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

All right. Welcome back to the Barclays Tech Conference. I'm Tom O'Malley, U.S. semi and semi-cap equipment analyst here at Barclays. We're here with Dean Butler, CFO of SLAB. Thank you very much for being here.

Absolutely, Tom.

I appreciate it.

So why don't we start off with just like a 30,000-foot view. So you went through, as a company, a pretty material correction. You saw the bottom. You've seen this recovery back up. And then if you look into December, you're seeing kind of like the first flattish quarter of a recovery that has been pretty strong off the bottom. And I think you've done a good job of kind of giving investors this view of things are getting better. It's really hard to tell how quickly things are getting better. But to investors who come back and say, "Hey, look, is this plateauing? Is this the level at which the company will stay?" Maybe give a description of what you're seeing kind of growing off the bottom. Is this really just a seasonal blip? Or are you going to continue to see this upside kind of in the next couple of quarters?

Yes. Sure, Tom. Good question. Look, first order, have no concern about sort of growth of the company. I think Silicon Labs as a team has done a really super job on coming off the bottom in a pretty material way. We troughed in December of 2023. So we're just about sort of 12 months past that point. Ever since sort of that troughing in Q4 of last year, the company has been sort of materially moving up like it's first quarter after its trough, I think it was up 10% or 15%, then it was up another 30%, and then up 14%, 15%. And then now a little bit of pause here for our December quarter what we just guided, which implies sort of a flat quarter to your point, Tom. I think this is really just a difference in some seasonality that's playing into Q4, but honestly, a little bit of a surprise out of industrial that sort of became a little bit more flat than what we had expected. Industrial has been growing as well as our Home & Life business been growing all through '24. And what we see is really probably just a slight pause for Q4 of '24. I don't expect that to continue. We've seen sort of strong bookings patterns for the business throughout '24 that continues today. We've seen strong resales from our distributors. So distributors is about 70% of revenue goes through channel. We've seen resales continue to grow. We've seen inventory levels continue to remain very modest at distribution. In fact, in Q3, we shipped in quite a bit into distribution, yet days of inventory sort of decrease, which implies actually resale of distribution had been going up in excess of what the company had recognized as our ship into channel. So I don't have any real concern on, hey, where do we go from here? Are we plateauing? I think there's a number of growth drivers that continue to lead us out even beyond sort of some of this recovery activity.

Perfect segue. So I think that during this period of time, you obviously looked at the different -- the business differently from a segmentation perspective, Home & Life and Industrial, Consumer as well, so you split those up. Can you talk about the big growth drivers that are in those 2 buckets? Because I think that you guys have done a good job of kind of talking about the broader technology portfolio, but looking at like the pockets of growth within each of those. And for example, you mentioned, hey, Industrial was a little bit slower than we had originally thought. Like what specifically in that bucket maybe is plateauing? Just maybe the 2 biggest growth drivers in each of those and then what you're seeing in terms of demand?

Yes. I mean, look, we report in 2 major buckets. One is called Home & Life. So I think smart home, medical-type applications. And the second one is Industrial & Commercial and think like smart meters, electronic shelf labels like on the commercial side. What we saw is actually -- when things decline and rolled over in 2023. What we saw is that Home & Life side of the portfolio actually started entering the downturn about 2 quarters before Industrial & Commercial. So sort of part of us says, hey, what we're seeing right now in the Industrial & Commercial side perhaps is just a time delay, what we saw sort of 2-quarter-time delay on the down and sort of Home & Life continues to grow up and moving positive even into this Q4, is likely just a time shift as we see things sort of coming out of the trough and continue to grow. So without any sort of further detail around it, it looks like it's sort of perhaps just the time difference between sort of those 2 businesses. On the Home & Life, it's a smart home business, it's a medical business. Smart home continues to do well. We continue to grow. We grew in Q3 in the smart home side. We think Q4 continues to grow in a smart home. We think that sort of continues to grow. Many applications that existed just 5 or 6 years ago were not connected, more and more things inside the home are sort of being connected, networked. Wireless standards are sort of the de facto there. Medical is probably the biggest growth. Like that engine, I think, is here to stay. The company has done a really super job in its history in sort of first going after industrial-type applications, smart meter is a great example, where it did super well. It then moved into smart home applications, that's been paying great dividends. It then took that smart home sort of position, move that into the commercial side of the portfolio. And in the last 2 years, the investments have been around sort of medical applications. And there's some pretty significant design wins there. I think externally, we talk about blood glucose is one of the applications that's sort of being a needle mover. That's sort of just getting started, Tom, like -- so as I think about like how is the company confident about 2025 and sort of beyond in its growth prospects, one is like big burden hand on that medical side of the portfolio.

