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Edited Transcript of SLAB earnings conference call or presentation 24-Jul-19 12:30pm GMT

Q2 2019 Silicon Laboratories Inc Earnings Call

AUSTIN Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Silicon Laboratories Inc earnings conference call or presentation Wednesday, July 24, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Tyson Tuttle

Silicon Laboratories Inc. - President and CEO

* Jalene Hoover

Silicon Laboratories Inc. - Director of IR & International Finance

* John Hollister

Silicon Laboratories Inc. - SVP and CFO

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Conference Call Participants

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* Alessandra Maria Elena Vecchi

William Blair & Company L.L.C., Research Division - Research Analyst

* Blayne Peter Curtis

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Cody Grant Acree

Loop Capital Markets LLC, Research Division - MD

* Gary Wade Mobley

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Matthew D. Ramsay

Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst

* Rajvindra S. Gill

Needham & Company, LLC, Research Division - Senior Analyst

* Ruben Roy

The Benchmark Company, LLC, Research Division - Analyst

* Sujeeva Desilva

Roth Capital Partners, LLC, Research Division - Senior Research Analyst

* Tore Egil Svanberg

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

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Presentation

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Operator [1]

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Good morning. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to Silicon Labs' Second Quarter Fiscal 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the call over to Jalene Hoover, Director of Investor Relations and International Finance. Jalene, please go ahead.

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Jalene Hoover, Silicon Laboratories Inc. - Director of IR & International Finance [2]

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Thank you, Nicole, and good morning, everyone.

Tyson Tuttle, Chief Executive Officer; and John Hollister, Chief Financial Officer, are on today's call. We will discuss our financial performance and review our business activities for the second quarter. After our prepared comments, we will take questions. Our earnings press release and the accompanying financial tables are available in the Investor Relations section of our website at www.silabs.com. This call is also being webcast, and a replay will be available for 4 weeks.

Our comments today will include forward-looking statements 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. A reconciliation of our GAAP to non-GAAP results is included in the company's earnings press release and also in the Investor Relations section of Silicon Labs' website.

I would now like to turn the call over to Silicon Labs' Chief Financial Officer, John Hollister.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [3]

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Thanks, Jalene. I'm pleased to report solid execution in Q2 with sales rebounding for Q1 as we had expected. Revenue for Q2 ended at $207 million, in line with expectations and up about $19 million or 10% sequentially. Non-GAAP earnings exceeded the top end of our guidance range at $0.83 per share.

Despite lingering macro weakness in the industry, IoT delivered a strong quarter, with wireless products achieving record sales due to ramps in lighting, smart home, metering and the broader industrial IoT end markets. Total Q2 IoT sales were $125 million, up 17% sequentially and just shy of a record. IoT sales represented 60% of consolidated second quarter revenue, which is an all-time high.

Infrastructure revenue was $44 million or 21% of Q2 revenue and down about 4% sequentially, with China trade issues negatively impacting timing product sales. Isolation revenue was up slightly for the quarter.

Broadcast revenue was flat in Q2 at $26 million and roughly 13% of our total revenue mix.

Access revenue rebounded in Q2, up 24% sequentially to $12 million or about 6% of total revenue.

Looking at second quarter revenue by end market. IoT drove growth in industrial and consumer. Automotive and computing were about flat, and communications was down primarily due to weakness in timing.

Revenue increased across all geographies, propelled by strength in IoT, with the Americas showing the largest sequential growth followed by APAC and Europe.

Distribution mix ended at 73%, up 2% from Q1, with distributor inventory days declining sequentially, reflecting an overall healthy state of channel inventory. No end customer accounted for more than 10% of our revenues.

Non-GAAP gross margin ended strong for the quarter at 61.6%, which was about 1 percentage point higher than expected due to product mix and supply chain efficiencies realized in the quarter.

Non-GAAP OpEx was slightly favorable to expectations at $88 million and flat to Q1. Non-GAAP R&D expenses increased to $50 million on employee-related costs and higher tape-out costs. Non-GAAP SG&A was down by about $2 million from Q1, ending at $38 million on lower payroll taxes and insurance cost.

Non-GAAP operating margin ended stronger than we expected for the quarter at 19.2% due to in-line revenue, positive gross margin and favorable OpEx. Our non-GAAP effective tax rate was 11.6%. Non-GAAP EPS ended at $0.83, just above the top end of our guidance range. The diluted share count for the quarter was 44 million shares outstanding, up slightly from Q1.

Looking at our GAAP P&L results, gross margin ended the quarter at 61.5%. GAAP R&D expenses were $64 million. GAAP SG&A expenses were $49 million, which includes approximately $1 million in acquisition-related expenses. GAAP operating margin was 7% for the quarter.

Stock compensation expense for the quarter was $14 million and amortization of intangible assets was $10 million, both in line with expectations.

