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

Hello. My name is Tanya, and I'll be your conference operator today. Welcome to Silicon Labs Second Quarter 2024 Fiscal Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to turn the conference over to Giovanni Pacelli, Silicon Labs' Senior Director of Finance. Giovanni, please go ahead.

Thank you, Tanya, and good morning, everyone. We are recording this meeting and a replay will be available for 4 weeks on the Investor Relations section of our website at investor.silabs.com. Our earnings press release and the accompanying financial tables are also available on our website. Joining me today are Silicon Labs' President and Chief Executive Officer, Matt Johnson; and Chief Financial Officer, Dean Butler. They will discuss our second quarter financial performance and review recent business activities. We will take questions after our prepared comments and our remarks today will include forward-looking statements that are subject to risks and uncertainties. We base these forward-looking statements on information available to us as of the date of this conference call and assume no obligation to update these statements in the future. We encourage you to review our SEC filings, which identify important risk factors that could cause actual results to differ materially from those contained in any forward-looking statements. Additionally, during our call today, we will refer to certain non-GAAP financial information. The reconciliation of our GAAP to non-GAAP results is included in the company's earnings press release and on the Investor Relations section of the Silicon Labs website. I'd now like to turn the call over to Silicon Labs' Chief Executive Officer, Matt Johnson. Matt?

Thanks, Giovanni, and good morning, everyone. Silicon Labs delivered strong second quarter results with revenue reaching the top of the end of our forecast and earnings exceeding expectations. Many surveyed customers report that their excess inventory levels have normalized, although some significant outliers remain. Improved booking patterns in the first half of the year indicates a continued recovery in the second half, even though weekly bookings are still below our target level. Our design-win pipeline is well on track for the year with record design-wins in industrial commercial business unit with particular strength in the Smart Cities business. The home business also set a design-win record in the quarter. We are also pleased to see numerous design-wins ramping into production and shipping to customers, including insulin management devices, electronic shelf labels and smart meters. In insulin management, we started shipping millions of units across multiple customers and regions. We expect this momentum to continue in the second half of the year and accelerate into 2025 as the market and our share for these products grow and large customers begin ramping new programs. In smart retail, global deployments in the electronic self-label market are expanding. And we have a clear leadership position in the space. We're working with 4 of the top 5 global ESL providers to support their rollout to retail customers. Lifetime, we've accumulatedly shipped 300 million units and ESL has become our fastest-growing business. We're meaningfully ramping our ESL unit volume and see this growth continuing to accelerate into the next year as this application gains further traction. In smart metering, we are participating in all of the largest smart metering deployments globally outside of the China domestic market. We've secured designs with a major global metering suppliers, positioning us to capture significant share in upcoming metering deployments in new and emerging markets like India, Central America, Southeast Asia as well as to support next-generation deployments in more established markets like the U.S. and Europe. We've also just secured a significant smart metering design-win with a top utility provider in Japan. This win will enable us to support a majority of Japan smart meter market servicing both new and existing deployments with our multi-protocol solutions, including our award-winning Wi-Fi 6 solution, the 917, and our best-in-class sub gigahertz solution, the FG25. Our first Wi-Fi 6 product, the 917, has meaningfully lower power consumption than competing products in the market and we believe it has the potential to drive share gains similar to our Series 2 Bluetooth solutions over the past several years. The 917 continues to generate significant market opportunities and we're now seeing those opportunities convert to dozens of design-wins, including at 1 of the world's largest appliance manufacturers. As IoT devices proliferate, our Series 2 portfolio is well positioned to unlock new use cases through industry-leading power consumption, security, multi-protocol wireless performance and edge computing power. We were the first in our industry to integrate PSA Level 3 security into our Series 2 products. We're seeing its importance and are now securing new business as a result. Similarly, our early integration of AI/ML into multiple Series 2 SoCs is also driving strong customer engagement as they seek to understand the potential use cases and applications for [indiscernible] and their product road maps. We continue to see strong momentum in the adoption of our current generation Series 2 products, while at the same time, we have started sampling the first product in our next-generation Series 3 platform. The strength of our current generation and potential of our next-generation platforms that are highly complementary is exciting and positions us extremely well going into the future. Further, customers will be able to transition from Series 2 to Series 3 as needed through common code based, scalable memory architecture and significant advancements in our performance, power consumption and compute capability. We will be talking more about Series 3 at our upcoming work with developers conference this September. Overall, I'm proud of the team's execution last quarter. As anticipated, the main driver of our recovery so far this year has been many of our end customers managing down their excess inventory. The steadily improving inventory backdrop, combined with design-win ramps in key focus areas, such as insulin management, DSL and metering, positions us to continue driving sequential growth in the second half. The third driver of our future growth is an improvement in the end market demand. The timing which remains hard to predict. That said, as bookings improve and shipments into our channel increase, we will benefit from this catalyst and the combination of all 3 of these factors will provide momentum for us moving forward. Lastly, we remain laser-focused on returning to profitability as quickly as possible and executing for our long-term financial model. Now I'll hand it over to Dean for the financial update. Dean?

