Silicon Laboratories Inc. (SLAB) Q3 2013 Earnings Report, Transcript and Summary

Good morning. My name is Roshira, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Silicon Labs Earning Conference Call. [Operator Instructions] Thank you. Ms. Stapleton, you may begin your conference.

Thank you, Roshira, and good morning, everyone. As a reminder, this call is being webcast and will be archived for 2 weeks. The financial press release, reconciliation of GAAP to non-GAAP financial measures and other financial measurement tables are now available on the Investor page of our website at www.silabs.com. I'm joined today by Tyson Tuttle, Chief Executive Officer; Bill Bock, President; and John Hollister, Chief Financial Officer. We will discuss our financial results and review our business activities for the quarter, then we will have a question-and-answer session following our prepared remarks. Our comments today will include forward-looking statements or projections that involve substantial risk and uncertainties. We base these forward-looking statements on information available to us as of the date of this conference call. This information will likely change over time. By discussing our current perception of our markets, the future performance of Silicon Labs and our products with you today, we are not undertaking an obligation to provide updates in the future. There are a variety of factors that we may not be able to accurately predict or control that could have a material adverse effect on our business, our operating results and financial condition. We encourage you to review our SEC filings that identify important factors, that could cause actual results to differ materially from those contained in any forward-looking statement. Also the non-GAAP financial measurements which are discussed today are not intended to replace the presentation of Silicon Labs' GAAP financial results. We are providing this information because it may enable investors to perform meaningful comparisons of operating results and more clearly highlight the results of core ongoing operations. I would now like to turn the call over to Silicon Labs' Chief Executive Officer, Tyson Tuttle.

Thanks, Deb, and morning, everyone. We completed our first quarter with Energy Micro as a key part of the company and are very pleased with our progress. The teams and operational systems are fully integrated and the product development roadmaps are aligned to enable the next generation of energy-friendly microcontrollers and radios. I'm also pleased to report that we delivered solid results in the third quarter including record revenue in broadcast video. However, we are seeing declines in Q4 due to weakness in end customer demand. I will talk more about third quarter results and our fourth quarter guidance later in the call. For now, I'd like to turn the call over to John, who will review our financial results in detail. John?

Thank you, Tyson. Third quarter revenue of $146.9 million was above the midpoint of our guidance range, reflecting a 3.8% increase sequentially. The increase in revenue was driven by strength in our MCU, video and timing products, partially offset by expected declines in access products. On a GAAP basis, third quarter gross margins ended at 60%. R&D investment increased to $40.7 million, and SG&A expense increased to $37 million, resulting in GAAP operating income of $10.5 million or 7.1% of sales. GAAP EPS was $0.15, which was slightly above our guidance range. On a non-GAAP basis, gross margin ended at 61.1%, which represents a decline from the prior quarter due to product mix and sales of acquired products that were below our corporate average. As expected, non-GAAP operating expenses increased in the quarter to $63.5 million. Non-GAAP R&D investment increased to $33.7 million, due to the addition of the Energy Micro team and higher investments in new product tape-outs. Non-GAAP SG&A expenses increased to $29.8 million based on increased headcount, significant travel spending in the quarter for sales and integration activities and higher legal spending. The combination of stable gross margin results and in-line operating expenses resulted in non-GAAP operating margin of 17.9%. Net other expenses were slightly higher than last quarter at $700,000 due to the reduced interest income from the acquisition cash outflow. Our effective tax rate was 22.6% in Q3, slightly better than expected. Non-GAAP net income for the quarter ended at $19.8 million or $0.45 per share, which is at the top of our Q3 guidance range. On a sequential basis, this represents a decline of $0.09 per share from last quarter, primarily due to the dilutive effects of the Energy Micro acquisition. Turning now to the balance sheet. Accounts receivable were $68.5 million or 42 days sales outstanding, which is consistent with our historical performance. We continue to have no known collection or bad debt issues. Inventory levels improved significantly in the quarter, decreasing to $44.8 million, resulting in improved turns of 5.1. This represents a stable turns level that we expect to sustain through year end. Channel inventory was stable in the quarter. In Q3, we saw an increase in other noncurrent liabilities of $52.4 million that is largely related to the holdback and earnout components of the acquisition. For the 9-month year-to-date period, we have generated $95 million in operating cash flow, which is around $10 million higher than the same period of the prior year. We ended Q3 with cash plus short- and long-term investments of $281 million, in line with our expectations. Our balance sheet continues to be very healthy. On the corporate front, we are pleased to have announced a satisfactory settlement with MaxLinear. The agreement resolved all outstanding patent litigation between the companies, and includes a global cross-licensing agreement covering all existing and future patents for the products involved in the litigation. The companies will refrain from bringing patent litigation against each other for a period of 3 -- for a 3-year period. At this point, I'll turn the call back to Tyson.

