Silicon Laboratories Inc. (NASDAQ:SLAB) Q3 2023 Earnings Call Transcript

Silicon Laboratories Inc. (NASDAQ:SLAB) Q3 2023 Earnings Call Transcript November 1, 2023

Silicon Laboratories Inc. beats earnings expectations. Reported EPS is $0.62, expectations were $0.61.

Operator: Hello. My name is Lisa, and I will be your conference operator today. Welcome to Silicon Labs’ Third Quarter Fiscal 2023 Earnings Call. I will now turn the call over to Giovanni Pacelli, Silicon Labs’ Senior Director of Finance. Giovanni, please go ahead.

Giovanni Pacelli: Thank you, Lisa, and good morning, everyone. We are recording this meeting, and a replay will be available for four 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, John Hollister. They will discuss our third quarter financial performance and review recent business activities. We’ll 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.

A technician using a microscope to inspect a complex semiconductor structure.

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. A 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’ll now turn the call over to Silicon Labs’ Chief Executive Officer, Matt Johnson. Matt?

Matt Johnson: Thanks, Giovanni, and good morning, everyone. In the third quarter, the Silicon Labs team executed well in a challenging environment, driving revenue and EPS to both exceeded the midpoint of our guidance. Current market environment continues to be characterized by a difficult combination of weak demand and high inventory. Specifically, end customers carry to — continue to carry inventory levels that are too high. At the same time, our end customers’ demand environment continues to be weaker than previously forecast. In particular, we see weakness extending further into the broad industrial end market. As a result of these factors, our fourth quarter will be negatively impacted across both business units. We have contained operating expenses thus far in the second half of this year by focusing on temporary reductions in discretionary and flexible spending.

Given the duration and severity of this downturn, we have now proactively taken a difficult decision to make structural reductions in headcount and other spending effective immediately to manage our OpEx further while maintaining investments in essential R&D projects to drive future growth. While the near-term outlook is clearly challenging, we are focused on managing what we can control and putting ourselves in a position to deliver strong growth and higher earnings power once it’s difficult market cycle corrects. Our design win momentum has never been stronger, and we are as confident as ever in our potential. To underscore this, our industry-leading Series two platform continues to perform exceptionally well, driving our design wins to an all-time record level in Q3 and up 25% year-over-year.

Importantly, we are starting to see this design win momentum pay off with some exciting ramps that I’ll share after we hear from John. Also, in Q3, we announced our next-generation platform called Series 3 that will further position us to lead this space. All of the items I’ve mentioned a strongly position us moving forward. With that, let me turn the call over to John to cover Q3 results and guidance for the fourth quarter. John?

John Hollister: Thanks, Matt, and good morning, everyone. Third quarter revenue was $204 million, above the midpoint of our guidance range and down 24% year-on-year. ASPs in the quarter declined sequentially, primarily due to product and customer mix. Unit volume was down just slightly on a sequential basis. Revenue was down year-over-year in both business units in the quarter. The Industrial & Commercial business ended at $121 million, down 17% during the same period last year. All three product groups in I&C declined in the quarter with the broad industrial category experiencing the largest decline. Within the I&C business, our performance in smart metering, however, has continued to be an area of relative strength. Home & Life revenue of $83 million was down 33% year-over-year and was up 4% sequentially.

We continue to see strength in Life applications, particularly in connected health devices. Geographically, we saw year-over-year decreases in all regions, with APAC being down less here Europe and the Americas. APAC, ex-China was up year-over-year. Distribution revenue was 81% for the third quarter, up slightly from the second quarter. Inventory in the channel was around 90 days. Our largest end customer was under 5% of revenue in the quarter, and our top 10 end customers were about 25%, consistent with our historical trends. Non-GAAP gross margin ended slightly lower than expected at 58.5% due to product mix. We continue to see a generally stable pricing and input cost environment with no significant changes expected in the next quarter. Non-GAAP operating expenses of $95 million was in line with our expectations as we executed focused spending reductions in the quarter primarily related to variable compensation, contractor spending, and travel.