During the quarter, the Ninth Circuit Court of Appeals ruled in favor of the IRS in the Altera case and as a result, we recorded a $28 million GAAP tax charge to our provision related to a deferred tax asset previously recognized in connection with intercompany cost-sharing arrangements. The charge had a $(0.64) per share negative impact on earnings, resulting in a $(0.37) GAAP loss per share for the second quarter. This adjustment had no cash flow impact for the quarter.

Turning now to the balance sheet. We ended the quarter with cash and investments of $647 million. Accounts receivable ended up slightly at $72 million, with 31 days sales outstanding. Inventory ended at $74 million. As expected, our inventory turns improved in the quarter to 4.3x due to greater shipments and effective supply chain management.

Operating cash flow for the sixth month year-to-date period was $71 million, up about 40% from the same period in fiscal 2018. Our long-term debt balance was stable at $400 million, representing approximately 2x EBITDA leverage. We continue to have additional borrowing capacity of up to $500 million under our bank credit agreement.

We have executed approximately $27 million in share repurchases thus far in 2019. Over the past 18 months, our repurchases have totaled $66 million, allowing us to retire more than 700,000 shares of common stock. We have about $134 million remaining in our share repurchase authorization through the end of this fiscal year.

In summary, our balance sheet and overall financial profile are in great shape.

I will now cover guidance for the third quarter.

We expect Q3 revenue to increase to a range of $213 million to $223 million, with IoT and Broadcast up, Access flat and Infrastructure down due to ongoing China trade headwinds.

On a non-GAAP basis, we expect gross margins to be 60%. We expect non-GAAP OpEx to increase to approximately $89 million. We expect non-GAAP earnings per share to be in the range of $0.79 to $0.89. We anticipate our non-GAAP effective tax rate will increase to around 12.5% due to some discrete charges for the quarter.

On a GAAP basis, we expect gross margin to be around 60% and GAAP OpEx to be approximately $112 million. We expect GAAP earnings per share to be in the range of $0.29 to $0.39, with an expected diluted share count of 44.5 million shares. We anticipate an approximate 10.5% GAAP effective tax rate for the quarter.

I will now turn the call over to Tyson.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [4]

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Thank you, John. We grew second quarter revenue 10% sequentially, despite macro headwinds impacting the semiconductor industry. We are gaining traction in our target markets, with total design win lifetime revenue establishing a new record, up 25% year-on-year.

Second quarter IoT revenue outperformed expectations, with strong sequential gains led by wireless. Wireless products achieved more than 1 billion units shipped to date and established record revenue in Q2, now representing more than 65% of IoT revenue. Our IoT opportunity funnel now exceeds $8 billion, up about 30% year-on-year, demonstrating the overall expansion of IoT markets and the competitiveness of our solutions as we convert the pipeline of opportunity for the design wins.

Despite China trade headwinds, we saw solid sequential growth in our MCU products in Q2. During the quarter, we announced the adoption of our microcontrollers and the latest smart lock products from Yunding, an innovative smart device and cloud-based service provider and a key member of the Xiaomi Mi Ecosystem. Silicon Labs, Yunding and a group of leading Chinese companies are collaborating in a new initiative to develop safety standards for the smart lock industry and guidelines for technical innovation. This type of collaboration is increasingly important as we -- to ensuring we develop the right software to enable IoT technologies in diverse markets and geographies.

During the quarter, we announced a collaboration with Notion on a battery-powered smart home sensor that detects water leaks, smoke, carbon monoxide and temperature changes. The Notion solution allows users to easily monitor their homes through a smartphone app and spot problems early on to mitigate damage. The Notion sensor is built on Silicon Labs' wireless Gecko platform, easing design complexity through low power consumption, flexible multi-protocol connectivity and leading wireless performance.

We are the leading provider of mesh networking solutions for low-powered wireless end nodes, including Zigbee, Bluetooth mesh and Z-Wave. We see growing opportunity in target market segments, including home automation, security, smart metering, smart lighting and gateways, where IoT ecosystems are proliferating worldwide and are gaining strong traction with Alarm.com, Amazon, Comcast, Google Home, Signify, Samsung SmartThings, Tuya, U.K. smart energy, Xiaomi and many others.

We are deeply engaged in smart lighting, which is redefining home automation through simple, affordable, do-it-yourself solutions. As the leading IoT technology for smart lighting, Zigbee has played a key role in driving smart home innovation and adoption. Today, Zigbee is used in 80% of all smart LED light bulbs sold from retailers, such as Amazon, Best Buy and Home Depot.

During the quarter, we announced our collaboration with Signify, the world leader in lighting to help ecosystem partners develop smart light switches for Philips Hue systems. The Friends of Hue ecosystem allows third-party vendors to build certified interoperable smart lighting products, which integrates seamlessly with Philips Hue, a leading Zigbee-based smart lighting solution. Silicon Labs is a key Friends of Hue partner and has worked closely with Signify to provide compliant Zigbee software, enabling advanced light switch functionality. With 20 years of experience in mesh networking, Silicon Labs is strengthening the Friends of Hue program with our deep mesh networking expertise, leading software and wireless development tools.