So it's really that life blood glucose monitoring. And then on the other side, you have the smart metering. And I've heard in the past, this is a tougher industry to check. You see where upgrades happen, but there was some smart metering upgrade in India. But can you talk about certain areas? Like how should you see that rollout kind of move globally? And how are you able to give investors a feel because I think it's really hard to go out there and track where you're seeing smart metering upgrades. Like where should we turn to look at that kind of cadence or help us out and kind of give us like where you're starting to see that get deployed?

Yes. I mean smart metering, the company has got a great position in smart metering. It's on the electrical side, it's on the water side, it's on the gas side. So it's across all the different metering applications. The company likely has very high market share in all 3 of those in every major country in the world. I mean, to be quite frank. I think the only outlier that we see is sort of domestic China. We sell into China makers that are for the export market. We don't sort of sell for their internal domestic consumption. Like you said, Tom, look, smart meters, it's a slow and steady rollout, like it's your classic industrial 7-, 10-year time horizon. You're not going to see sort of these big pops up. India is maybe a little different. Like their rollout seems to be faster than some of the other countries. We've won a big tender in India. I think it's 250 million meters that are rolling out. We've been shipping in the back half of '24. Those things started shipping. It looks like that rollout actually might happen faster than some of the other countries. So that's sort of giving us sort of a nice little tailwind on the next year and sort of continuing. But look, the share among metering is very high and like we're very confident in continuing to lead in that business. What's also happening there is ASP lift. So it's going from sort of single communication link to multi-communication link, upping some of the processing capability that some of these meterings are doing, and that's leading to sort of higher ASP uplifts as well sort of as you roll out sort of generation to next generation.

Perfect. So I want to dive into 2 of the comments you made. So the first one is we went by product type, but how about we look at it from a technology perspective? You mentioned on the last call that Bluetooth was kind of the fastest-growing technology medium within SLAB. So oftentimes like we have conversations where like you have a connected MCU, you have different radios, like over time, the flavor of those radios really changes kind of in the demand profile of the marketplace. And like Bluetooth has been one for a prolonged period of time now. I think it just works really well across a variety of different products. Is Bluetooth in your eyes like the key to your success is? Is it the radio? Or is it the ability to kind of have the MCU with the Bluetooth with a bunch of other radios with it as well? Is it the entire offering? Or is it just your ability to out-execute in the single radio?

Yes. I mean, look, on just pound-for-pound hardware, one, I think we have the best engineers in the world. And like actually, the hardware itself, actually, the specifications are sort of bar none. It's like top of the class. But I think the real secret sauce actually comes down to the software and sort of the usability of software. As you know, our customer base is thousands, if not tens of thousands of customers. And we cannot handhold every single customer. So we actually have to design our solutions and software for easability so that our customers' engineers can sort of get the hardware, get the software, get up and running and integrated into their operating system in a fairly easy manner. And I think that's ultimately our secret sauce is sort of that software. Then you have leading hardware specs on top of it. Oh, and by the way, we have every type of radio that you really need for your application. And some people are using a point technology, say they were using just Bluetooth. Some people are using multiprotocols. Some people like have a Bluetooth radio, Wi-Fi radio and a long-range some gigahertz radio sort of all-in-one. And we can run that on one set of software and sort of make that easier for customers on how they deploy it.

Super interesting. And then to the point that you made earlier on the ASP increases, you talked a lot about Series 3 refreshing the portfolio. To a non-product person in the connected MCU world, what does it mean going from Series 2 to Series 3? Is it the upgrade of the MCU? Is it the upgrade of the radio protocols? Are you packaging them differently? Like what gets you to that next level? And what does that mean from an ASP perspective for your business?

