Silicon Laboratories Inc. (SLAB) Q3 2007 Earnings Report, Transcript and Summary

Welcome to the quarter Silicone Laboratories’ conference call. At this time all participants are in a listen only mode. After the presentation we will conduct a question-and-answer session. [Operator Instructions]. Today’s conference is being recorded if you have any objections you may disconnect at this time. I would now like to turn the meeting over to your host Ms. Shannon Pleasant. Shannon Pleasant – Director of Corporate Communications: Thank you, Sherry. Good morning this is Shannon Pleasant Director of Corporate Communications for Silicone Laboratories. Thank you for joining us today to discuss the company’s quarterly financial results. The financial press release, reconciliation of GAAP and Non-GAAP financial measures, details on discontinued operation and other financial measurement tables are now available on the investor page of our website, at www.silabs.com. This call is being simulcast and will be archived on our website. There will also be a telephone replay available approximately one hour after the completion of the call at 866-347-5805. I’m joined today by Necip Sayiner, President and Chief Executive Officer; Bill Bock, Chief Financial Officer and Paul Wallace, Chief Accounting Officer. Bill will discuss our financial results and Necip will review our business activities for the quarter. We will have a question and answer session following the presentation. Before we begin let me comment on the safe harbor statement under the private securities litigation format of 1995. Our comments and presentation today will include forward-looking statements or projections that involve substantial risk, risks and uncertainties. We base these forward looking statements on information available to us as of the day of this conference call. This information will likely change over time. By discussing our current perception of our market in the future performance of Silicone Laboratories 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, operating results and financial conditions. We encourage you to review our SEC filings, including the Form 10Q that we anticipate will be filed later today; 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 Silicone Laboratories 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 on-going operations. I would now like to turn the call over to Silicone Laboratories’ Chief Financial Officer, Bill Bock. William G. Bock – Chief Financial Officer, Senior Vice President: Good morning everyone. I am very pleased to report outstanding third quarter results. Strong demand combined lower operating expenses drove better than anticipated results. We exceeded expectations on virtually every measure in this fiscal period. As we previously communicated we are striving to improved profitability toward our 25$ operating income target. We made major progress in that direction and also growing our top line 16% sequentially to a record $87.9 million. We’ll first cover our GAAP results. On this basis gross margin was 16.2% of revenue. Research and development investment was $20.8 million and SG&A expense was $21.7 million. Other income, principally interest income on invested cash was $6.8 million. Due to one time favorable results from tax-audit resolutions on the fiscal tears 2002 and 2003, which amounted to about $4 million the tax-rate was a negative 2.4%. The resulting total GAAP earnings per share from continuing operations on a fully diluted basis nearly tripled sequentially to $0.31. The tax adjustment contributed an additional $2.8 million to income from discontinued operations, yielding corporate GAAP earnings per share on a fully diluted basis of $0.36. Our Non-GAAP financials that follow exclude approximately $8.5 million of pre-tax, stock compensation expense. Record revenue of $87.9 million represents a step function increase over any previous quarter in the last year and was above the high-end of our guidance range. Non-GAAP gross margin increased slightly from the prior quarter and was within our target range at 16.7%. Our de-investment declined slightly to $17.4 million or 20% of revenue. The slower expense versus our guidance was due to favorable variances and discretionary spending and the cost benefit of a full quarter of the NXP [ph] transition services agreement. SG&A expense was flat as planned at $17 million or 19% of revenue. The combined impact of accelerating revenues and lower operating expenses drove operating income to $19 million or 21.6% of revenue. This represents a doubling of our profitability since the first quarter of this year. Wrapping up the income statement for the third quarter, other income in the period was $6.8 million nearly flat with the prior quarter. Our Non-GAAP income tax provision was only 4.3% due to the favorable tax outcome on prior year audits I previously described. Going forward we expect our basic tax-rate for the company to remain about 20%. Income from continuing operations therefore was $24.6 million or 28% of revenue. EPS from continuing operations cam in at $0.23, which can be adjusted to $0.36 if you wish to see the underlying earnings without the $0.07 impact of the one time tax benefit. Looking ahead we expect operating expenses to increase in the fourth quarter. The transitions services agreement with NXP which represented a nearly $2 million cost benefit in each of the prior 2 quarters has expired. We are increasing our investment in our R&D, which is consistent with our original intention to