No other company offers Z-Wave, the leading smartphone mesh connectivity solution used in 3,000 certified interoperable products and adopted by more than 700 companies worldwide. In Q2, we launched Z-Wave 700, now running on our Series 1 wireless Gecko platform and offering multiple benefits to customers, including increased range, longer battery life, wider temperature range and multi-protocol capabilities. We are aggressively promoting the Z-Wave Alliance to drive increased adoption across multiple ecosystems, market expansion of the new device types and the convergence of standards in end nodes and gateways to simplify the end user experience.

We are driving industry-leading Bluetooth and Bluetooth mesh roadmaps to deliver best-in-class cost and power efficiency and are well positioned to capture share in this multibillion-dollar market.

Our footing in proprietary wireless, especially in commercial and industrial IoT applications is solid, supporting more than 50 customer stacks on our easy-to-use Radio Abstraction Interface Layer, or RAIL software.

Having multiple connectivity standards under one roof strengthens our influence on the evolution and adoption of wireless standards in targeted IoT market segments. We differentiate ourselves from the competition by combining multiple wireless capabilities onto the same platform, developing our own standards-based wireless protocols rather than licensing stacks from third parties and optimizing our hardware and software to work seamlessly together.

We are making significant progress with our next-generation Series 2 wireless Gecko platform, which offers best-in-class integration, wireless range, battery life, security and cost and are heavily engaged with alpha customers since the release of the first product in April. We continue to drive an aggressive roadmap to further our differentiation and market leadership. Our long-term commitment to developing the industry-leading IoT platform of silicon software and solutions is resonating with our customers, enabling them to future-proof their designs, upgrade to new features, reuse their hardware and software investments in ways not possible with single-point solutions.

Offering a comprehensive hardware platform, a common software development environment and simplicity across the portfolio, with easy-to-use tools and modules, is critical to efficiently scaling across thousands of applications and tens of thousands of customers in the IoT markets.

Turning now to Infrastructure. Macro conditions and trade tensions continue to impact revenue. Second quarter Infrastructure revenue was down 4% sequentially and approximately 15% year-on-year, with declines in timing and isolation products. Timing and isolation each delivered record lifetime revenue design wins in the second quarter, signaling strong market traction going forward.

Network equipment providers are racing to develop higher-speed, higher-capacity gear to support 5G wireless traffic. This transition is driving the need for higher-performance timing solutions for fronthaul, backhaul, metro core and data center applications. During the quarter, we announced new jitter attenuating clocks with a fully integrated crystal, improving system reliability and performance while simplifying PCB layout in high-speed networking designs. Our new jitter attenuators address the demanding reference clock requirements of next-generation communications designs.

New 5G features that minimize intercell interference and optimize spectral capacity require precise IEEE 1588 packet-based timing synchronization in radio access networks and wired networks carrying 5G traffic. To meet the growing demand for this functionality, in Q2 we introduced a family of high-performance clocks supporting IEEE 1588 in synchronous Ethernet. These new clocks combine Silicon Labs' patented DSPLL technology with standards compliant software to offer a complete solution and to simplify the adoption of IEEE 1588 in wireless backhaul, IP radio, small and macro cell wireless systems and data center switches.

We believe we are uniquely positioned to address the IoT and Infrastructure markets where we continue to invest and have established leadership positions. Tens of thousands of customers worldwide choose Silicon Labs because they want to work with a technology leader focused on the big picture and offering a long-term commitment, which is a key driver of the growth we are seeing in the channel, in our pipeline and in our design win momentum. We believe we have the right technical expertise, are developing the right solutions and are investing in the right segments to continue to outperform the market.

Thank you for your time and attention. Before we take your questions, I'd like to turn the call back to Jalene.

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Jalene Hoover, Silicon Laboratories Inc. - Director of IR & International Finance [5]

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Thank you, Tyson. Before we open the call for the question-and-answer session, I would like to announce our participation in the upcoming conference, including KeyBanc Capital Markets 21st Annual Technology Leadership Forum in Vail on August 12th and Citi's Global Technology Conference in New York on September 4th.