Thanks, Matt. And it's great to be joining everyone this morning having officially stepped into the CFO role during Q2. Before discussing our results and outlook, I thought it'd be helpful to begin with some early observations. Those of you who know me know that I've long been an admirer of the Silicon Labs business, and I'm thrilled to be the newest member of such a great team. Silicon Labs is a unique company in our semiconductor industry, with a singular focus as a pure player for one of the fastest-growing end markets for semiconductors, the IoT. The characteristics of this market offer many compelling financial attributes such as a tremendously diverse customer base, long product life cycles, emerging new growth applications and the ability to command market-leading pricing with highly valued technology central to the end market application needs. Having now joined and begun to integrate into the organization, I'm pleased to share that the product depth and breadth are even more impressive than I originally understood. I'm happy to report that the sales funnel is extremely robust with a pipeline of customer engagements and design wins as diverse as the IoT itself, bolstering my belief and future growth for years to come. A key focus area for us will be ensuring that we convert this pipeline of design-wins to measurable top line growth and importantly, delivering that sales growth to the bottom line in the form of EPS expansion. We can do this by putting a renewed focus on our operational expenses and improving product margins which will become clear as our revenue continues to recover and our newest products are released to market. Now moving forward to the June quarter results. Revenue was $145 million, up an impressive 37% sequentially and above the midpoint of our prior guidance as our recovery path takes hold. Year-over-year, revenue was down 41% as expected. In our Industrial and Commercial business, June quarter revenue was $88 million, up 35% sequentially and down 47% year-over-year. The sequential increase was driven by strength in applications such as smart meters, smart building controls, and retail electronic shelf labels, all delivering double-digit growth. Home and Life, June quarter revenue was $57 million up 39% sequentially and down 28% year-over-year. During the quarter, we saw strength in home automation and security. In the life business, we're seeing continued traction in connected health and fitness customers and has completed the qualification at several new continuous blood glucose monitoring customers and are now shipping products to multiple of these CGM customers globally. These medical and health-centric applications are forced to deliver future growth for Silicon Labs as customers begin to ramp their production. We continue to focus on the level of inventory in our distribution channel, which has now declined to 55 days in the June quarter. Even more encouraging is the sequential growth in our distributor POS, which leads us to believe that some of the long-tail customers are beginning to work faster excess inventory conditions. Distribution made up approximately 69% of our revenue mix for the June quarter, an increase from the prior quarter, but still below our typical distribution versus direct sales channel mix. Overall, ASPs were down slightly compared to the prior quarter but this is due to product and customer mix during the quarter, while unit volume was up significantly, driving our strong sequential growth. Geographically, we saw sequential increases in all regions with APAC being up more than EMEA and the Americas during the quarter. For the June quarter, our GAAP gross margin was 53%. Non-GAAP gross margin was also 53%, which was in line with our guidance range and reflected a mix tilted toward direct customers versus the channel as we previously discussed. GAAP operating expenses were $125 million, which includes share-based compensation of $16 million and intangible asset amortization of $6 million. Non-GAAP operating expense of $102 million was in line with our guidance range. We continue our focus on diligent expense controls and converting our working capital back into cash while experiencing non-GAAP operating losses. GAAP operating loss for the quarter was $48 million and non-GAAP operating loss was $25 million. During the quarter, we reported a GAAP tax expense of approximately $37 million. Our non-GAAP tax rate remained at 20%. GAAP loss per share was $2.56, and non-GAAP loss of $0.56 per share was better than our guidance range. Turning to the balance sheet. We ended the quarter with $339 million of cash, cash equivalents and short-term investments. Our days of sales outstanding was approximately 30 days. During the quarter, we depleted $32 million of our internal inventory, which ended the quarter down to $166 million of net inventory. Our days of inventory on hand improved to 217 days, and we expect further to reduce our balance sheet inventory position in the subsequent quarters as sales levels improve. Now let me turn to our September quarter outlook. While this ability is somewhat limited, excess inventory to our customers is moving in the right direction and distribution POS and our bookings have rapidly improved throughout the course of the year. Although the rate and pace of the recovery is still somewhat uncertain, we remain confident in our ability to continue to drive sequential growth in the second half of the year. We anticipate revenue in the September quarter to be in the range of $160 million to $170 million. We expect both the industrial and commercial as well as the Home and Life business units to be up sequentially in the September quarter with growth being led by the Home and Life, but also returning broadly across products and applications. We expect our GAAP gross margin in the September quarter to be in the range of 54% to 56%. We expect our non-GAAP gross margin to also be in the range of 54% to 56%, both of which marked strong sequential improvement from the prior quarter. As revenue further recovers towards a more normal run rate, our distribution mix improves, and we would expect those margins to continue to increase. We expect GAAP operating expenses in the September quarter to be in the range of $123 million to $125 million. We expect non-GAAP operating expenses to be in the range of $101 million to $103 million. And finally, we expect GAAP loss per share to be in the range of $0.95 to $1.25 loss and we expect non-GAAP loss per share is expected to be in the range of $0.10 to $0.30 loss. I'll now hand the call back over to Giovanni for the Q&A session. Giovanni?