Non-GAAP operating income was $25 million or 12% of sales, and our non-GAAP effective tax rate was in line with the quarter at 24%. Non-GAAP earnings of $0.62 was $0.03 above the midpoint of our guidance, primarily due to higher revenue. On a GAAP basis, the gross margin ended at 58.4%, GAAP operating expenses were $107 million, which was better than expected and was $13 million below the midpoint of our guidance, primarily due to a change in stock compensation expense driven by the expected lower achievement on performance-based awards. Accordingly, GAAP earnings per share were $0.32 for the quarter. Turning to the balance sheet. We ended the quarter with cash and investments of $417 million. Our accounts receivable balance grew in the quarter to $102 million with days sales outstanding 45 days.

Customers, including distributors, have requested longer payment terms in this current market environment. Accordingly, we temporarily extended payment terms for certain customers from our standard early-day terms. We added about $22 million in net inventory in the quarter to $168 million as we continue to accumulate a strategic benefit based on the strong design win momentum we’ve seen for the past few years. inventory turns into at two times. We repurchased approximately $16 million worth of shares in Q3, targeting approximately 100,000 shares. Our fully diluted shares outstanding in Q3 ended up 32 million shares. In Q2, we drew $80 million revolving — from our revolving credit facility. We repaid $35 million of that balance in Q3 and have an outstanding amount remaining of $45 million.

Overall, the balance sheet continues to be very healthy and remains well positioned to weather the current market environment and to execute on our strategy. Before I turn the call back to Matt, I will cover guidance for the fourth quarter. As Matt mentioned in his opening statement, the current demand environment is still quite challenging as customers are focused on reducing their excess inventory. Our bookings activity slowed significantly during Q3, and we believe many of our end customers still hold higher-than-normal inventory levels. As a result, we expect a decline in revenue for the fourth quarter with a guided range of $70 million to $100 million. We anticipate both units — business units to decline in Q4. Due to the uncertainty in the market environment, we are widening the guidance range to plus minus $15 million from the revenue midpoint for this quarter.

We expect non-GAAP gross margin in the fourth quarter to be approximately 53%. The lower gross margin for this quarter primarily reflects the impact of certain fixed cost developments in our cost of goods sold, which are being absorbed over a significantly lower revenue level. We continue to maintain discipline over our operating expenses, and the temporary reductions we discussed last quarter will remain in place to the fourth quarter. We expect non-GAAP operating expenses in the fourth quarter to be approximately $94 million. We expect the non-GAAP effective tax rate to be approximately 3% in the fourth quarter. Accordingly, our non-GAAP loss per share for Q4 is expected to be in the range of $1.22 to $1.66. On a GAAP basis, we expect gross margin to be 53%.

We expect GAAP operating expenses to be approximately $123 million, inclusive of an expected restructuring charge of around $6 million in Q4. We expect GAAP earnings per share to be a loss of between $1.95 to $2.39 per share. I will now turn the call back over to Matt.

Matt Johnson: Thanks, John. Despite the current economic challenges, we continue to execute on design win ramps and long-term growth markets such as smart cities and health care, which are driving significant deployments of devices with sizable ramps in the coming year. In smart cities, Silicon Labs has been the wireless leader in smart metering market for many years. Like the leadership role we played in the successful rollout of smart meters in the U.K., we are now planning a similar and dominant role in India’s rollout where 250 million smart meters are expected to be deployed in the coming years, with our production ramp starting early next year. In addition, we were awarded new designs with Landis+Gyr, a leading provider of energy management solutions to use our Series 2 SoC in its primary smart electric metering platform, ramping early next year.

Also, within our Industrial business, we have been designed into multiple products at one of the top two EV providers in the world, which we expect to ramp over the next few quarters. Turning to our Life business. The health care space continues to accelerate and offer exciting new growth opportunities that are a great fit for our platform. We are starting to see our multiyear focus on this market payoff, having secured multiple designs globally. As part of this, we are excited to share our partnership with Dexcom, which will use our platform in its continuous glucose monitors, or CGMs, moving forward. Silicon Labs’ ability to offer customizable and highly secure solutions with our Bluetooth SoCs was key in solidifying this relationship, and we expect these product ramps will begin contributing to our revenue early in 2024.

At our fourth annual Works with Conference in August, which attracted thousands of IoT developers, I previewed Silicon Labs’ fifth-generation platform called Series 3, which is on track to sample early next year. Series 3 brings three major new capability to the IoT. First, it brings new to industry performance through new levels of security, wireless performance, power consumption, and multiband and multi-protocol capabilities, areas we have always stood out in. Second, our new levels of compute. Series 3 can support more than 100 times of processing capability of our current generation Series 2, including integrated artificial intelligence and machine learning accelerators and enabling the integration of system processing from stand-alone MCUs into our wireless SoCs. And third, the IoT is seeing new-to-world volumes and applications.

