Silicon Laboratories (SLAB) Q2 2022 Earnings Call Transcript

Silicon Laboratories (SLAB -8.89%)
Q2 2022 Earnings Call
Jul 27, 2022, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello. My name is Sarah, and I will be your conference operator today. Welcome to Silicon Labs' second quarter fiscal 2022 earnings call. [Operator instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Giovanni Pacelli, Silicon Labs' senior director of finance. Giovanni, please go ahead.

Giovanni Pacelli -- Senior Director of Finance

Thank you, Sarah. We are recording this meeting, and a replay will be available for four weeks on the Investor Relations section of our website at silabs.com/investors. Joining me today are Silicon Labs, president and chief executive officer, Matt Johnson; and chief financial officer, John Hollister. They will discuss our second quarter financial performance and review recent business activities.

This information, along with accompanying financial tables and the earnings press release is available on our website. We will take questions after our prepared comments. And our remarks 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 on the Investor Relations section of the Silicon Labs website. I would now like to turn the call over to Silicon Labs' Chief Financial Officer, John Hollister.

John?

John Hollister -- Chief Financial Officer

Thanks, Giovanni. I'm pleased to report that strong revenue performance for the second quarter set a new record at $263 million, up 55% year on year and above the top end of our guidance range. Our industrial and commercial business grew exceptionally well in Q2, ending at $144 million, up 61% from the same period of fiscal 2021. We saw significant year-on-year growth in Q2 across all major portions of the I&C business in industrial, commercial, and smart city applications.

The home & life business was also up strong for the quarter to $119 million, an increase of 49% year on year with particular strength in connected home applications. In terms of our connectivity protocols, revenue from our Bluetooth product lines more than doubled in the second quarter year on year. We also saw mid- to upper double-digit growth rates across our other supportive protocols such as Zigbee thread, proprietary wireless, Z-Wave, and Wi-Fi. Looking at our revenue in Q2.

Geographically, we saw the strongest sequential growth in Q2 in the Americas region, followed by Europe. Asia Pacific was down. In Q2, the COVID lockdown situation in China did impact our customers, distributors, and suppliers. For example, two of our large regional distributors in China experienced increases in distribution inventory levels due to the lockdowns and are primarily responsible for the increase in our Disty inventory.

Distribution revenue for the second quarter was around 80% of total revenue. Our business continues to be very diverse, and our solutions are used in thousands of applications by tens of thousands of customers worldwide. Our top 20 end customers represent around 30% of total sales and our single largest customer is 5% of sales. The demand environment continues to be strong and our demand remains above our ability to fully supply it.

That said, we are seeing more volatility in our recent bookings patterns with more variation on a week-to-week basis, combined with higher levels of customer reschedules. We have not seen a large uptick in order cancellations. We believe the broad-based nature of our customer footprint, combined with our significant industrial exposure offers greater stability to macro weakness than more heavily consumer-oriented semiconductor operations. Non-GAAP gross margin for the quarter exceeded expectations due to favorable product mix.

Q2 gross margin was 62.4%, which was a decline from first quarter as anticipated due to the significant price increase effects in Q1. Non-GAAP operating expenses were slightly elevated, ending at $110 billion due to additional product development costs, higher variable costs on upside business performance, and increased travel as we resumed more normalized travel patterns in Q2 coming out of pandemic. R&D expenses were $68 million or 26% of revenue and SG&A expenses were $41 million or 16% of revenue. Non-GAAP operating income was $55 million or 21% of sales, exceeding expectations.

Our non-GAAP effective tax rate was slightly favorable at 24%. Non-GAAP earnings ended at $1.17 per share above the top end of our guidance range. On a GAAP basis, gross margin was 62.3%. GAAP operating expenses were $133 million, with R&D expenses at $84 million and SG&A expenses at $49 million.

GAAP operating income was $31 million or 12% of sales. Stock compensation expense for the quarter was $14 million and amortization of intangible assets was $9 million, both in line with our expectations. GAAP earnings were $0.60 per share, above the high end of our guidance range. Turning to the balance sheet.

Cash and investments ended at $1.5 billion. Accounts receivable ended at $72 million, reflecting DSO of 25 days. Net inventory increased in the quarter to $74 million, up from Q1 and ending at 5.4 turns. We also invested working capital into our supply chain in Q2 to secure future capacity.

Our distributor inventory increased slightly to 60 days. So far this year, we have returned $600 million to shareholders through our stock repurchase program. Since we announced the divestiture just over a year ago, we have returned a cumulative $1.75 billion, retiring 11 million shares or 25% of our pre-divestiture share count. Our share repurchase activities will provide a durable long-term benefit to our earnings power going forward, and we intend to continue to return capital to shareholders.