Yes. I think the thing that many people don't quite understand about the company is not only do we sell a lot of wireless technology and sort of these great wireless technologies that are connected, we also sell either stand-alone MCUs or integrated MCUs in the vast majority of our solutions. And in Series 3, look, we're designing for what do we think comes next in the world. And we think actually what ultimately comes next is sort of the AI craze that's happening. It's happening at the data center. That will likely move into the enterprise. But ultimately, the winning prize is kind of at the client edge. Look, on the IoT world that we service, look, you're looking at potentially 100 billion of these sort of client connected devices out there in the world. Ultimately, AI is actually going to move toward the edge. And Series 3 for us is going to continue to enable sort of that future proofing. On the processing side, it's spec'd out to be on the high-end version, 100x on what the Series 2 is on the processing capability. We're upping the game again in security. So if -- you know well, Tom, then I've talked about it is security has been a big sort of feature set that's enabled the company to outperform in its design win capability and capturing a lot of these new applications. In Series 3, the expectation is we actually have a post-quantum-resistant set of security features that run on the chip, which says, look, at someday, we're going to be faced with higher and higher ability to crack the code and these things. If one day actually more and more things autonomously happen, AI at the edge, you are going to want higher levels of security, and that is a choice that we think many customers will make. I think what we've seen over the last 10 years is going from fairly sort of basic protocols, say, just like a basic Bluetooth, was relatively insecure, like there wasn't a whole lot of protocols that were securing a lot of Bluetooth links. Now that tends to be a very strong sort of winning feature set for us on a lot of our customers, specifically like medical applications security protocol has been huge. So as we think about Series 3, upping processing capability, enabling the future of sort of client AI and then actually adding security levels on top of it. And there's a bunch of other neat tricks that are sort of for customers as well that has a seamless upgrade path as customers move forward. By the way, using the same software. So we actually -- customers that are using Series 3 versus Series 2, same software stack so that people can go back and forth, whether you're using Wi-Fi or Bluetooth or sub-gigahertz or Thread or any of these other protocols sort of all packaged in one.

So I would imagine with the increased performance you're talking pretty substantial gen-over-gen gains. You have some ability to take some price. So this goes back to the conversation that we've had many times as well as I think the biggest debate on the stock is there was an ASP trajectory into the pandemic, which really benefited you guys and benefited a lot of names as well. But since then, you've seen some give back of that pricing and units are really going to be the driving factor of growth on a go-forward basis. So I guess question one is, can you talk about what kind of uplift that Series 3 could get you from an ASP perspective? And then two, if I look at like the standard cadence of pricing without an upgrade cycle kind of going on, what does that look like on a go-forward basis for Silicon Labs?

Yes. Just like on a pricing perspective, one, Series 3 should come with a higher ASP. There's a lot more feature sets in there. There's 100x of processing power. So I would expect like a pretty decent ASP uplift and sort of margins to kind of pull with that. If you said sort of agnostic of Series 3 and if the world would just sort of go back to its past history, past history semiconductors are sort of single-digit down ASP year-on-year. I think what's interesting now is what's tending to evolve is most semiconductors are dependent on the suppliers actually getting more efficient and giving some cost downs. That doesn't seem to be happening quite as much. I mean sure you sort of get pockets here and there. But I think with the build-out of all this CapEx and these fabs all around the world that are happening, I think it's difficult to foresee a lot of supplier input pricing coming down. And I think that will lead a lot of semiconductor designers to sort of not be able to give the same price downs that maybe historically you could. At the same time, you're adding more features. And I think at least from a Silicon Labs customer perspective, we haven't seen like a material push in like trying to get ASPs down or pricing battles that are happening in the marketplace that people are just going after cost rather than features. We see the ability to hold ASP or increase with increased feature sets.

So technology is one side of it, but competition is another side of it. So I think we talked last year at this time kind of about increased competition from other U.S. suppliers in the MCU market. I think TI was called out at that time. Are you still seeing additional pressure from the larger guys trying to move into areas where they may have kind of backed away from? And then two -- multiparter here. On China, how aggressive are you seeing China in the marketplace? Are they popping up in areas that you didn't see before? Is that a real threat to kind of the areas where you're playing?