We would now like to open the call up for your questions. (Operator Instructions) Nicole?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Blayne Curtis of Barclays.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [2]

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Maybe first, Tyson, your involvement with the SIA is maybe a good perspective here. Just on Huawei, seems like Texas Instruments is back reshipping. And I know there's a lot of subtleties here. But I'm just kind of curious of your perspective. It seems like your forecast, you have them out. I'm just kind of curious your view on what the status of this is and whether you think you can eventually restart shipment.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [3]

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Yes, Blayne. This is John. With respect to Huawei, it's a complex issue. There are different products that have different types of export control designations. Over the past few months, we've been working closely with the SIA as well as external counsel to understand the landscape. And in light of that, we have resumed some shipments where possible with Huawei and view the Q3 guide that we have out this morning as more of a normalized level of business with Huawei. The China ecosystem remains very important to us, and we continue to gain traction out on the market with Xiaomi and others as we indicated on the prepared comments.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [4]

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And then I just want to ask you. You mentioned -- and IoT lighting was the first one you mentioned. You highlighted again 80% Zigbee. I was wondering if you can just walk us through, one, just any view on the market over the next couple of years. And then within that 80% of Zigbee, can you just give us the competitive landscape? That will be helpful.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [5]

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So Silicon Labs is the leader in Zigbee. We've got a 15-year-plus history developing mesh networking software and have a dominant position in the Zigbee market. And Zigbee has been very successful in lighting. One of the reasons is because in lighting applications, you actually have to support varied high temperatures. And when you optimize the cost of the bulbs, you want to run them as close to the limit as possible. And our solutions have been one of the few that have support in the requirements of lighting.

From a software standpoint, we've got the leading Zigbee stack and development environment and interoperability and have had a lot of success with the leading consumers as well as commercial and industrial lighting manufacturers. I think that the benefit of Zigbee is the robustness of the mesh network compared to Wi-Fi applications and the fact that it works without a mobile phone. So they typically use a gateway. You've seen the integration of those gateways into things like the Amazon Alexa and other control points that you can get rid of the gateway and you can talk to those. And we see a growing trend to the integration of Zigbee into gateways by the operators and ecosystem providers. So that provides kind of an ease of installation. We've also seen pretty good traction with the retailers in promoting these. We've seen the cost curves come down on smart lighting. And so we anticipate that smart lighting, in general, and the attach of smart lighting compared to just a regular bulb, that percentage to go up over time. So we see this as a nice tailwind for us. And we feel like we have a very strong competitive position to maintain our share.

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Operator [6]

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Our next question comes from Matt Ramsay of Cowen.

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Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [7]

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Tyson, I wanted to follow up a little bit on Blayne's question around Infrastructure and timing, in particular. It sounds like you guys are calling for the timing business to be down sequentially into September. And John just commented that you guys had included sort of a normal run rate quarter for Huawei. So maybe you can talk a little bit about the market overall for your timing products and where there might be softness and what, in particular, you think might be causing that if your shipment to Huawei are resuming.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [8]

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Yes, Matt. This is John. So we see a good long-term opportunity in the timing market and see a good design win traction in 5G with customers around the world in that market. The opportunity at Huawei is down from where it was previously based on the trade issues, and Huawei works through that. It's a partial recovery of where we were previously related to that based on the export control designations as I talked about. But longer term, we continue to see a very good opportunity in the timing market. But yes, you're right. We did highlight Infrastructure as an overall category to be down in the third quarter sequentially.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [9]

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Yes. I think I can add a little bit of color to that. You've got Huawei's inability to ship product because of the unavailability of some components that are required within their solution. So we anticipate that Huawei shipments will be challenged. And if you look at what China is doing in terms of CapEx and 5G rollout, they're going to pause a little bit and wait for Huawei to catch up. And so within China, the anticipation is that there will be a bit of a slowdown in deployments of 5G Infrastructure, which really drives a lot of the overall CapEx within China.

If you look globally, you've got a lot of political pressures to move out -- away from Huawei and into other vendors. And so that tends to move shipments around and also cause some churn in terms of the share changes and things like that, and that takes a little bit of time. So we think that is actually favorable to non-Huawei -- non-China vendors of equipment. We do see that there is a bit of an impact to that on overall demand, but overall will be a vendor shift. And just if you look at our timing business, in general, we ship to essentially everyone, all of the major vendors of telecom equipment, both wired. Really, the majority of the revenue is still on traditional optical, high-speed networking wireline-type communications applications. We have a growing opportunity in wireless and 5G and have 4 out of the top 5 vendors there. So as share shifts change, we view that as kind of fairly neutral to our business. But overall, we see that the market is maybe a little bit challenged given the trade tensions and the ban on Huawei.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [10]

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Yes, Matt. This is John. Just one more comment and then you can follow up. But the macro continues to apply some lingering pressure out there as well. We're very pleased with our performance in the second quarter and pleased to guide a sequential growth overall for the company in third quarter. But we were just commenting on timing. Also for isolation, there is some lingering headwinds related to the macro environment.

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Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [11]

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Got it, got it. Just as a follow-up and sort of related to the mix of the business, Infrastructure versus IoT. I was pleased to see the upside in gross margin despite sort of the mix change. And just looking back over a year ago, I think the IoT business is now, what, 7 points higher in your revenue mix. And Infrastructure is down, yet gross margin is flat. So John, maybe you could talk us through a little bit on gross margins. Are there some upside leverage you're using within the IoT business or some improvements with scale there? And are some of these margin things maybe sustainable going forward?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [12]

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Yes. I think it's a combination of those factors. We're pleased with the hard work from our operations team to adjust some things in the supply chain to drive greater efficiencies in the model. Also the addition of Z-Wave into the mix has helped gross margins. We improved the Z-Wave gross margins about 500 basis points from the time of the acquisition, so really good performance there.