Thanks, John. We're very pleased to deliver solid third quarter results. Our extensive product portfolio, enhanced by the integration of Energy Micro, further solidifies our diversification strategy. We continue to see the expansion of the Internet of Things market driving our business forward, with the adoption of smart connected devices and the ongoing need for lower power, higher bandwidth and more data. During the quarter, we saw record revenue in Broadcast video and solid results for our Broad-based product line. Design win activity remains healthy and we continue to introduce exciting new products. Our Broad-based portfolio, consisting of microcontrollers, timing, power and sensor products was $73.3 million or 50% of revenue in Q3, up 6.5% sequentially. Microcontrollers were 28% of our total Q3 revenue, reflecting solid growth in our wireless and 32-bit ARM MCU products. We announced our first EFM32 Gecko MCU since the acquisition, underscoring our execution of the Energy Micro roadmap. Our new Zero Gecko family is based on the ARM Cortex-M0+ core, the industry's most energy-efficient 32-bit engine. Shipping now at very competitive prices, the Zero Gecko MCUs enable developers to create embedded systems that are 4x more energy-friendly than comparable offerings. Our Zero Gecko family strengthens our position as the industry leader in low-energy solutions for the Internet of Things. These MCUs are ideal for an array of power-sensitive applications such as mobile health and fitness monitors, smart watches, security systems and smart meters. MCU design win activity in the embedded market is robust, and we are on track with our 2013 revenue goal. Further demonstrating our success in the MCU market, we are expanding our position in the Internet of Things to our wireless product line. We continue to drive solid wireless design win activity in home automation, smart metering and smart energy and realized record revenue in the third quarter. We announced that we are providing sub-gigahertz wireless technology to Robulink, a leading supplier of advanced metering infrastructure solutions to utility companies in China, Southeast Asia and Australia. Leveraging Silicon Labs' EZRadio Pro transceivers, Robulink's AMI solutions enable utilities to quickly implement next-generation smart meters that communicate wirelessly through mesh networks. We expect our wireless RF products to be a growth engine in 2014. During the third quarter, we introduced highly integrated, feature-rich 8-bit microcontrollers which are optimized for motor control and other cost-sensitive applications. These MCUs combine best-in-class analogue and communications peripherals, small footprint packaging and competitive pricing, making them ideal for a variety of applications. Our timing products performed better than expected in the third quarter and represented 15% of overall revenue. Timing was down only 1.5% from its record last quarter, and was up almost 16% year-on-year. We see strong design win activity, growing momentum for our newer products and expansion of our customer base. We continue to invest in our diverse timing portfolio and are a market leader in high-performance clocking solutions. During the quarter, we introduced the industry's lowest-jitter, lowest-power clocks for high-speed networking equipment based on the Synchronous Ethernet standard, which is gaining traction in telecom infrastructure market. Our CMEMS technology platform, announced in Q2, continued to attract strong customer interest during the third quarter. We expect our new CMEMS oscillators will contribute meaningfully to revenue in the second half of next year. Broadcast products, including our audio and video tuner product lines, were $50.7 million or 35% of revenue in Q3 and delivered another strong growth quarter, up 5% sequentially. Our performance in Broadcast audio was again seller. We are pleased to deliver another record quarter in Broadcast video. During Q3, we introduced our fifth-generation of TV tuners, offering the industry's highest performance in integration and the lowest system cost. The new silicon tuners provide TV and set-top box makers with exceptional performance, based on 5 generations of patented architectural enhancements and a production history of more than 200 million tuner units shipped to date. Solidifying our #1 position in the video tuner market, we are supplying silicon tuners in high volumes to 9 out of the world's top 10 TV makers. Design win momentum for the 2014 model year is excellent and, therefore, we expect to gain additional market share with our Broadcast video products in the coming year. During the quarter, we also continued to diversify our Broadcast video revenue. For example, we announced the world's most advanced digital video broadcast demodulators for TVs and set-top boxes. We have gained a substantial share of the DVB demodulator markets by supporting the latest standards and providing highly integrated solutions like our new dual demodulators that enable customers to reduce cost and design complexity. Access, comprising modem, ProSLIC and Power over Ethernet devices totaled $22.9 million or 15% of revenue in Q3 and, as expected, declined 6% sequentially. We anticipate Access revenue will be down slightly in Q4, resulting in about a 10% overall decline in 2013 versus the prior year. And finally, we are very excited to welcome Mr. Alf-Egil Bogen to Silicon Labs' Board of Directors this week. A 20-year semiconductor veteran, Alf was the Chief Marketing Officer of Energy Micro, as well as the CMO at Atmel, where he was co-inventor of the AVR microcontroller. He currently serves as CEO of Norway-based Novelda, an innovator in nanoscale wireless technology for ultra-high-resolution radar. Alf's expertise in microcontrollers, corporate marketing and branding will be extremely valuable to Silicon Labs as we continue to focus on driving high-quality revenue and growth in market leadership. Now to fourth quarter guidance. We expect Q4 revenue to be in the range of $140 million to $145 million, primarily due to declines in broadcast video, reflecting weak end customer demand and pronounced seasonality. We do not believe this decline is due to any market share loss to our competitors. We expect fourth quarter declines in Broadcast to be mitigated somewhat by growth in Broad-based product lines, including strength in MCUs, power and sensor products. In Q4, we also expect record revenue for timing, reflecting continued strength in the communications market. Gross margin is expected to be approximately 61%, consistent with Q3. We expect non-GAAP EPS to be $0.40 to $0.45 per share, with an effective tax rate of 21%. On a non-GAAP basis, we expect total operating expenses to decline by approximately $1 million. We continue to be disciplined with our SG&A expenses, including reducing our spending on legal cost. In Q4, this will be somewhat offset by higher R&D investments, primarily due to new product tape-out expenses. Fourth quarter GAAP earnings are expected to be $0.12 to $0.17 per share and we anticipate fewer acquisition-related adjustments for the quarter. Before turning the call over to questions, I'd like to note that we are executing on our vision of diversifying revenue across multiple Broad-based product lines. Though disappointed by market conditions impacting near-term revenue, we are pleased with the design win momentum that we're seeing in our Broad-based business, including MCUs, timing, power and sensors. As we expected, the Energy Micro acquisition has proven to be a strategic and cultural fit with Silicon Labs. Thank you for your time and attention. We are happy to take your questions.