maintain alignment of operating expenses with our anticipated Q4 revenue exit rate. And this month we acquired a small engineering company in China called Source Core for $10 million. The related operating expense will primarily impact the R&D line in our income statement. Turning to the balance sheet, accounts receivable increased to $56.7 million. Day’s sales outstanding increased to 58 days. Both increases were due to modest non-minority in the quarter and the increasing revenue base. We ended the quarter with $22.2 million in inventory or approximately 5.7 turns. As increase from the very low inventory levels in Q2. Inventory in the distribution channel also increased to more normal levels of approximately 45 days. Cash and equivalents totaled $638 million at the end of the quarter, a decrease of only 6 million from the prior quarter. This balance reflects a share repurchase of $32.8 million, resulting from the new $400 million authorization announced in late July. These shares were repurchased during the two-month period of August and September, and we've continued to purchase this month. This use of cash was significantly offset by over $19 million in proceeds from option exercises. Necip, I'll now turn the discussion over to you. Necip Sayiner – President, Chief Executive Officer, Director: Thank you, Bill. When we announced the sale of our cellular products in February, we said the transaction was a strategic inflexion point for our company, allowing us to sharpen our focus on our growing high margin mixed signal business. We stated our goal of creating the unique combination of a rapidly growing and highly profitable enterprise and we laid out aggressive near-term financial goals for our business. Since then, over the last couple of quarters, we have demonstrated significant progress on our financial metrics. As Bill described, our revenue in the third quarter increased by 16% sequentially and our operating margin percentage doubled from first quarter levels. This was achieved through the dedicated efforts of all Silicon Labs employees who have been executing to our plan on all fronts. We now have an opportunity to build upon the solid foundation of core competencies. To build a diversified horizontal business while exploiting this continuities in select vertical markets that favor our core technologies. The success of the strategy relies on our proven ability to develop differentiated new products. Having achieved a near-term revenue growth objectives we had for the business, we are now prepared to add to our R&D investments to do just that. As Bill mentioned earlier this month, we closed on an acquisition in China, adding a design and applications team of 29 engineers. This team gives us scale in this growing region, offering a stronger application support base for our existing products. It will also enable us to accelerate our product development plans in new markets that leverage our existing RF expertise. While this has a modest near-term impact on operating margin of about 1%, we believe the larger benefits of expanded footprints in China and accelerated product development justify the investment. Our current portfolio is performing very well. We experienced growth broadly in Q3. With the exception of our mature products, which remain flat, every major business grew sequentially in the high single-digits or better. Starting with our foundation businesses, both voice-over broad band and embedded modems increased nicely in the quarter. Embedded modems grew due to increased share among our customers, supporting DIRECTV. We are also benefiting from the transition to high-definition set top boxes. This, coupled with in roads into the fax market gives us confidence that embedded modems will continue to be a stable business going forward. Sequential growth in our voice revenue was due to customer recovery in Europe, as the inventory issues from the first half were resolved. We see opportunities for modest revenue increases in our voice business, as we expand our presence in the cable and central office markets and take advantage of market growth. Our broad-based products grew in the double-digits. In the timing business, there are a number of positive trends. We are now shipping to more than 120 unique customers and rapidly adding new ones. We generated first revenue from our Aneraf Clark [ph] family launched only six months ago and design activities accelerating with opportunities that represent $100 or more of content per board. And we continue to expand the timing product line in Q3, announcing the first programmable XO and VCXOs. The increasing design momentum and strong R&D pipeline are very positive indications of the long-term potential of our timing business. The microcontroller products had a record quarter in Q3. While this is still a very diverse business with thousands of customers, we are seeing increased volumes among our top 10. We are also adding new large volume customers in the portable navigation and MP3 accessory market. Our MCUs sell alongside our FM products to offer panel back lighting, bottom control, or act as an interface to traffic messaging. This is one of several examples of our MCUs being designed in with other Silicon Labs products. We expect to see increased penetration at key customers by being able to offer a broader suite of Silicon Labs products for their applications. We expanded our MCU channel as well in Q3, introducing the MCU University program, targeted at seeding engineering students with our development tools. This