Earlier this month, our board of directors approved an additional open market repurchase program of $250 million through the end of fiscal 2023. Next, I'll cover guidance for the third quarter. We expect our revenue for Q3 to be in the range of $265 million to $275 million. We expect our non-GAAP gross margin for Q3 to be between 60% and 61%.

We expect non-GAAP operating expenses to increase to around $113 million, with the increase from the Q2 level, primarily in R&D based on continued investment in new products. Due to our strong cash position and rising interest rate environment, we expect our other income and expenses line item to increase to around $4 million for Q3. Our convertible notes have a fixed interest rate. We expect our non-GAAP effective tax rate for Q3 to be 26%, and please note that absent any legislative changes, we expect -- we continue to expect the tax rate to decline by a couple of hundred basis points next year as the amortization stack on R&D deductions accumulative.

We expect our non-GAAP earnings to be in the range of $1.08 to $1.18 per share. We expect GAAP gross margin to be about 60%. GAAP operating expenses to be approximately $137 million and GAAP earnings to be in the range of $0.49 to $0.59 per share. I will now turn the call over to Matt for the business update.

Matt?

Matt Johnson -- President and Chief Executive Officer

Thank you, John, and good morning, everyone. Silicon Labs continues to execute well in a challenging macro environment, posting record revenue of EPS during the June quarter. We are seeing volatility in the market, and as John mentioned, increasing variability in our bookings patterns. That said, we are driving solid execution.

Strong design and momentum and notable share gains while experiencing continued strength in our diverse end markets. Demand continues to meaningfully exceed our ability to supply, and we are focused on meeting our customers' requirements. Our second quarter results were driven by double-digit growth across all our major product groups and end markets, highlighting the diversity within our business. Our opportunity pipeline continues to expand and now sits at $15.5 billion, up 54% year over year.

We continue to see significant design win momentum as well. And our year-to-date total already approaching our 2021 full year levels. This gives us confidence in our expectations for continued outperformance in the market. In Q2, we saw strong growth across all wireless protocols.

Our Bluetooth solutions were a notable source of strength, reflecting our growing market share. Revenue related to our Bluetooth portfolio grew at an exceptional pace, up 52% sequentially and 114% year over year, and our Bluetooth design win momentum has accelerated. In the industrial and commercial business, we saw solid revenue growth, record design wins, and a strong demand environment. We also steered major design wins with leading global electronic shelf label customers, including two of the top three providers.

In home & life, we saw solid revenue growth again this quarter as well as record-level design wins, led by the smart home segment specifically. While we recognize the market volatility, including some consumer weakness and market softening in the quarter, we note our ongoing design win momentum. For example, we continue to expand our smart home position with design wins to take advantage of the Matter Connectivity Standard supported in our recently launched MG24 product. Customers are showing strong interest in that, and we continue to support the Connectivity Standards Alliance and Matter protocol development to help developers create the world's best Matter based solutions.

We are highly focused on the competitive landscape for recruiting and retaining talented employees. We have built a strong early talent pipeline and have over 350 interns and new college graduates joining this year. 45% of our global intern class this year comes from historically underrepresented talent groups. Our new college graduate hiring also continued at an accelerated pace, further enhancing our ability to scale and build a sustainable talent base.

We are investing in our employee experience through a variety of training programs, resource groups and other initiatives to ensure that we retain and attract the critical talent that drives our business. As we announced earlier this morning, Bob Conrad has been appointed to our board of directors. Bob has nearly 40 years of experience in the semiconductor industry, most recently with Freescale and NXP before retiring in 2019. He brings a strategic mindset and deep industry experience, which will be invaluable as we continue to scale and grow the company.

We also announced that Bill Wood has shared his intention not to stand for reelection to our board of directors. He will retire effective as of the date of our 2023 annual stockholder meeting. Bill has served on the Silicon Labs' board of directors since the beginning of the company, and we were grateful for his leadership over the years. We're also looking forward to our upcoming Works With Developer Conference being held September 13th to the 15th.

In its third year, Works With is the premier developer conference from building the skills to create impactful connected devices. We bring the industry together to continue simplifying and accelerating wireless adoption globally. In summary, despite the changing landscape in the broader market, our team executed well across the board. In the one year since Silicon Labs became a pure-play IoT company, we have delivered record revenue growth and increased earnings power while returning significant capital to our shareholders.

The IoT wireless market is showing remarkable resilience and we are more confident than ever in our ability to lead and scale in this large and growing market. Giovanni?