Thank you, Dean. Before we open up the call for Q&A, I'd like to announce our participation in KeyBanc's Capital Markets Technology Leadership Forum in Vail on August 5. Jeffreries' Semiconductor, IT Hardware and Communications Technology Conference in Chicago in late August and Evercore ISI's 2024 semiconductor IT Hardware and Networking Conference also in Chicago in late August. We'll now open up the call for questions. To accommodate as many people as possible before the market opens, I ask that you limit your time to 1 question and 1 follow-up. Tanya?

[Operator Instructions] which will come from Matt Ramsey of TD Cowen.

Dean, welcome to the show here. I guess for my first question, Matt, I wanted to dig into a couple of the end markets. I think we're all obviously following the cyclical recovery for your company, but there's some new drivers out of the back of this that I wanted to dig into a little bit. And the first one is on the electronic shelf labeling market. Maybe you could spend a couple of minutes on the size of the market, the growth trajectory of the market, unit economics? And then just a little bit about how that market works for a company like you guys. You go through an intermediary, do you go to the retailer directly, does you see retailers once they make the decision to go electronic, roll things out super fast, do they do it regionally? just trying to get my head around the growth dynamics and some of the unit economics of that market as it takes off.

Yes. Sure, Matt. So maybe just starting at the top with electronic or digital shelf labels. Like a lot of areas that we focus on, these things don't happen overnight. So this has been a multiyear investment and multiyear partnerships with a lot of customers out there. So to answer some of those questions, first is we do work directly with our customers being the shelf label suppliers. So they would actually make the shelf label and then they would work with the retailers on the strategy, deployment and kind of roll off of those products and technologies. Shelf labels are not new as a technology. They've been around for a long time, but we've seen a real increase in the adoption of those technologies really led by a few dynamics. One is, I think the technology maturity is now there in terms of the robustness, the interoperability, reliability. Another key factor that we've seen is battery life, where the battery life of these labels is enough that the retailers don't have to worry about going around and replacing those. They can last years, depending on how they're being used and then the software reliability is also critical. And then I think the key, key here is the return. Our retailers are seeing returns that are really attractive to them. And as a result of those things coming together, we're seeing the adoption of retailers globally really accelerate. And this is not a phenomenon that's unique to 1 retailer, or 1 geo. We're seeing this as a broad trend. And as we've said, we see ourselves as very well positioned in that space and as a leading supplier because of, one, our underlying technology, a lot of our customers deploy a proprietary implementation, which is 1 of the many areas we thrive in IoT. We know how to develop products that last a long time. From a battery life perspective, they're secure, they're reliable, they work well, they work well together. All things that are critical in a retail environment where consumers are actually going to be seeing new things and experiencing these products. So I think even though we've started shipping over the last few years, a lot of the unit volume. I still think we're early days in this market. And I'd also add that in terms of ways to think about these deployments, most of our customers and retailers, they'll prototype, right. They'll prototype stores, they'll try different configuration. They'll see what's happening, and then they'll expand those within a region or within a geo and they'll keep going. So again, still early days, but we like the progress we see. We think this is a durable trend. And it's really because of, one, the maturity of the technology and the returns and our position here is strong. So we're excited about this.