investment will establish a new generation of engineers familiar with our products. We also further expanded the MCU portfolio during the quarter with the goal of filling gaps in our current product line to expand our served market. We have talked about how critical portfolio expansion is to maintaining the high annual growth rates we have achieved in this business historically. We're making good progress on this goal through R&D investment and design execution. We will have added more than 30 new MCU products this year, bringing our total portfolio to about 150 products. By staying focused on thickening our portfolio, we're experiencing an overall lift in demand. We added more than 250 design wins during the quarter. Our products are finding homes across a number of interesting applications. For example, our F-331 small form factor MCU is part of the Nike Sport Watch as remote control for the Nike iPOD kit. The unique combination of small size and suite of high performance mixed signal peripherals continues to be the winning formula for our MCUs. The broadcast products represented the most significant growth in Q3, driven by revenue increases in our new transmitter product, combined with the strong growth of tuner adoption in hand sets. The transmitter is shipping into portable audio players, accessories and portable navigation devices and as a result, our non-handset revenue increased to more than 40% of the broadcast total in Q3. With about 75 new design wins at cost the audio products in the third quarter, we're clearly demonstrating the sustainability of this product line. The quality of the end user experience combined with the integration and system savings associated with our audio products are still unmatched by the competition. We're also rapidly diversifying the audio family and expect to see first revenue on our AM/FM receiver in Q4. You can expect us to proliferate our audio technology into a number of new segments of the market throughout the next 12 months. In summary, we're enjoying strong demand for our current products and also have a healthy, innovative pipeline of new developments under way. Having restored our financial metrics in the business, we are focusing on seizing the opportunities in front of us and realizing the long-term potential of Silicon Labs. Now, turning to guidance for Q4, we're expecting our broadcast MCU and timing businesses to grow sequentially. Total revenue is expected to be up sequentially by 6% to 10% to $93 million to $97 million. We're expecting gross margin to stay within our target range of 60% to 62%. We anticipate R&D investment to be between 20% to 21% of revenue, and SG&A expense to be 18% to 19% of revenue. We expect our adjusted operating profit will be in the range of 21% to 23%. Fourth quarter net income per fully diluted share on a GAAP basis is expected to be $0.25 to $0.27. Non-GAAP EPS excluding a non-cash charge for stock compensation is expected to be in the range of $0.37 to $0.39. We would now like to take your questions. Shannon Pleasant – Director of Corporate Communications: Thank you, Necip. We'll now open the call for the question and answer session. So that we can accommodate questions from as many people as possible before the market opens, please limit your questions to one, with one follow-up question. Operator please review the question-and-answer instruction for our call participants. Question and Answer

[Operator Instructions]. Srini Pajjuri from Merrill Lynch, you may ask your question. Srini Pajjuri – Merrill Lynch: Thank you. Necip, you talked about R&D going up a little bit in Q4. Do you consider that a one-quarter trend or do you expect to continue to invest as you look out to 2008? Necip Sayiner – President, Chief Executive Officer, Director: Well, as Bill described, there's a step function in Q4 because of the NXP service agreement expiring. But in general going forward, I would expect the R&D investment to increase, somewhat commensurate with the revenue increase we're going to see in the business. Srini Pajjuri – Merrill Lynch: Okay, great. And then on the business side, you mentioned you are shipping for AM/FM product for revenue this quarter. Could you talk about, your outlook for that particular product as you look into the next few quarters and also what kind of end markets you are seeing traction in? Necip Sayiner – President, Chief Executive Officer, Director: Sure. The AM/FM product is currently getting designed in a wide variety of applications, portable radios, MP3 accessories and so on. We also have a couple of handset OEMs actively looking at this product offering. I expect that our revenues from AM/FM will grow sequentially in the next several quarters. I expect the growth, sequential growth to be relatively slow in that the design cycles for those products are longer than they are in handsets, for example. Therefore, I expect the revenue ramp to be somewhat slow on AM/FM. Srini Pajjuri – Merrill Lynch: Just one last question, Necip, as we look out into 2008 and look into your different business segments, could you give us from a high level where you see the most growth and, which group, which segments, do you expect kind of to stay flattish? Necip Sayiner – President, Chief Executive Officer, Director: I think it's fair to say Srini that the businesses that are fueling our growth today in Q4 in particular, the broadcast business, the MCU business and the timing business are going to post year-over-year growth in 2008. Srini Pajjuri – Merrill Lynch: Great, thank you.