Looking ahead into the third quarter, of course, it's a seasonally high quarter for consumer applications led by Broadcast Video. That tends to drag margins a little bit. So we are pleased with the execution there. On a longer-term basis, we're holding the 58% to 60% range and see the ability to really drive growth at a somewhat lower gross margin. It may add some pressure, but we're definitely pleased with what we see right now.

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Operator [13]

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Our next question comes from Gary Mobley of Wells Fargo Securities.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14]

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A question about OpEx. Your non-GAAP OpEx has been running between $87 million and $80 million for each of the past 5 quarters, essentially keeping the dog in the leash, so to speak. And as your revenue improves and you look into the future, and I guess beginning in Q3 and perhaps into 2020, are you going to let the dog run free with respect to OpEx? Or how should we think about the rate of increase in OpEx as revenues begin to improve?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [15]

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Yes, Gary. So we have controlled OpEx a bit this year. But at the same time, we're keeping our eye longer term on the objectives to grow IoT, in Infrastructure, in Broadcast, automotive and want to continue investing in those areas. We're going to be meeting with the management team and Board of Directors through the course of this fall. And I think, heading into 2020, early part of the year, we should be able to provide some more color on the expectation for 2020 OpEx. But in light of the industry decline in the first quarter, we did draw back a little bit and you're seeing the continuing benefits from that. But yes, we will need to step up the investment level with continued growth in the business, and that is what we intend to do.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [16]

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Okay. Want to clarify something on Huawei for the just reported June quarter. I think in late May, you quantified potentially a $3 million impact for the June quarter as it relates to the Huawei shipment ban. Was that in fact the case for the quarter?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [17]

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Yes. yes. That's roughly accurate. We did pick up shipments right toward the end of the quarter, but that is accurate, yes.

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Operator [18]

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Our next question comes from Suji Desilva of Roth Capital.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [19]

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So you talked about inventory kind of returning to normal levels. I'm wondering if you expect to ship to consumption going forward or whether there will be further drawdown in a conservative macro environment and if the China 8- and 32-bit microcontrollers are kind of returning to normal growth levels into the second half '19 of inventory would affect that as well.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [20]

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Yes, Suji. This is John. So yes, we view inventory at the company and at our distribution partners at -- as being at a healthy level and do not see that, in and of itself, creating a headwind in the business. It's hard to really redirect into the customers' inventory levels themselves. But certainly, for the distribution partners, we see that as normalized and positive.

On the 8- and 32-bit MCU side on China, there is some continuing weakness in that portion of the market relative to the Chinese economy. And we'll have to see how things play out. If PMI and manufacturing levels can pick up in China, that should be good for our 8-bit MCUs in China. But we'll have to see how that shakes out.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [21]

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Okay. And then my other question, just specific question on IoT and the smart energy program. The transition there in U.K., did that create some sort of ordering ramp-up that might mitigate and be lumpy or a bit steady progress going forward with the transition to SMETS program?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [22]

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Yes. So the transition is making good progress, and I don't see a lot of lumpiness there. I see steady recovery there. That was depressed more in 2018. And now that the SMETS 2 transition is ongoing and really settling in, in the market, that's creating more of a steady level of business there.

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Operator [23]

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Our next question comes from Ruben Roy of Benchmark.

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Ruben Roy, The Benchmark Company, LLC, Research Division - Analyst [24]

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Tyson, first to follow up on Suji's question on IoT and sort of customer behavior. I think Industrial was a little weak back in Q1. And I'm just wondering how you'd assess or characterize what you're hearing from customers in terms of the overall market environment. Are they still cautious, would you say? Or I know that you talked about design activity continuing to be strong. But I'm just wondering in terms of sort of the near- to medium-term trends on demand, how you're feeling about IoT in particular.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [25]

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Overall, we're feeling very bullish about IoT. If you look at the deployment of IoT technologies broadly, we see -- and this is really independent of any sort of macro commentary, you see a growing proliferation of applications, of use cases, of really the need to integrate connectivity and IoT functionality into a broad range of applications. And every year, we're seeing a steady increase in the volumes, in the opportunities, in the number of customers, the number of programs at each customer that is very encouraging. And I think the fact that we have really the leading IoT in this node platform that supports all of the different various wireless standards, that supports legacy standards, we mentioned in the call that we have got over 50 customer stacks with proprietary protocols running on our solution, you can run that at the same time with Zigbee or Bluetooth connection to a phone, and that flexibility to be able to remain compatible with legacy solutions, but also evolve into the future and the fact that we're committed long term has really resonated well with the customer base. So I would say that we're -- you look at the opportunity funnel in IoT, we're at about $8 billion of opportunity. And we've been able to drive substantial year-on-year -- our design wins are on track. We've been ahead of track on about a 30% year-on-year increase for increasing the design win numbers. And so that portends well to the continued strength of the IoT markets. And I think that if you look at our investments in our Series 2 and in software and in the development tools and really simplifying the user experience, the big challenges -- the opportunity is just massive for IoT. But the biggest challenge is to be able to efficiently support all of those and efficiently convert all that -- these different applications. It's a very broad range of applications. There's tens of thousands of customers, and you've got to rely on your channel partners. And the fact that you could just make this stuff work easily, and it's a complicated technology, it takes time for customers to really get their arms around the apps and the cloud and the business models. But every year, we see improvements and progress in the markets and in technology and in the standards, and we're really excited about where we are.

