the technologies that's the foundation of Matter. Wi-Fi, different. We're earlier days in Wi-Fi. We're entering that market. There's a lot of competition out there with different strengths and weaknesses, literally about 5 or 6 other companies. But for that space, what we're going to do is not go in like any of those, we're going to go in leveraging our strengths in low power, security, our customers and applications, tens of thousands of customers, and we're going to bring what we do to those other areas like Bluetooth to Wi-Fi, and I think that will serve us well.

A point I wanted to make on your commentary is just a guy like TI backing away from a product portfolio, particularly during the shortages. By far, their capacity issues were the worst going into the cycle, but you saw other guys run a little short as well, particularly at the peak of this entire pandemic. I would say, what is your worry? Does it worry you that larger guys, particularly with aggressive capacity plans like a TI, decide, hey, I need to push product. I'm going to reenter markets in which I retrenched from during that period of time. Is that something that you're seeing where, hey, I'm glad that I backed away, comes back into the...

Absolutely. They will all try. They would defy logic for them not to try. Easiest way to think about it is before the supply chain crisis, we competed against the big guys, and were able to gain share. During the supply chain crisis, everyone thought you're a smaller company. You're not going to -- you're going to need that scale to navigate this thing. We outgrew everyone in that space, over 40%, 2 years in a row because we were able to navigate it even as a small guy. So coming out on the other side, of course, they'll try to go back after. But it's not just them saying, I want it. It's the underlying fundamentals on multigenerations of technology platform approach. It's just -- you can invest in fabs. That doesn't mean you're going to be able to win those sockets.

Helpful. All right. So I want to step back. We did the supply chain. We did pricing. We did gross margins, all of the fun intricate stuff. Let's step back to look at the big segments here. So Home & Life, industrial and consumer, when you look at those 2 businesses, where do you think the recovery starts? Is one coming off the bottom faster than the other? And then maybe point to some products within those 2 segments that are driving that growth off the bottom.

Sure. So what we're seeing, and it's what we expected, it's kind of almost on a FIFO basis, right, where Home & Life has been weak now, again, I think I mentioned earlier, 4 or 5 quarters. And we are seeing some signs of life there. Matt referred to the bookings, design wins. We talked a lot about our partnership with Dexcom in our last earnings call. We expect that to ramp in the coming year and meaningfully contribute to revenue. So industrial, later to the party, and we expect that it will probably lag the recovery in Home & Life a little bit, which is not surprising.

Yes. Yes, I wouldn't dare call industrial done yet. It could take a while for that to work through.

Any products within those 2 that you'd specifically point to that are leading that charge? I think the -- on your latest call, you highlighted India smart meters and your partnership with Dexcom and their continuous glucose monitors. I know that's more of the maybe some newer products, but will they be material in '24? Are those part of the reason why you're more optimistic?

Yes and yes. So I'll just work quickly from Industrial & Commercial, work our way back. Industrial & Commercial, we break it into three subsegments within that, we have industrial, then we have smart cities and then we have retail and commercial. Smart cities is where we have metering, for better for worse. And in that space, metering has not been that impacted by this overall environment. These are long-term 10-, 15-year plays, tenders run by the government, et cetera. So we've had the leading position in that space for a long time, but what we're seeing is adoption accelerate. The ROIs are just getting really good in water, electric, gas. We mentioned on the call that this -- just like we did in Great Britain with the rollout there, we see the same opportunity in India, where they have the next decade of growth. We are the leading supplier by a long shot for all the options there, and that's starting to ramp. So we called that out, and that is going to have a good impact on 2024. Then you get into ESL in the retail space, we've been strong there for a while. We see continued growth there. General industrial, I'd be less bullish and confident on because I still think it has a few clicks to go as it works through its correction, but we definitely see share gain there. It just depends on how that end market works out. Home & Life. Home, hardest hit by a long shot. It literally almost couldn't be lower, and we're seeing those signs of recovery. Seeing the bookings come through. We're starting to see pull-ins more than push outs. I'm not saying it's going to be a rocket ship, but we're seeing it start the process of crawling its way out of the hole there. And the life and health care piece is phenomenal. We didn't see that go down during this whole cycle, and that's because. [Audio Gap] Yes, we talk about Dexcom, which is extremely exciting, great partnership, going to help us in 2024, but that's just the tip of the iceberg in what we have in health care in CGM. That's the one we announced. So the combination of those makes us feel pretty good going forward.