Giovanni Pacelli -- Senior Director of Finance

Thanks, Matt. Before we open the call for Q&A, I would like to announce our participation in two upcoming conferences. KeyBanc Capital Markets Annual Technology Leadership Forum in Vail on August 8th, and Citi's 2022 Global Technology Conference in New York in early September. We'll now open the call for questions.

[Operator instructions]

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Raji Gill with Needham and Company. Please go ahead

Raji Gill -- Needham and Company -- Analyst

Yeah. Thank you for taking my questions and congrats on all the good momentum. I just wanted to get a little more insight on your commentary around seeing more volatility and variability in the order books and customer scheduling. Wonder if you could clarify, did you say that you have not seen an uptick in customer cancellations? Or have you haven't seen a large uptick in order cancellations? I'm just trying to get clarity on that language.

And also if you could elaborate a little bit further on when you say you're seeing variability in the order books, what does that mean? And is there specific --

John Hollister -- Chief Financial Officer

This is John. Yes, let me start, Raji. As we all know, in the supply crunch over the last period of time. And just given the strength of our demand and the secular drivers that we have, it's been a period of really sustained strong bookings for several quarters.

We have begun to see more variability there in the week-to-week booking patterns with some weeks continuing to be very strong. Some weeks are more light. In the regard of new bookings, although the cumulative backlog remains high and significantly above our ability to fully service that backlog. In terms of the pushouts and cancellations, yes, we've seen a few cancellations, Raji, but not as a major trend or sort of broad-based in nature, but what we are seeing more frequently are customer requests to reschedule deliveries further out in time as they continue to assess their own demand profile.

Raji Gill -- Needham and Company -- Analyst

Thank you for that. That's helpful. Just for my follow-up, if you look at your revenue growth, you're on track to kind of exceed your annual guidance of 35% to 40%. And last year, you grew also 40% or so.

Wondering if you could talk about the contrast between pricing and unit growth? If I recall, last year, much of the growth, a majority of the revenue growth was attributed to unit growth and maybe 10% of the growth was attributed to ASP increases. This year, it seems like it's going to be more even. So double-digit price increases versus, say, double-digit unit increases. So I wanted to get your thoughts on the pricing environment? Are you continuing to kind of pass on input cost to your customers? How long do you think that pricing power, the price increases is going to sustain itself, especially if we go into next year where there could be a deceleration in demand? Thank you.

John Hollister -- Chief Financial Officer

Let me start, and then I'll pass it to Matt. Raji, this is John again. So you're right. Your sort of summary assessment there is a good way to frame that with double-digit contributions this year from both pricing and unit output.

And we saw more unit output contribution in the second quarter than the first quarter. And as we progress through the year, you'll see more of a stable pricing environment. Just as another data point, to highlight that, the ASPs that we generated in Q2 were essentially flat to Q1. So sequentially, the growth in the business was fully driven by unit output.

As far as the pricing power and how long that will sustain, let me turn it to Matt to comment longer term.

Matt Johnson -- President and Chief Executive Officer

Yeah. Sure. This is Matt. I think two quick comments.

One is, it's important to recognize that we have been incrementing up our supply, which is extremely important for our customers, and we expect that to continue. On the pricing piece, we took a little bit different approach than some others, and we did an increased onetime that with telling our customers, we're trying to not [Inaudible] on this, we're trying to reflect what we think is going to happen over the course of the year based on what we're being communicated by our suppliers as well as some estimates, and that worked pretty well. I think that we're seeing that, that works well for our customers. It allows them to plan and navigate the year.

In terms of the durability of that, right now, we don't see any indicating -- indications of supplier pricing change, right? And that seems to be relatively durable. And in fact, I think the expectations for most suppliers is that they're going to continue to increase their price. So we feel good about how we've approached it. And right now, indications are those prices will continue to increase in small amounts from suppliers, and that's what we baked into our plans.

So we feel good about it.

Raji Gill -- Needham and Company -- Analyst

If I could just squeeze in one more and I'll back up in the queue. Just can you remind us, John, what your lead times are?

John Hollister -- Chief Financial Officer

Yes. They're quite extended. We're looking -- it depends on the product line, but just in sort of aggregate terms, between six and 12 months of lead time at this point.

Raji Gill -- Needham and Company -- Analyst

Thank you.

Operator

Our next question comes from Gary Mobley with Wells Fargo Securities. Please go ahead.

Gary Mobley -- Wells Fargo Securities -- Analyst

Hey, guys. Thanks for taking my question. I want to start by saying I appreciate the fact that you guys have been exceeding your long-term financial targets so far this year, and congratulations on that. But as I look at the low end of your long-term financial target as you presented at your Analyst Day, that's roughly $1.25 billion of revenue, 55% gross margin.