Yes. And about a year ago, you're right, Tom. We talked about larger competitors that maybe own their own fabs that are getting a little bit more price aggressive to try to fill fabs sort of during this downturn. We have not seen any sort of new activity in that side of the world like, hey, there's not an increased sort of battle around price to try to fill fabs. In fact, even when that had been occurring about a year ago, we were still winning despite larger competitors sort of lowering prices and trying to win. And really, it's on the basis of we have a very clear focus. Like our clear focus is these set of IoT customers, and we work day and night to try to fulfill their orders, give them the feature sets, like upgrade our software features that they may need, where when they are with a larger competitor of ours, this is like #72 on their priority list, where for us, it's like #1. So I think a lot of the customers during the pandemic supply crunch and then now the rolling over are sort of realizing actually, it's better to go with somebody that, hey, it's focused on your same market that cares about you in a way that a larger supplier wouldn't. So we're actually, I would say, winning more and very resistant to people bombing prices for no rational reason, and we're still holding our own and still winning despite some of that. On the China side, look, I think there's a weird dynamic that's starting to happen where historically, you would say China competitors bombing price, maybe that's bad for you, maybe that's leading down the road of commoditization. The opposite is actually happening. The opposite in the geopolitical tension is starting to evolve where actually like western companies, western customers of ours are starting to say, actually, we would rather move away from some of the China suppliers and actually harden our ability to sort of resist any geopolitical tensions that might arise there. And people are waking up to, look, it's not about price. It's about actually sustainability of supply chain, it's sustainability of your partnership. And in what people worry about China is actually also a positive in some respects.

Interesting. You're seeing that in certain other areas of the market like potentially in interconnect, but I didn't realize it was moving all the way down. So customers are coming to you, are they reaching out proactively being like, look, we're trying to be more internal U.S. products? Or is it more a negotiations that are like, oh, we prefer to come?

No, it's proactive. And look, it's not like every customer. It tends to be, hey, the more the customers value their brand, like perhaps they're a bigger customer and sort of their brand is a higher value, the more often we're seeing that as like a starting place on why they're opening a design up.

Okay. So I think people generally understand the trajectory of revenue where you have a couple of really good pockets of growth across your 2 businesses. The Series 3 transition gives you maybe a little bit of an ASP increase that maybe offsets some typical declines in the business. But I think like where I think generally, people struggle is just on the gross margin expansion. So ASPs play a part in that. Disty plays another part, which we can touch on. But can you talk about what you can get from a gross margin leverage progression into this '25 period of time with the anticipation of some growth year-over-year, where are you seeing that leverage? Is it really just the absorption on the revenue side? Or is there other levers that you can pull?

Yes. I mean it's, one, distribution. We tend to get a little better gross margin on distribution. Long-tail customers do a different pricing dynamic. Secondly, is scale on revenue. And then of course, there's mix and mix is sometimes positive, sometimes negative. And the company has been really clear on, hey, what our model is. Like our model is, hey, mid-50s to high 50s, somewhere in that range. Look, when we sort of hit our trough, we were low 50s. When we were at our peak, we were like mid-60s. And even at the point we're in mid-60s, we told people, look, that's not the sustainable gross margin of the business, it's mid- to high 50s. And that's where we think we continue to trend to. So all throughout '24, we've sort of been moving up, and I think we're last quarter, 54%. And so we're kind of already back in that sort of mid-50s sort of zone. As we look into '25, '26, look, I think there's a reasonable path to continue to march that up into higher 50s. But I would sort of set the expectation that unlikely will the company move into a model where we expect 60% or more gross margin. I think it's probably just not the right business model for the company. And look, I think we want to continue to grow as fast as we can and mid-50s among semiconductors is really good.

Yes. And to have the same gross margin structure you did at the peak of the pandemic would be surprising, right, over the longer term?

Right. And I think you look across semiconductors and no one does. Yes, no one does.

Okay. So Disty was one of the ones you mentioned scale mix, Disty versus direct. So you saw direct as a percentage of revenue and then your top 10 customers grow pretty significantly. You stopped giving the top 10, at least, I think about a quarter ago. But in terms of the Disty can you talk about what the normalized level is? Are you going to go back to that like 80% range that you were before? Is that the right way to think about it? Or as you're growing into this kind of new phase with a couple of different growth drivers than you had before, like are you going to be a little bit more direct than you were historically?

I don't think we've quite figured out what that mix is because, look, the base business hasn't fully recovered back to where it was historically. Like the historical mix on Disty versus direct was about 80% distribution based and about 20% direct. We're at 70% today, so 70-30. Look, my expectation is, it's going to be somewhere in that range. Look, I think some of the recent growth drivers around medical. Actually, it's a mix. It's not all direct and it's not all distribution. So I think as these things grow, there's going to be a mix between distribution and direct. How it totally plays out, it's going to be in between that 70%, 80% is my expectation. You're not going to see 90% distribution. You're also not going to see 60%, 50% distribution. So it's likely in this zone. I mean I think our intention is not to focus solely on direct. I mean the distribution channel, the long tail has come a long way for the company. We do a lot of work around that activity. That business is growing super well also, and we would expect that to continue to grow. So I do think it will be up above the 70%.