Helpful. I wanted to ask one on smart metering. I think that you saw the ramp in Britain. You're pointing to India as the next region. Are there a number of other regions that are on that list that are looking to upgrade to the smart metering? Or is this kind of the end of the cycle?

No. So we also announced on the call Landis+Gyr for their mainstream solution that is unrelated to the India and Great Britain opportunities. We're seeing a lot of progress globally and for ourselves, South America, Japan, U.S. I'd say if you look at the returns, which have different flavors by region, by application, it makes sense. And it's worth pointing out those applications increasingly rely on multiple wireless technologies, which plays right to our bread and butter, where they'll need a subgig for long range, they'll need Bluetooth for commissioning for the setup on your phone, Wi-Fi might talk back to the building there. It's an interesting space.

You noted that design win activity was up 25% year-over-year in Q3 on your call. Can you talk about what areas you're seeing that traction? Maybe what's helpful is by standard potentially, just thinking about where you're winning there. I know Bluetooth has been strong, you mentioned that, but any color in that traction?

So just to frame it for everybody, our revenue grew over 40% in '21 and '22 each year. Our design wins grew faster during that same time. Here we are in 2023 -- I almost said '24, 2023, revenue is bad. Design wins are on or ahead of plan, which is meaningful growth over those prior years. So that's an awesome trend to see because usually when you see the market, you see design wins impacted by that market cycle. We're not. So that's -- we clearly see ourselves gaining share. To answer your question directly, I'd say gains, and I want to make this clear, gains in all our end segments and markets and in all our technologies. And if you had to call out clear trends within that, Series 2 has been a workhorse. It's just the beast in there that is driving the vast majority of our funnel and design wins because of the strength of that platform and products. And we're not done, we've already announced our Series 3, the next gen. We're still knocking out products in Series 2 and will for a while. So that's an exciting combination. In that, I'd say Bluetooth stand out in terms of growth. And I'm talking not absolute magnitude, but growth, relative growth. Bluetooth is strong. Wi-Fi is strong. 15.4 on Thread and Matter is really starting to present. And then subgig is always strong because we're really one of the only companies out there that has it.

Got it. And when you start that design process or you say, okay, we're going to go in with this customer, talk about the life cycle of that product coming to market.

Never fast enough.

So when you announced 25% year-over-year, that's a big number. When are we seeing that revenue [ if at all ]?

So a quick way to think about it. When we do design wins in, let's say, 2023, we will see some of that in '24 because we're conservative by nature in the way we report design wins, they have to have started shipping something. So -- but you're talking very small sub, let's call it, single-digit percent of the total lifetime revenue will be in the following year. So easy way to think about it, Home & Life, faster ramps. You'll see those as a 3- or 4-year cycle and really start the next year. Industrial & Commercial, 6-, 7-year cycles, longer ramps, it takes much longer to go. So we are starting to see the compounding of those take place now, which is what's making us confident to say we can drive sequential growth from here. But easy way to think about it, when we engage, say, a year or 2 on average, until it becomes a win and once it becomes a win, let's call it a year, 12 to 18 months, before it starts to meaningfully impact revenue on the other side.

I wanted to zoom out once again on the decision you guys made to sell most of your profits to Skyworks. And you saw 2 very strong years of growth. And I think it was very impressive and clearly, during this downturn, everyone's going to question, was it the right decision? Is this direction we should have gone. I'd say, one, in retrospect, if you look back, talk to me about that decision and what you think about it now. And two, you do have cash still even after this downturn, would you be interested in going out and doing M&A again, and your feelings on that?