Our next question comes from Arnab Chandra from Deutsche Bank. Arnab Chanda – Deutsche Bank: Thank you. Couple of questions. First, [inaudible] if you could talk a little bit about roughly speaking what was the mix of what you call your foundation businesses versus your growth businesses in Q3 and if you look out, say, roughly a year later, how that mix change shift follow up is?. Necip Sayiner – President, Chief Executive Officer, Director: Okay. Both foundation businesses grew in the single-digits sequentially, while the MCU timing and broadcast businesses all grew in double-digits. That's changing the overall mix of our business, and I would expect this mix change to continue into 2008, as the growth in those three businesses outpace the revenue in the foundation businesses. Having said that, we were pleasantly surprised this quarter, in third quarter by the strength we’ve seen in embedded modems and as I indicated, the voice business also came back nicely, having recovered from the first half inventory issues in Europe. So we look at our foundations businesses also as very stable businesses going forward. Arnab Chanda – Deutsche Bank: Thank you, and then a question on gross margins for Bill. If I look at your non-wireless as in the business you have today, seemed like the gross margins recorded last year were quite a bit higher, although they were coming down. And it seems like we're sort of towards the lower end of that sort of range. Is this a mix issue, or is this a volume issue, or is this something that you can kind of improve or stay the same? Just curious about. Thank you. William G. Bock – Chief Financial Officer, Senior Vice President: Arnab, when you compare gross margins in 2007 to 2006 or before, you're really looking at a business that today has a much higher mix of revenue from our broadcast product lines and were the case in those prior periods. So mix does have an effect relative to prior years. I think that we're pleased with the gross margin performance this quarter at 60.7, relatively close to the mid of out point of our range and were looking to be able to sustain this range of gross margins in the fourth quarter and hopefully on into the future. Arnab Chanda – Deutsche Bank: Thanks, Bill. Thanks, Necip. Necip Sayiner – President, Chief Executive Officer, Director: Thank you.

Our next question comes from Jeremy Bunting from Thomas Weisel Partners. Jeremy Bunting – Thomas Weisel Partners: Great, thanks very much. If you could just give us a broader perspective on the voice-over IP business in terms of what is your international distribution, what are the pockets of strengths and do you see any other areas where you may hit an inventory issue? And then I have a question for Bill. Necip Sayiner – President, Chief Executive Officer, Director: Okay. The application base for our voice products are quite broad. We are obviously participating in residential gateways. We have significant share in DSL residential gateways in particular. Our customers are all in three regions, North America, Europe and Asia. We’re also participating in Fiber-to-the-Home applications here in North America and in Japan. We are participating in cable modem, residential gateway applications with our SLICs and voice DAAs and finally, we have some exposure to central office markets with our quad ProSLIC. Jeremy Bunting – Thomas Weisel Partners: Continue to [inaudible] say your historic exposure to Vonnage for example. Are you still being held back there, or is that being able to move forward as Europe has done? Necip Sayiner – President, Chief Executive Officer, Director: Yes, our demand from our customer who is serving Vonnage has been reduced in the first half and the demand remains low through the third quarter as well. Jeremy Bunting – Thomas Weisel Partners: Okay, thanks, Bill. And I am sorry if I missed this in your prepared comments. Can you just give us an update on the status and the prospects of the stock buyback program? William G. Bock – Chief Financial Officer, Senior Vice President: So the status of the program is that we repurchased $32.8 million worth of stock during the months of August and September. We actually had the program authorized in very late July, announced it in this call last quarter and then commenced execution against the plan on the first of August. We continue to be in the market repurchasing shares during the month of October, so the program is working to our expectations. We expect to be a repurchaser of shares during the fourth quarter and we'll report on our progress again at the next call, although we Jeremy, enjoy, a great deal of flexibility in terms of how we execute this plan in any given time period. Jeremy Bunting – Thomas Weisel Partners: Is there any change to the $400 million cap and is there a timeframe to that? William G. Bock – Chief Financial Officer, Senior Vice President: There is not. The cap was authorized bit board in July. It had a 24-month time period associated with it. Jeremy Bunting – Thomas Weisel Partners: Great. Thanks very much, Bill.