So we've got the growth trajectory kind of mapped out. We have the profitability kind of mapped out. If you look at the spend, as you're starting to see this acceleration in growth, how should we think about the fall-through in the model? Where do you have areas of flexibility in spend? What is the framework we should be thinking about into this coming year?

Yes. I mean the company has been spending ahead of revenue. And rightfully so, and we look at it sort of very closely on, hey, are we doing the right thing on spend and revenue. Look, the design wins like the bird in hand actually says, look, we're spending in the right areas and like the thing is going to pay off. Our expectation is we are likely to hold the operating expenses kind of at the same level. I think, look, we're spending at the right amount. We're spending on the right things. We're capturing enough new design wins and net new revenue coming in to say we're doing the right thing. That being said, in '25, we will have sort of the typical Q1 step-up between tax reset, merit cycles and then resetting of the employee bonus pool. So we do expect the operating expenses to come up a little bit just for '25 on that basis. But under the covers, everything else is sort of staying flat in the company on what we're investing in. And look, I think if you look at the history of the company, look, it started in a lot of sub gig technologies that were for smart meter. Then it moved into a lot of 15.4, ZigBee, Thread, Z-Wave type technologies that were great for smart home, built a fantastic business there. Then about 6 years ago, the company focused on Bluetooth. So a lot of the investments sort of going into, hey, how do we build out the Bluetooth technology of the company? And that's paid huge dividends, not only in smart home, but it's been a big driver in some of these medical wins have been sort of Bluetooth-centric. Now over the last couple of years, the focus has been Wi-Fi. So Wi-Fi is like the next leg of technology that's being built and a lot of effort in the company is going into that. And like we expect that to pay off in a big way. This last earnings call and publicly, we said we expect the first production shipments on our Wi-Fi device called 917 is expected to also occur in the first calendar quarter as well. So that's starting to pay off. So I think what we're investing in totally makes sense to me. And I think what we're doing, we don't need to add a whole lot of incremental from here to allow some of that leverage from the model to flow through like as the design wins come into revenue.

It's almost like you spent ahead here, let's keep things where they are because you feel like that's generating the growth at the...

Yes, exactly. Exactly, Tom.

Lastly, capital returns. Early after the split, there was a lot of accelerated buybacks. Is there any different way that you're thinking about capital returns right now given where the business is? The way that you're describing it, it seems like things are on an upward trajectory for the next several quarters. So would you be more aggressive with share buybacks? Are you going to think about it from like a multiyear period of time? Like what's your framework for capital returns?

Yes. I mean I think our framework for capital return, just a little bit of history on sort of this accelerated buyback. We ended up buying back about 25% of the company. And look, that was from a divestiture that we sold off about half the company to Skyworks and we had a big cash balance. And we said, look, it's really prudent to return that to shareholders in the best way we can and share buybacks is sort of the mechanism that we chose. The framework for the company is we're likely going to be active in share buybacks going forward. I think 2 things are going to happen. One, we're going to return back into profitability and get the scale running. And I think what you want is like a multi-quarter under your belt that says, "Hey, yes, the scale is happening. It's looking good", and we'll start sweeping some of the excess free cash flow back into share buybacks. Look, the company has got so much growth projections ahead of itself that we don't need the capital to self-fund like organically, we can fund ourselves on what we need to do. And anything that we earn in excess, I think you'll see come as EBITDA grows, you'll see excess cash flows grow as well, and we'll start returning back to share buybacks. We keep an eye out for M&A, just to be clear about that, Tom, because the company was built on a lot of technology acquisitions that cobbled together actually to make the IoT platform that we have. We'll probably continue to look for that. But look, it's -- we're very prescriptive on what we're looking for. Look, there's not a whole lot of assets that can meet our 20% growth target. There's not a whole lot of assets that can sort of help us grow faster. We don't feel like we're missing a bunch of technologies that we need to go add to the portfolio. So while that's still on radar, I think that's just lower likelihood relative to like a share buyback type program.

Super helpful. It's been a pleasure. Thank you for being here, Dean. Have a great rest of the day and into 2025.

Absolutely. Thanks, Tom.