However, if I simply extrapolate out your $113 million non-GAAP opex guide that you're putting out there for the third quarter, it looks like you might be a little below that long-term 20% op margin target, maybe let's call it, high teens per se. So my question is what can give to allow you -- allow fruition of that low end of the financial target? Is it gross margin? Is it maybe some more opex discipline?

John Hollister -- Chief Financial Officer

Gary, this is John. I understand the point. And yes, we are pleased to be outperforming our long-term targets this year. As we look ahead, we've got a ways to go to that point, and we have no change to report.

That's the first thing to say. No change in the long-term model. We do have puts and takes between gross margin and opex, as you indicated. That's one point to make.

And second point is we have introduced a bit more variability in flex into our spending profile that provides more optionality to the management team here.

Gary Mobley -- Wells Fargo Securities -- Analyst

As my follow-up, can you remind us what you have remaining for capital return? I believe that your return long term is to keep maybe $1 billion in cash for optionality, so to speak. Does that mean there's roughly $500 million left to return?

John Hollister -- Chief Financial Officer

Yeah. Just suffice to say, Gary, that we expect to continue to return capital to shareholders and don't really have a view that there's a terminal points around this. Yes, we would like to maintain some dry powder for M&A optionality quite pleased with how this has gone so far, and we'd like to continue with that program, and happy that the board has authorized another $250 million. That would top up to the full $2 billion we talked about when we did the deal, but that doesn't mean that's the end of the road is what I'm trying to say.

Gary Mobley -- Wells Fargo Securities -- Analyst

All right. Thanks, John. Appreciate it.

Operator

Our next question comes from Matt Ramsay with Cowen. Please go ahead.

Matt Ramsay -- Cowen and Company -- Analyst

Thank you very much. Good morning, everybody. I guess for my first question, John, you mentioned in your script that distribution inventory had gone up, and I think that was you called out due to a couple of the big disties in China having some COVID shutdown stuff that happened during the quarter. And I guess that's understandable.

Maybe if you could give a little bit more color on how much that's gone up? And have you been tracking sell-through from those disties and seeing that inventory start to come back down? Thanks.

John Hollister -- Chief Financial Officer

Yeah, a bit. On the second question, we're seeing the China market open up better than where it was in the second quarter for sure. And suffice to say that the two areas where we saw accumulation are above the average, clearly. And our composite goal for this remains to be in the 45 to 55 days category.

So we're a little ahead. But on some distributors, they're below target actually. So we expect to continue to normalize this and create more fill and also relieve some of the accumulation that's taken place in China.

Matt Ramsay -- Cowen and Company -- Analyst

Got it. I guess stepping back a little bit bigger picture for my follow-up. I guess the observation is that you and your peer companies, the results are really good. ASPs margins really strong right now, and there's kind of the juxtaposition of the investor fears of what's coming down the pipe with the economy.

I think to that end, Matt, maybe you could spend a little bit of time on the design win momentum, how you're seeing different end markets behave from a design in and design win perspective? What ASPs are being sort of contemplated in some of the new wins that you're getting? Just trends like that, that might, I guess, help us talk to investors about the fact that these trends that you're seeing now are sustainable and maybe defensible if the economy does get a little more hairy? Thanks.

Matt Johnson -- President and Chief Executive Officer

Sure. Yeah. So this is Matt. And focusing on that, I think it's a really important point because there's a lot of uncertainty out there in terms of what the market is going to look like in the coming quarters.

And one of the things that we can do that makes a massive impact and the most meaningful to insulate us from whatever happens is our share gains and design win momentum. It's one of the strongest indicators that we have of what the future is going to look like. So you see our current performance. And what I mentioned earlier is year to date, we have secured design wins that are approaching the level of our entire year in 2021.

And 2021 was a strong design win year for us. So that gives us the most momentum and confidence that however, this ends up playing out, we'll be well-positioned, gaining share and outperforming. That being said, you asked about ASPs as well, we win on competitive ASPs in the socket. So these design wins are priced at competitive ASPs.

There's not any assumption in there of a long-term change. It's -- honestly, it's one customer at a time, one application time, one socket at a time, and those have to be competitive when we win them. So that's how it's reflected when we recognize the design win. So an important topic, and we are very proud of the team's momentum there.

And our goal is to not only continue that but accelerate it to the maximum extent we can win going forward.

Matt Ramsay -- Cowen and Company -- Analyst

Thanks, Matt. Really appreciate the color.

Operator

Our next question comes from Tore Svanberg with Stifel. Please go ahead.