[Operator Instructions] Your first question comes from Srini Pajjuri with CLSA Securities.

Tyson, you talked about video being the weaker -- I guess, the TV demand has been relatively weak. I'm just wondering, you also mentioned seasonality. I thought Q4 seasonality is typically stronger. I'm just wondering what your customers are telling you about the overall demand and how we should think about this business as we head into Q1? And also, if you could talk about where we are in terms of the CMOS penetration, that would be helpful.

Really, in the video space, as we've seen in prior years, we haven't seen that pronounced a seasonality. If I have to put a peak within the year, it's probably in Q2. And then in Q4, you have a transition to the next model year, the beginning, and that really happens more in Q1. But we've seen across multiple customers, really since the beginning of the quarter, kind of a little bit of a slowdown in ordering patterns in video, and we think that, that reflects some end market demand or maybe some inventory in the channel. We don't think that it's due to any sort of loss, and we believe that, that should come back in Q1 at this point. But that's just what we're seeing. We don't believe that it's anything other than an end market condition at this point.

Okay, great. And then you said Access is on track to decline about 10% this year. How should we think about that business next year? And I guess, in terms of the overall legacy business, what would you say, as a percent of sales, your legacy business today is?

Right. So the Access business, again, it's a slow and measured decline in that -- in particular, in the modem and I think the SLICs and the Power over Ethernet are relatively stable in terms of their revenue profile. But I would expect that in 2014, the Access products would be down less than 10%. We took a step-down in the set-top box modems kind of in the middle part of this year, which was reflected in the results in Q3. And we think that, again, that's going to be relatively stable going into next year. So I think going forward into '14, that looks similar to the way it looked this year, although at a lower base. If you look at the total legacy products, we're pretty much out now of the handset touch controllers and the handset FMs. So that headwind is largely behind us and I think the set-top box, as well. So I wouldn't factor that into 2014. So I think at this point, the growth in '14 hinges on our execution on the Broad-based area.