Thank you, Matt, for all the details there. I think it's an important point on the returns for the customer. I guess as my second question, sort of similar, but on the smart metering market. You guys had a lot of success in the U.K. in some of their programs a few years ago, and it seems like there's some developments in different countries, you mentioned Japan in your prepared script, Matt. And maybe just kind of level set us on the different programs that your customers have in flight now in the different regions and what we should expect from that market in the next, I don't know, 24 months?

Sure. Maybe the compare contrast to DSL a little more mature market in the grand scheme of things, market dynamics is very different in terms of the rate and pace at which it moves, these things can be out there for 10 or 15 years in terms of life cycles. But big picture, again, very well positioned market leader. That market leadership is a function of having all the record technologies our customers need, not just 1 technology, it's multiple technologies that we have to bring together across sub gigahertz in Bluetooth, WiFi, all coming together, as we mentioned in the prepared remarks. And the way it started, as you mentioned, roll-outs like we saw in the U.K., but a couple of phenomenons. One is the roll-outs you'd expect it takes years for these deployments to happen and then you could expect kind of a peak and then the business to roll off, what we're seeing is it's much more resilient and durable because once the rollout kind of gets to its saturation, if you will, they start renewing the meters on the back end of that. So we're seeing a lot more license stability in each deployment than I think would have been originally expected, and you only know that as this technology becomes more mature and you get to see it. And then we're also seeing new deployments go out globally. And that's important, right? So across new geos, new applications and this has brought -- this is gas, water and electric. And you can really just see again, that combination of the maturity of the technology, the reliability, the robustness and the returns for those customers. Putting that intelligence inside the meters, gives returns for those deployments. And it can be different depending on the geo and their care abouts and what they're trying to accomplish, but the point is they see the returns and they see the technology maturity and we have a leadership position there. So we think that's a very long-term, robust and reliable space for us. And we don't take that for granted, and we're not doing a victory lap in the sense that this is done. It's still early days. But we're well positioned to continue bringing new technologies to the space and continuing that leadership with what we have in Series 2 and what's coming with Series 3.

Really appreciate the thoughts and best of luck as we get through the cyclicality here and back to the growth vectors.

And our next question will be coming from Thomas O'Malley of Barclays.

My first one was just on pricing over the last couple of quarters. It's really held in a lot better than some would have imagined kind of on the upswing. Could you guys talk about when you look at September, just kind of taking the assumption of just a little bit of pricing decrease, the midpoint of your guidance assumes another robust step-up in units. Is that how we should be thinking about the next couple of quarters on the revenue upswing. Is it largely driven by units? Or should we be seeing any sort of ASP tailwind as we get some of the upgrades to your newer products?

Yes, Tom, good question. This is Dean. Thanks for the warm welcome. On the ASP front, you were largely what we saw in the June quarter and then now it would look into the September quarter guidance is primarily a function of mix. In the June quarter, actually, we ended up shipping quite a bit more at direct customers than we typically would. What we find is that the mix of products and the ASPs between direct versus channel is just a little bit different in the nature of long tail versus large consolidated customers. So I wouldn't read into that too much. Pricing continues to be relatively stable. There hasn't been a whole lot of change in the last couple of quarters from what I can ascertain, and as I look forward into probably the next couple of quarters, at least what we can see on the visibility front, I don't think you'll see much change at all from a sort of like-to-like, customer on customer ASP change if that helps, Tom.

I'd just add to that. Exactly and the easy way to think about it is no big change in the pricing environment out there. And what we're seeing right now is, as we said, really a function of our mix. So as revenue goes up and that mix continues to change, you'll see the gross margin improve, and that's what we're guiding from Q2 to Q3, which is really important for people to understand.

Yes. And I think that the second part of that is obviously the mix back to Disti. So you said Disti was 55 days. If you look over the last 3 quarters, similarly, you've gone from like 63% to 66% to 69% of revenue. Can you just talk about like the cadence there? Like do you think 55 days is a place where you're going to start to see some of these guys being more aggressive? Like what's the right target for Disti and like in terms of how quickly you can get back to what was the norm, which is low 80s by my math, like how long do you think that takes?