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Ruben Roy, The Benchmark Company, LLC, Research Division - Analyst [26]

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I guess just follow-up. Obviously, wireless is going well for you guys. There's been a bit of consolidation in wireless/connectivity assets over the last several months. And I'm just wondering, on the one hand, it obviously validates the value of those assets in IP. On the other hand, I'm wondering if you have an early view on how the competitive environment would shape up over the next several quarters or years.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [27]

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Yes. So first, I want to say that our IoT wireless is really primarily command and control, be it in the deployment of sensors and sensing applications, where it's actually very low data rate and very low duty cycle, but where you have to have very good energy efficiency. And that's -- those are the markets where we see that $8 billion of opportunity. That's everything from Bluetooth to Z-Wave to Zigbee to a lot of the proprietary technologies that we've got. And that is really unrelated to what the consolidation that's been going on in the industry. We've seen a lot of the legacy Wi-Fi assets, some of those going into access points. And we've partnered with a lot of folks on making sure that these low data rate command-and-control IOT technologies get integrated into the gateways, especially with a lot of the ecosystem providers. But that's not a market that we're chasing or -- in terms of the Wi-Fi for access points. So that's -- Marvell had a decent solution there. You've got Qualcomm, Broadcom and MediaTek playing in those areas.

And then a lot of the Wi-Fi, the consolidation has also been around Wi-Fi that have -- has basically been the redeployment of cellphone technologies into some number of IoT applications. And that's things like printers and TVs and video cameras, things that are plugged in to the wall where you need a higher data rate and you need to have wireless connectivity, similar to what you would have on a tablet or a phone or a PC. And that's what's -- that's been the primary driver of the IoT market. You've seen what Cypress acquired from Broadcom, and now that's going over to Infineon. But those are really different class of applications where we've been -- where we have competed. We have introduced our first Wi-Fi solution. It's an 802.11 and optimized for ultralow power. And so that is actually able to scale Wi-Fi a bit down into battery-powered applications, things like a few smart locks and a few lighting applications. But overall, the cost and the power consumption of Wi-Fi has kept it from really being able to compete in these, like, more mainstream sensing IoT applications.

I would say that going forward, the Wi-Fi, we'll continue to see improvements in power consumption. We're continuing to monitor the evolution of standards as we -- as they deploy Wi-Fi 6 in 11ax. And so that's a very interesting technology. But our growth in IoT is not really impacted by the consolidation that we're seeing right now. And our opportunity remains in areas outside of Wi-Fi.

We see a big opportunity on the Bluetooth side to gain market share there. We've got a multibillion funnel on Bluetooth and a leading stack on Bluetooth mesh, and that's an exciting trend as well. And we continue to invest aggressively there and see a lot of opportunities, especially actually in China.

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Operator [28]

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Our next question comes from Tore Svanberg of Stifel.

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Tore Egil Svanberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [29]

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And congratulations on the results. So first of all, your IoT revenue is back to $500 million run rate and you kind of lost $19 million there in Q4 and in Q1, and you made it all back here last quarter. Is there a way you could talk about how much of that was sort of the supply chain catching back up versus new business? Is there any way to look at it that way?

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [30]

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Yes, Tore. Looking at -- I don't have precise breakdowns on those dimensions, but what we see here is strong secular growth coming from the new areas, the new applications that we've been talking about, very good traction in the smart home and security, home automation and home security market with a good uptick in business there. Lighting is more of a new application where we have very good market share in lighting design wins and applications and are seeing those ramp now, whereas that was a few quarters on the com and it's really performing well now. Metering has recovered, and I would probably put that in -- more on the -- in the supply chain recovery side of what you were describing. But by and large, the growth we're seeing is secular and driven by emerging IoT applications. And across the range of connectivity, across Zigbee and Bluetooth and Z-Wave and proprietary wireless, these are where we are seeing good traction on the market.