Tore Svanberg -- Stifel Financial Corp. -- Analyst

Yes. Congratulations on the strong results, record quarter. First one for John. John, on the previous call, you talked about some potential gross margin pressures as we move throughout the year.

It does sound or seem like gross margin is holding up quite a bit better. Can you talk more about the dynamics there beyond the guidance that you gave for the September quarter?

John Hollister -- Chief Financial Officer

Yes. Sure, Tore. We are seeing some downward shift here. We saw the somewhat anomalous Q1 due to the asynchronous effect of pricing costs that come down in Q2, again, forecasting a bit more down in Q3.

And really expect to what Matt was talking about earlier in the call, where we implemented price dynamics ahead of some of the cost increases that were coming, and now we're seeing some of that. So we had some additional cost increases materializing in the second half. We have talked about that before. And looking ahead, we will continue to monitor this and see how the market progresses as the supply chain may open up and capacity open up over time.

So really no major changes in our messaging around those points at this point.

Tore Svanberg -- Stifel Financial Corp. -- Analyst

Great. Very good. I still several hundred basis points, I think, higher than what we had or you had perhaps suggested before. Second question is for you, Matt.

I think you called out the electronic shelf label market where you're now working with two of the largest players there. Could you just elaborate a little bit on that? It seems like we're still in the very early innings of that becoming potentially a huge market over the next few years?

Matt Johnson -- President and Chief Executive Officer

Yes. Absolutely. Thanks, Tore. This is Matt.

First of all, that's a market that, as you said, early days, just beginning, I think it has a substantial growth potential as the space. I think the global adoption of that type of technology is relatively low, but the used cases and needs accelerated in the pandemic. And I think we're seeing what I would start to define as early signs of very broad adoption being planned by a lot of stores, not just in the U.S. but globally as well.

It's interesting to point out, this is not a new phenomenon for us internally. We've actually been focused on this space now for about seven or eight years. And we're starting to see the impact of that, and we're really excited about it. So early days, well-positioned and I think a substantial potential moving forward.

Tore Svanberg -- Stifel Financial Corp. -- Analyst

Great. Congratulations again. Thank you.

Operator

[Operator instructions] Our next question comes from Blayne Curtis with Barclays. Please go ahead.

Blayne Curtis -- Barclays -- Analyst

Hey. Thanks for taking my question. You mentioned in the script that you saw some weakness in home & life. Just curious when you saw that weakness.

And you're able to offset it with design wins and actually grew quite nicely. Just kind of curious, if you look at September, any color on that consumer weakness within that September guide, and whether home & life can still grow?

John Hollister -- Chief Financial Officer

Yeah, Blayne. We have seen some of the pushouts affecting that part of the business a bit more. Fair to say that. And yes, we'll see how the trends evolve over the course of the quarter, but it is possible that that business to grow forward.

Matt Johnson -- President and Chief Executive Officer

Yeah. This is Matt. I'd just add to what John is saying, the -- it's important to understand that dynamic that demand continues to meaningfully exceed supply across all of those markets and applications. So we are seeing some of those pushouts and some of that volatility which creates some challenges to schedule as those things happen, but we definitely see the ability to continue growing in that space.

And our priority is to find a way to close the gap for our customers on demand versus supply because we still have a lot of hurting customers out there. We want to close those gaps. So there's definitely opportunity for growth.

Blayne Curtis -- Barclays -- Analyst

Gotcha. And then just a follow-up. In terms of the increase in inventory, I just -- I mean it's not that much on an overall basis, but it is a big sequential increase. So was that product that you had hoped to ship and just could not given all these moving pieces?

John Hollister -- Chief Financial Officer

Yeah. Essentially, that's right. And it also speaks to our work on supply chain and what we've done there as well. But we're making some progress here, but I'm not really at our goal.

I mean our target inventory turns level is more in the three to four times neighborhood. So we remain a couple of turns above our target inventory return level.

Blayne Curtis -- Barclays -- Analyst

Thank you.

John Hollister -- Chief Financial Officer

Sure.

Operator

I will now hand the call back to Giovanni Pacelli.

Giovanni Pacelli -- Senior Director of Finance

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

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Giovanni Pacelli -- Senior Director of Finance

John Hollister -- Chief Financial Officer

Matt Johnson -- President and Chief Executive Officer

Raji Gill -- Needham and Company -- Analyst

Gary Mobley -- Wells Fargo Securities -- Analyst

Matt Ramsay -- Cowen and Company -- Analyst

Tore Svanberg -- Stifel Financial Corp. -- Analyst

Blayne Curtis -- Barclays -- Analyst

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