Because of this, our Series 3 platform will offer new levels of scalability with a multi-radio platform and common code base that will serve over 30 new wireless SoCs, a 2 time to 3 time increase over the number of Series 2 products as well as extendable and scalable memory architecture, including support for external flash. As part of scalability, Series 3 is built on a supply chain that leverages multiple fabs and geographies to maximize the resiliency and reliability of supply. As part of the Series 3 announcement, Silicon Labs also announced the next version of its developer tool suite, Simplicity Studio 6, which will allow developers to utilize the most preferred integrated development environment on the market while giving them the latest tools to support their continued development on Series 2 as well as Series 3.

As we told our developers, an investment in our industry-leading Series 2 platform is also an investment in our Series 3 platform. Importantly, Series 2 will continue to grow and be supportive of new silicon and software and will complement Series 3 with both platforms coexisting for many years to come. In closing, I would like to acknowledge that despite the near-term weakness in our end markets, our team is dedicated to overcoming this market downturn without hampering our long-term strategic and financial goals. The fundamentals of our story and the growth prospects for our end markets remain sound, and our position in those markets has only become stronger. Based on everything we’re seeing, we believe Q4 will be our bottom, and we expect to return to sequential growth in the first quarter of 2024.

I will now hand it back over to Giovanni for Q&A. Giovanni?

Giovanni Pacelli: Thank you, Matt. Before we open the call for Q&A, I would like to announce our participation in three upcoming conferences. Stifel’s 2023 Midwest One-On-One Growth Conference in Chicago on November 9, Wells Fargo’s Seventh Annual TMT Summit on November 29 in Rancho Palos Verdes, and the Barclays Global Technology Conference in San Francisco on December 7. 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 one question and one follow-up. Lisa?

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Q&A Session

Operator: [Operator Instructions]. Our first question will be coming from Matt Ramsey of TD Cowen. Please go ahead.

Matt Ramsay : Thank you, very much. Good morning everybody. Hang-in there guys in the tough environment. I think, Matt, I wanted to start my question and just to kind of back up and reassess things on kind of first principles about some of the assumptions we have in the model relative to what’s going on here. It sounds like pricing stability, exciting things coming with Series 3, still really strong design win traction and at first read, that seems just to me like an inventory correction on steroids a bit. And I’d like to get you to respond to that and just think about — as you think about the design wins going forward that you guys continue to accumulate, are you concerned that maybe the volumes and revenue going forward that underpin those design wins have just come down and the TAM for the business that you’re looking at is smaller?

Or is this just literally an inventory correction that we got to get through before we get back on the bike? I’m just trying to think about, given the level of falloff in revenue here, how are you guys thinking about reassessing the actual TAM for units and dollars relative to just the design wins? Thanks.

Matt Johnson: Yes. Completely understand. Thanks, Matt. Yes, let me do my best to answer that. Just to start with, before we get into the inventory and the demand, it’s important to point out that we really essentially indexed to a couple of major end segments, consumer, which has been down for a year now pretty significantly. And Industrial, which had been more resilient but we’ve been seeing signs of that, and that really came through as we were leading in Q3 and going into Q4, the weakness in that space. But the end inventory is really important to talk about, right? So, we’ve — really, when we sample our top 40 or 50 customers, they’re carrying more inventory than they normally do by at least a quarter. I’d say it’s an easy way to think about that.

And on top of that, I think their expectation for demand and growth and strength was higher. And when those two things converge and the demand less and that inventory is high, the impact is profound, and that’s what we’re seeing. So that is the first piece of it. And in terms of the second piece, in terms of end markets and design wins and all that, a few things. One is we don’t see share loss here. When we look at it on a socket-by-socket basis, we see gains. And that’s reflected in our design win numbers and strength with a record Q3 that was, I think, up around 25% year-over-year. But what we do see is while some of those have ramped, we see those ramps being impacted by the overall market. Maybe their volumes are less than they thought, ramps might be pushed out as they work through inventory, et cetera.