Sure. First answer is, strategically, absolutely, we'll do it again. No hesitation there. But to be brutally honest, yes, there was a few days. In the last couple of quarters, it was like, wow, it would be nice to have that there for sure. But what's important to realize is we wouldn't have been able to perform as well as we did those prior 2 years if we hadn't done the divestiture. One of the reasons we were able to secure the supply that we did and engage with customers the way we did, we didn't have any conflicts. We were focused on one thing and that focus helped us get the supply we needed and make the commitments to customers that we needed. If we've had the other business, I guarantee it wouldn't have been the same result on the upside as well, which is important for people to realize. Strategically, the focus, having the entire company doing one thing and this is what our future depends on, has been a surprise to me from an academic perspective because I would have said mid- and long-term impact. We've even seen short-term impact from this. So absolutely wouldn't go back on it. But yes, there was a few days I wish that we had more revenue and more diversity in the end business for sure, but wouldn't change the fundamental strategically at all. In terms of M&A, absolutely. Always looking, always open to it. I think our M&A focus has shifted as a company for a decade. We were acquiring to get capability. We have the requisite capabilities and technologies we need right now. And that's coming through in our funnel, which is over $18 billion. We have what we need. We're just winning as fast as we can. What we do now would be to different -- not to acquire technologies we don't have, it'd be to step function in terms of share and position in the market and scale in areas where we want to continue growing, Bluetooth, Wi-Fi. Big markets, we're making great progress. How do we go even faster? Be more aggressive.

Yes, I think that leads me right into the next question, which is, historically, if you looked at the success in your end market, it was either best MCU wins or best radio wins, right? And then you saw the evolution of a connected MCU, it's who had the correct standards and where -- what end market took off. And the guy that was there won. What do you think the next development from a technology perspective is in your end market? Because you're saying instead of going out and doing M&A and adding more standards and making sure that you can do more for more people, that has changed. Where are you looking next as the next pivot in your industry?

Yes. So I mean it's -- some people don't realize, at our peak, we had almost 100 different wireless technologies. There's no more to get for the most part, right? We don't need more of those. It's about scaling the ones that have the biggest -- best return and best need in our end market. To answer your question, I do think you're going to continue to see this dynamic play out between MCUs and wireless products, but simply said, every MCU over time, most likely will need a wireless capability eventually. And that's why you see the MCU players out there acquiring as much as they can because you can't home-grow. You've got to buy it. It takes a long time, takes decades to bring up that capability and integrate it. And we are incredibly, incredibly well positioned for that dynamic because what people don't realize is we talk about ourselves as a wireless company. We sell as much microcontrollers as we do wireless because every wireless product has a microcontroller integrated in it. So we are a wireless company and an MCU company all day in every product that we ship. To integrate wireless into digital is hard. To integrate digital into wireless, not as hard. We've already done it and that's what we're scaling. So that's why we're gaining share against those other companies, but I think that dynamic will be pretty big over the next decade that you'll see the integration of wireless and compute in almost everything because it can be done and we're proving that.

Helpful. One last one here because we're running out of time. You obviously have the accelerated buyback when the deal is getting done and shortly thereafter. If I recall, you still have some authorization there. How are you thinking about buybacks? I think the stock made a pretty big jump after the initial announcement of the revenue coming down. But talk to me about strategically is now a time where you'd be getting more aggressive? Because you clearly see your business accelerating from here.

Sure. So we do have, as you mentioned, remaining authorization, but we're going to be very thoughtful and conservative with the approach given the revenue levels that we're operating this quarter and next quarter. We have to be mindful of liquidity, obviously, and we feel really good about the balance sheet. But with negative cash flow for this quarter and into next quarter, like I said, we will be opportunistic, but we're not going to lean too far into it.

Yes. Helpful. I just want to thank you both for being here.

Thank you. Yes, absolutely. Thank you, Tom.

Have a great rest of the week. Thank you, everyone, for joining.

Thank you.