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [31]

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Yes. I think, actually, if you look within IoT, we've got a microcontroller piece and then we've got the wireless piece. The microcontroller piece has been impacted by macro. I mean if you look at microcontrollers overall year-on-year, they're down about 15% within that IoT number. Wireless, on the other hand, has been growing. It was up over 20% in the last quarter, and that's really driven by that design win funnel and all the new applications and new customers that we're bringing online. And we're guiding IoT up here into the third quarter. And so the growth that we're seeing on wireless is really from the growth in the markets and also the traction that we've got with customers. But you still have a macro component of this that's still working through in terms -- and that's primarily impacting the microcontroller. You can think of that possibly impacting some amount of the wireless, but I think that the design win traction and the growth there is swamping that out.

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Tore Egil Svanberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [32]

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That's very helpful. And as a follow-up and maybe back to the whole connectivity consolidation that's been happening, just kind of want your perspective, Tyson. I mean do you think this is happening now because customers are basically telling also the companies, "Hey, you have to have connectivity in your portfolio if you want to be a significant player now"? And if that's the case, how does that really position Silicon Labs, vis-à-vis some of your main competitors?

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [33]

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Yes. So we believe that we have leader -- leadership positions in all of the low-speed connectivity. The -- and the lower data rate is really appropriate for the majority of these IoT applications where you've got your sensing and you're having to deploy low-cost sensors around. And the cost points and the robustness that you get with mesh networking are very important. So that is really unrelated to -- we've been seeing a lot of the legacy Wi-Fi and Bluetooth, the connectivity combos for phones. That was part of the Marvell asset. That's what the Cypress asset is.

And then you've got -- there's a lot of Wi-Fi and connectivity in automotive. I think that was a big part of NXP in pulling in the -- that wireless asset. And then you've got Access points. For instance, Quantenna was the -- they were playing in Access points, literally have much else to put around that. And competing with the big guys like Qualcomm and Broadcom and MediaTek and you had Marvell in there a little bit. So you've got Access, you've got automotive and then you've got IoT applications. And then you've got the emergence of new standards and investments required to be able to address those.

So I think that a lot of the microcontroller companies, I guess on, you've got Infineon, you've got NXP looking to pick up this IoT, the Wi-Fi -- legacy Wi-Fi assets, but we didn't -- don't see those as essential to the growth in the markets that we're trying to address, although we do see convergence longer term, and that's why we've been investing in our own organic Wi-Fi efforts as those applications start to proliferate.

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Operator [34]

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Our next question comes from Rajvindra Gill of Needham & Company.

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Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [35]

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Question, Tyson, on your commentary around 5G in China slowing down. Just trying to reconcile that with some of the recent developments going on in China where China is releasing spectrum at a much, much sooner than expected and a lot of the Chinese telcos are tendering for base stations much faster than expected. So just wanted to try to reconcile your commentary about a potential slowdown in deployment of -- in Chinese 5G base stations given the fact that there seem to be some commentary going in the other direction.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [36]

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Yes. My commentary on the China slowdown was relative to -- before the export controls were placed onto Huawei, there was a rapid rollout of 5G in China. When we were on our last call, we talked a lot about the opportunity around 5G, and a lot of that was being driven by China. We see that because of the export controls and the inability for Huawei to procure all the components required for all their equipment, that there's been a lot of commentary around this in the analyst community about the pace of 5G rollout in China taking a pause and waiting for Huawei to be able to catch back up. So it's really relative to that accelerated pace that I had commented on before.

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Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [37]

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Okay. That's very clear. And for my follow-up, this is more kind of a long-term question. But when we look at connectivity for IoT, how do you think about 5G for IoT applications? It seems one of the main purposes of 5G is to enable machine-to-machine communications. So how do you look at -- how do you think about getting -- sell your capability if that's even needed to kind of support some of the next-generation IoT applications that might be on cellular versus technologies?

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [38]

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Yes. So I think you have to really break the connectivity technologies down into classifications. You've got personal area networks that essentially talk to -- essentially are talking to your phone. So you can think about Bluetooth and Bluetooth low-energy talking from your phone to a device, and that's kind of a point-to-point. You do have some expansion of that into the Bluetooth mesh. But really, your access to the network is through a mobile device. Maybe you've got a local area network, which connects to the Internet through an Access point or something like that, and that's -- Wi-Fi is in that category. You've got Zigbee, you've got Z-Wave and those types of standards. And that's where we're really playing is in that personal area network and local area network where this is free spectrum that you can deploy at will. You're not depending on a carrier. You don't have to go get a subscription. As long as you've got Internet Access, those work. And so far a lot of industrial applications, they want to know the networks there. They want to have control. Within your home, you've got your Internet service. In China, actually, they use a lot of times using the mobile phones, so some of the personal area network technologies are more prevalent over in some of the Asian markets.