Okay, great. And then one final question, Tyson. You mentioned that you expect revenues from the CMEMS product some time in second half of next year. Can you give us an update on what end markets are you seeing progress in? And also, if you can talk a little bit about the competitive landscape, I think that would be really helpful.

Okay. The markets that we're targeting with our first set of products in CMEMS are kind of at the entry level. They are crystal oscillator replacements that can go into a variety of applications, that are more like digital systems. So things like computing things, so there's a lot of consumer applications. It's -- the first product are not targeted at wireless or handsets but -- and as we go forward with the roadmap, we will be targeting higher performance in different types of functional integration with that technology. So it's truly a broad-based market that we're going after with these first products and we're seeing fairly broad-based interest in sampling and customer activity. It's not just one particular market. It's truly all over.

And the competitive landscape?

Oh, and the competitive landscape, it really -- competing against the crystal oscillator modules. So these are modules that have a piece of quartz inside along with a chip and built in a hermetically-sealed module. And we're coming up that with a single-chip solution. We don't see really competition from other MEMS providers. If you look, 99% of the market is crystal oscillator modules. So that's where we will remain focused. And that's consistent with how we've approached a lot of the markets where we've targeted discrete solutions. For instance, when we targeted the silicon tuner market, we were really competing against the discrete CAN and not against the other silicon vendors. And we think that's a similar situation here.

Your next question comes from Craig Ellis with B. Riley.

The first is a clarification on gross margin. I think in the prepared comments, it was mentioned that mix and acquired products were the factors that contributed to the sequential decline. What was the relative magnitude of those 2 dynamics?

Roughly split, Craig.

Okay, John. And then, on the outlook, and sticking with the gross margin line, if video is down meaningfully and timing is up, it seems like there is a very favorable mix dynamic on the gross margin line. And yet, they're guided flat. So why wouldn't gross margins be higher sequentially in the quarter?

We have growth in the acquired products, which as we stated, were below corporate average. We anticipate improving that margin profile going forward, as we migrate that product set into our supply chain. We see room for improvement in that area. We also see mix, as well, playing a factor in Q4. Craig A. Ellis - Caris & Company, Inc., Research Division: Tyson. [Indiscernible] I don't think it's much greater than the acquired products, isn't it, John?

I'm sorry? Craig A. Ellis - Caris & Company, Inc., Research Division: The size of the timing business is dramatically bigger than the acquired business. So it would seem that the growth of the timing business would overshadow any negative impact from growth in the Energy Micro business?

Well, certainly, the strength of timing will help margins, that's accurate. And we will see mix as an issue in Q4 as well, in the balance of the business.

Craig, there are 2 other things to think about in terms of the margin. If you go back to Q1, we were at 60.5 and we had a good pop-up in Q2, due to some specific product mixes. So we're actually still going to be higher than that. But also, at a little bit lower revenue base, some of our fixed manufacturing costs do weigh on the gross margin slightly. So while it's true that there is, from a mix standpoint, with video being down and timing being up, there would be a tendency to push the margin up. The video margins have improved considerably since they -- since we first introduced this product line. And as we introduced the fifth generation, cost reduction has been a key goal of ours.

Craig, this is Bill. I think, this is really the key point here. While video margins remain below the corporate average, they have improved toward that midpoint significantly over the last couple of years. So this decline in video is of a quality margin product now and not one that is a huge drag on corporate results.

How much of that beneficial impact will Gen-5 be to video gross margins next year, and what does that imply for the trajectory of gross margins through the year, next year?

Well, I think that it implies the video margins will be sustained and enhanced with this fifth generation of technology. It is this set of technologies that are being won for model year '14 designs. So I think this will be the product line that is shipping through the bulk of 2014 and will hold video margins in good stead throughout the year.

Okay. And then switching to the timing business, Tyson. There's certainly been mixed outlooks, if I were to characterize it that way, with some of the other semiconductor company competitors, with regard to communications. So what are you seeing in timing that is driving the sequential strength? Is it new design wins that are kicking in for you? Or is it increased share, it's specific customers? What's driving the sequential growth?

I would not say that it's improvement in the end market conditions. I think it's really a result of our design win momentum. I mean, if you look in Q3, our design wins were up 32% year-to-date. On a dollar basis, they were up 50% -- over 50% year-to-date. And that's been a pretty consistent story for the last year or more. So we've been gaining share, we've been gaining more content per box and some of those design wins are starting to ramp into production. And that's continuing to propel the revenue as we go into Q4 and into 2014.