But the big ramps are solid and there, although some might be delayed. And so, we shared some of those in the prepared remarks that are pretty substantial and coming very soon in Q1. But I don’t see anything on share loss, I want to be clear about that. And your question about the TAM, I mean I think there’s an argument being made that when the market is down like the size of the market is significantly less, but the fundamentals in terms of the long-term size of the market, the growth of the market, none of that’s changed at all. So, what we really see is that confluence of end inventory and demand being much softer than expected coming together and we got to navigate that. But the fundamentals haven’t changed, and that’s what gives us confidence moving forward.

Matt Ramsay : Thank you for all that perspective, Matt. I really appreciate it. John, just as my follow-up, two things. One, it looked like you guys burned $50 million or something like that in cash, and you’re guiding to, obviously, negative P&L for the December quarter. So, I just wanted to do a check on cash balances, liquidity, the revolver, stuff like that, just to see how you’re thinking about it. And then you spent a little time on some OpEx reductions in the script. Maybe you could quantify how we should think about that for 2024? Thanks.

John Hollister : Sure, Matt. So, on the cash balance, we continue to have a strong cash balance, our revolver that’s outstanding is really around optimizing between short-term investments and interest, et cetera, to optimize that portion of our cash flow P&L. So, we’re not concerned about the liquidity of the company, and we continue to have a robust cash balance. In terms of the OpEx actions, remember that in the second half of 2023, we undertook temporary non-sustainable OpEx containment actions, such as travel, contractor spending, some of our bonus programs, et cetera. These things need to come back heading into next year. And it’s because related to that, unfortunately, we are taking some structural reductions in the business.

From a quantification perspective there, Matt, the way to think about that is first quarter OpEx, we see is roughly flat to the second half run rate as these two things basically offset each other. And then we’ll monitor this as we move through the rest of next year based on the rate pace of revenue improvements, which we do anticipate happening through the course of next year. We just need to see how strong the recovery is based on the ramps and recovery of the general market.

Matt Ramsay : Very clear. Thanks guys. See you next week.

Operator: And our next question will be coming from Tore Svanberg of Stifel. Your line is open.

Tore Svanberg: Yes. Thank you. I wanted to zoom in on your comment about Q4 being a bottom and seeing some growth sequentially in Q1. It sounds like you have some design wins ramping. That’s pretty clear. But can you also talk about the inventory correction? I mean, obviously, given the size of the Q4 guidance down here, obviously, one would think that, that’s clearing out of inventories. But any more color or visibility you have on the inventory situation as you go into 2024, that would be helpful.

Matt Johnson: Sure. Yes, Tore. This is Matt. A few things on that. we are definitely not calling the market bottom, and we want to be clear about that. And it should be clear, there’s also headwinds, right? It’s unclear how much more of a correction Industrial has as an end segment. So, there’s some headwinds there. And on end customer inventory, that would be awesome if it was super clean on the quarter boundary, but it isn’t. It’s not uniforms across our customers. We talk to — as I said, our top 40 or 50, they’re carrying more than they should, some less, some more, some extending into Q1 and Q2, some okay now. But if you average it all out, it’s really the biggest impact is, it’s about a quarter that they have. They’re carrying more than they typically should or would.

So that’s important. So, we’re not saying the inventory headwind will go away, but the biggest piece of it should hopefully be addressed. So that’s one. And so, you have those headwinds for sure, but that should be working its way through an end inventory. And then the tailwinds would be obviously starting from a remarkably low revenue number moving forward, and that inventory working down at our customers and the design win strength that we have. As I said earlier, none of those sockets are gone. We continue to accumulate them, and some of the bigger ones are right around the corner. So, it’s a confluence of those things story that gives us the confidence to say, based on what we’re seeing and what we believe is this will be our bottom, and we can drive sequential growth from here.

Tore Svanberg: Yes. That’s very helpful. And as my follow-up, I know this is always a very tricky question given cyclicality, and inventory management, and so on and so forth. But your revenues peaked at $270 million, you’re guiding $285 million at the midpoint. Where do you think the true consumption is of your business, whether on a quarterly or an annual basis, just to sort of we get a sense for where you will eventually go back to as we get through this inventory adjustment period? Thank you.

John Hollister : Yes, Tore, this is John. Yes, it is a hard question to answer, given the lack of visibility we have to into the inventory level and how that relates to our revenue run rate as seeing the effect of that right now. But suffice to say, we think it’s meaningfully higher than where we’re running guiding right now. That is clear. But clearly, we do need to take some action around our OpEx and we’re reacting and executing important.