And then you've got the wide area network stuff, which has traditionally been end to end. I mean we've seen cellular modems for everything, from street lighting to parking meters to asset tracking, where you have to be untethered from a location. So you're -- it can roam. You're trying to track your dog or track your luggage or track your shipment or a scooter or a lot of these applications. Typically, that also involves location technology. So you have to have GPS, GNSS technology along with that. And that's traditionally had a higher power consumption and a higher cost point. We've seen, with the deployment of things like LORA, which, again, is kind of a mix, that's kind of a more -- it's unlicensed spectrum and you've got to deploy your own network. We've seen the deployment of that, but this is really for like wider area networks and not really competing with the technologies that we're in.

And then you've got all the narrowband IoT and LTE Cat-M, which is a cellular standard. You've got to go through an operator. And those markets are still very, very early. You've seen a number of companies invest there, and the number of applications starting to pick up. But we haven't really seen the high-volume applications in that area. It's more Industrial, and that's not -- you're not going to deploy 100 sensors in your house each with a cellular connection and each with -- talking to an operator. That's going to be a long time coming.

So we're being very cautious in our monitoring of this market. We're understanding the technology, but also are cognizant of the fact that there's multiple obstacles to the deployment of that, both in terms of the availability of solutions, the operators and just the overall market applications where that's more appropriate compared to the LAN and CAN technologies.

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Operator [39]

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Our next question comes from Alessandra Vecchi of William Blair.

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Alessandra Maria Elena Vecchi, William Blair & Company L.L.C., Research Division - Research Analyst [40]

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Just continuing on the acquisition front. You've always talked about the potential for future tuck-in acquisitions. Do you see like the recent environment of things getting bought breeding valuations? Or how are you currently viewing the environment for additive acquisitions for you guys?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [41]

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Yes, Alex. This is John. So acquisitions have been an important part of our strategy over the last several years as we have built out our software team, in particular, and added some good complementary adjacent technology and revenue sources into the story, and that's worked well for us. The Z-Wave acquisition last year has gone well. We continue to survey the landscape and look for additional acquisition opportunities, which could include tuck-ins, for sure, and also could involve some larger-scale targets. But really looking to add to the organic story to the company is the primary strategy that we have.

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [42]

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Yes. I would also just reiterate that we have talked in the past -- most of the -- or all of the acquisitions that we've done since 2012 have been related to IoT, adding in additional capabilities to the team as we built out the portfolio and the technology stack around IoT. We have indicated that we are -- we would consider an acquisition on the Infrastructure side. We have very strong pillars within our timing business and within our isolation business. And those would not be off-limits in terms of a tuck-in acquisition as well. So while it's -- we've been primarily focused on IoT and we remain optimistic about a number of different opportunities there. We would also consider something on the Infrastructure side to scale that business as well.

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Alessandra Maria Elena Vecchi, William Blair & Company L.L.C., Research Division - Research Analyst [43]

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That makes sense. And then just one last question. On the timing side of the business, John, I think, last quarter, you had sort of implied that the wireless side of timing would double year-on-year. We know Huawei probably changes that a tiny smidge. But in general, do you view that as tracking this year?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [44]

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Yes, Alex. We see the opportunity to grow the wireless business. Doubling it is less likely now, but do -- we do continue to see the opportunity to grow that business in 2019.

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Operator [45]

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Our next question comes from Cody Acree of Loop Capital.

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Cody Grant Acree, Loop Capital Markets LLC, Research Division - MD [46]

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Going back to China and the Infrastructure business, understand the macro and the trade concerns. But as you're seeing that as a fairly recent event, do you believe that your customers still have any inventory that they're still working through? Or is this simply a matter of tracking in demand? And then how does that compare to the rest of your Infrastructure business globally?

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Tyson Tuttle, Silicon Laboratories Inc. - President and CEO [47]

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Yes, Cody. I think, again, it's hard to redirect the end customers. It's certainly from the distribution channel perspective. I think the inventory is relatively healthy. And we should be tracking closer to end market demand and don't really see a wide geographical difference in that metric.

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Cody Grant Acree, Loop Capital Markets LLC, Research Division - MD [48]

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And John, just a follow-up then. So gross margin, nice step-up this quarter, step-back for September. The IoT business is growing in both those cases. Infrastructure has declined in both those cases. You mentioned that one of the drivers was IoT starting to get some better efficient -- or maybe better leverage, maybe better gross margin products in that mix. So I'm curious, with similar trends in the end markets, are you seeing some seasonal shifts within IoT? Or what maybe is driving that 1-point decline?

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John Hollister, Silicon Laboratories Inc. - SVP and CFO [49]

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Yes. It's primarily the seasonal uptick in consumer, which is more led by Broadcast. So we continue to have very strong market position in the video market. That business is picking up in the third quarter as we head into the Christmas build season, but that uptick does come in a bit lower gross margin.

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Operator [50]

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This concludes our question-and-answer session. I would like to hand the call over back over to Jalene Hoover.

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Jalene Hoover, Silicon Laboratories Inc. - Director of IR & International Finance [51]

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Thank you, Nicole, and thank you all for joining us this morning. This concludes today's call.

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Operator [52]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.