And you don't think that there is any risk that the strength you're seeing in calendar -- or, excuse me, in the fourth quarter, is pulling in what would typically be a seasonally stronger first quarter in that business?

The booking patterns in timing remain strong. And both in the fourth quarter, starting out in the first quarter. So I continue to believe that the timing business is going to continue to perform for us.

Your next question comes from Tore Svanberg with Stifel. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: I'm hoping if you could first comment on your relative visibility for your guidance, either qualitative or quantitatively, talking about you backlog coverage?

Tore, this is Bill. The guidance in our coverage is similar to our historical pattern in that we take access or assessment for every piece of data we've got coming up to this call, and then attempt to give you a guide that we feel highly confident that we can meet. The reality of this month is that we have run a book-to-bill below unity, for the last several weeks, and that has been principally in the video product category. So we are providing this guide on the strength of the information we have presently, but we think it is a conservative guide and one that we are in a good position to deliver. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: Very good. And the question for Tyson. Tyson, on the video side, can you maybe comment on where your share stands today, either by your revenue or silicon tuners? And then would you expect that business to still be a growth business in 2014?

Yes. I think we are on track to exceed our target of 45% share this year. And the overall TV market is not growing, but the silicon tuner penetration into the market is continuing to advance. We see strong displacement of the CAN tuner, the discrete tuners, in the latest round of design wins. In particular, in China and Taiwan. And we've logged in -- I think we've locked in the Tier 1 business that we were chasing. So I think that we'll be able to maintain and grow our share in the Tier 1 accounts, and also expand significantly our business, in particular, in China. So my expectation is that our unit share is going to increase in 2014. We also have increased content with multi-tuner solutions into some of the high-end TVs, as well as our demodulator products are gaining traction and are going to be generating a significant amount of revenue growth in 2014, as well. And that's mainly targeting the European standard televisions with our demodulator, the advanced demodulator that we just introduced. So overall, looking into 2014, I think the video business is quite healthy. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: Very good. One last question on the microcontroller business. You're now obviously becoming a force across the board in the microcontroller market. I'm just wondering, at 32-bit, is that today primarily a direct business? Or have you also signed up some new distributors in the 32-bit MCU market?

Yes, I think the microcontroller business is primarily a distribution business. We've got 10,000-plus customers on the 8-bit side. When Energy Micro came onboard, they brought with them a number of distributors and we've kept a number of those distributors and expanded the opportunity with them. We've got Aero and Apnet and a number of distributors in Asia who market these products. So it's really -- and there's a number of direct customers, as well, but it's primarily a distribution business. And I think that taking the Energy Micro products and putting them within our distribution channel is having a major impact on the design win trajectory going forward.

[Operator Instructions] Your next question comes from Anil Doradla with William Blair. Anil K. Doradla - William Blair & Company L.L.C., Research Division: Could you, Tyson, remind us, when you look at 2014, what are your design wins in TVs? And how much visibility you have in, perhaps, your overall designs?

So in the broadcast video area, I think that the -- that at least with the Tier 1s, the design win season is pretty much done. We've locked in the Tier 1 design wins and believe it will maintain or grow our share with the Tier 1s going into 2014. There's a number of new opportunities with multi-tuner and with demodulators that will layer on top of that, at the Tier 1s. In China, though, it's not quite a model year and these design wins come up on a more frequent basis, and we continue to have significant design win traction with all the Tier 1 TV makers in China. So I think that the visibility there is a little bit less. But overall, given that we didn't have that much of business in 2013 in China, we're certainly looking at some significant growth in that region, as well. Anil K. Doradla - William Blair & Company L.L.C., Research Division: And, again, when I look at your business, can you help us understand what percentage is booking versus turns in any given quarter?

Anil, Bill again, generally speaking, our lead times from customers are in the order of 6 to 8 weeks. So most typically, when we enter a quarter, we have less than half of the quarter in backlog. So there's a substantial amount of turns business that we rely on to make any fiscal quarter result. Hence, the range that we provide in the guide. And we track then our performance against this turns business, the remainder of the quarter to deliver on the results that we indicate for you.

And there are no further questions at this time. Ms. Stapleton, do you have any closing remarks?

Thank you. And thanks to everyone for joining us today. Before we go, I'd like to invite all of you to the first Silicon Labs Analyst Day, which will be held at the NASDAQ Times Square site next May 12. Please save the date and we'll be in touch about further details as we get closer. Thank you and goodbye for now.

This concludes today's conference call. You may now disconnect.