Yes, that's right. I think that replenishment is probably -- I'll call it for roughly 2 quarters to sort of keep moving. Look, we've deliberately been shipping less into the channel to try to continue to burn down inventory as the channels and customers also look to burn down inventories. What has happened is that's gotten lower than we typically expect. Typically, now we would obviously look at 70, 75 days as kind of the healthy sort of channel inventory mix. Like you said, we're at 55 today. Look, I think customers and distributors, they're all sort of watching it and nobody is going to hurry to sort of replenish quickly, and we're not pushing for that. Just to be clear about it. I do think we ended the quarter at about 69% of our revenue coming from channel, typically, like you said, we're 80% kind of channel based and about 20% direct. So I do think as channel inventory comes down, start to replenish those long tail end customers turn through their final access inventory and start coming back into a normal run rate, we'll keep moving up towards that more normal distribution versus direct your set of business. And then hopefully, over the course of the next couple of quarters, distributors are comfortable to holding a more normal inventory level. And we'd like to see that back to the 70, 75 days. But like I said, I would just reiterate, we're not pushing for that, and that is not something that we're contemplating in the September guide as we talk to it.

Our next question will be coming from Quinn Bolton of Needham.

Just a quick clarification on your answer to Tom's question there. Dean, it sounds like you're sort of saying or implying that the Disti mix does normalize. I think you said over a couple of quarters, but I hoping to try to pin you down a little bit more. Do you think it normalizes kind of by the end of this year? Or do you think the Disti mix takes into calendar '25 before you get back to that more typical 80% sales level?

Yes. I don't have a perfect crystal ball, Quinn. But if I were a betting person, I really would sort of put highest odds on early 2025 rather than you're getting all the way there back to normal by the end of this calendar year. So that's for what I can see on backlog and the way customers behaving, it's probably an early 2025 rather than an end of '24.

Got it. And then I guess my first question is kind of knowing that the mix towards Disti is helping somewhat, but you're not fully there in the September quarter, the roughly 200 basis point margin improvement in September. It feels like some of that probably is -- it's not entirely all Disti mix. And so can you just kind of walk us through what are the biggest drivers of the gross margin improvement in the September quarter beyond the mix back towards Disti?

Yes. I mean there's channel, there's product specifics and then there's absorption of overhead. So I think all 3 contribute to different levels. In the move from June quarter 53% to now guiding September quarter 55%, that 200 basis points. It's largely around channel and product mix. So if I look at it, it looks like better margin products are likely to shift in the September quarter. Channel will continue to probably make some progress as an overall mix of the revenue. And then to a less degree, but is certainly a contributing factor in growing the revenue by $20 million sequentially that has an overhead absorption contribution as well. And when I think about September quarter 200 basis points and then going forward for there -- I think about September is 55% is you sort of back into kind of the normal range. And then as we sort of sequentially grow from there, okay, channel sort of contributing and then overhead absorption contributing and probably less so than a specific set of products or a specific set of customers as being probably third on the list as I look forward over the next few quarters.

Got it. And then I guess just -- obviously, continuing to digest inventory albeit at a lower rate into the second half of the year. Any updated thoughts on when you think you'll largely be back to shipping in line with consumption. Is that something you think happens by year-end? Could you see some customers continuing to early '25. Just any updated thoughts on when you think you're largely back to shipping in line with consumption.

It's actually -- it's a tough question. I know a lot of people have that on the top of their list, when do we get back to sort of regular consumption. Look, for us, it's difficult to tell. I don't think anybody has any great precision on this one. Look, we're looking at trends. They are things trending in the right direction, our bookings coming up, the POS coming back, our inventory and the customers that we surveyed coming down and therefore, sort of the excess is bleeding off. Those indicators are all going the right direction. When we're back to full sort of call it, regular normalized consumption rate. I don't know. I don't have a great prediction. I think it's also clouded by a number of new designs that are now starting to hit production as well that are contributing, but also mask it to some degree. And you have to imagine a company like Silicon Labs with thousands of customers. There's no 1 generic answer that's going to be a great fit for everything. So long story short, don't think we're quite there yet, but really tough to call when and what level that kind of normal consumption is. I don't know, Matt, if you want to add anything.

No, I think 100% of it. Maybe the only thing to add is clearly, Q2 is not at our consumption level and neither is our Q3 guide. And as Dean said, I think the 3 kind of pillars we've talked about are, to drive growth. The inventory destocking going in the right direction, but not done yet, design-win ramps that's encouraging that we've been on an incredible design-win pace over the last few years, we've been driving design-win growth annually throughout this cycle, which is remarkable, and we're finally starting to see those designs ramp, it's early days, but they are ramping. So that's going to give us some lift moving forward in addition to the destocking as that starts to wind down at some point. And then the third pillar is the end market, which is obviously the most difficult to call. But like the progress on destocking, like the progress on design-wins, still watching the end market there's still a fair amount of uncertainty out there.