Our next question comes from Sandy Harrison from Signal Hill. William ‘Sandy’ Harrison – Signal Hill: Thanks, guys. Necip, if you could spend a little bit of additional time with us on talking about sort of the investment in China, the 29 engineers, what are sort of their areas of expertise, and along with that had you mentioned that that would serve sort of as a beach head as you enter into some of these newer markets in Asia. And what do you see as some of those? If you could provide a little more color on that deal? Necip Sayiner – President, Chief Executive Officer, Director: Sure. The motivation behind this acquisition is really two-fold. One is a team of application engineers who are, have been serving the local market in southern China who will give us additional scale in reaching out to a broader base of customers, with several of our products starting with the broadcast products in particular. The design engineering talent in this company is our RF and mix signal related and we intend to deploy those resources on some organic developments we had ongoing and one of our businesses that will allow us to create products using our RF capability into new markets we are not currently addressing. William ‘Sandy’ Harrison – Signal Hill: Okay. William G. Bock – Chief Financial Officer, Senior Vice President: And I would add that this is a transaction that very much follows the line that we have been discussing with you for the last couple of quarters. A small private company transaction, relatively limited impact on earnings and the opportunity to become accretive through expanded revenues in their geography within 12 months. I also think that we should point out that this is a critically strategic geography for our future and is a lower cost structure than we have here in the United States or in Europe and provides with us engineering resources in that environment. William ‘Sandy’ Harrison – Signal Hill: Okay, and if I could just take my follow-on. As you look at sort of what's going on in the microcontroller markets, you highlighted how you've been able to package perhaps your tuner with perhaps a remote control from some other products. Is there a paradigm shift, and I hate to use that word, but is there a paradigm shift in the microcontroller market today where companies like yourself and another one who has been successful are sort of over taking and changing what has traditionally been dominated by the microchips and the more generic providers of these products? Necip Sayiner – President, Chief Executive Officer, Director: Sandy, I think it's fair to say that we don't compete solely on the MCU engine. While we have a high performance processor under the hood, what we are replacing in the applications we are targeting is more than the microcontroller. We are replacing in many cases one or more mixed signal peripheral ICs. So we are really providing a lower cost system solution that incorporates a high performance microcontroller with mixed signal peripherals. William ‘Sandy’ Harrison – Signal Hill: Great. Thanks, guys.

Our next question comes from Adam Benjamin from Jefferies. Adam Benjamin – Jefferies: Thanks, guys. First up the second broadcast, I think last quarter the split between hand sets and portable audio was about 70/30. And you've talked about that business moving more toward the portable audio segment. It seemed as if greater than 40% mix in the, toward the portable audio in Q3 was probably maybe ahead of the expectations and I'm just curious if that was kind of a one-quarter blip or that's something we can continue to see the mix shifting over to portable audio off the base in Q3. Necip Sayiner – President, Chief Executive Officer, Director: I think we are going to see an ongoing shift that's very consistent with the strategy we adopted a while ago in diversifying the revenue base. I indicated last time that we would hope to get closer to a 50/50 mix as we exit this year. And I think we are going to be able to get close to that in Q4, and I certainly believe that over time, the piece of the business that is being driven from non-handset applications is going to increase. Adam Benjamin – Jefferies: Okay, thanks. And just to follow up on the gross margin side, obviously with broadcast becoming a bigger percentage of the mix going forward as is growing faster than your other businesses and you're a little bit below the midpoint of that 60%, 62 % range, can you help us understand how you're going to be able to either get that margin back to the midpoint or above, as that mix continues to kind of work unfavorably in that direction. William G. Bock – Chief Financial Officer, Senior Vice President: We have a mix change occurring within the broadcast business unit itself that is aiding us in this regard. Certainly the product that is under the most ASP pressure is the stand-alone FM tuner. The shipping of the transmitter, which is a fundamentally unique part without direct competition, the introduction of the AM radio, which is a higher ASP part, and the transceiver products all give us a mix profile within the broadcast business itself that will improve the margin within that business unit. So it's the introduction of these new products that really don't have direct competition that will allow us to maintain the gross margins in that business and across the company in total. Adam Benjamin – Jefferies: Got you. With respect to that mix being benefiting from the portable audio, can you give some percentage Delta between the margins without giving the exact margins for portable audio or the handset broadcast gross margin? Necip Sayiner – President, Chief Executive Officer, Director: We wouldn't be able to provide the margin split, but I can give you a data point that might prove helpful and that is the blended ASP for our broadcast audio products remained essentially flat in the third quarter versus the second quarter and we expect that it to remain so in the fourth quarter also. Adam Benjamin – Jefferies: Great. Thanks a lot, guys.

Our next question comes from Tayyib Shah from Longbow Research. Tayyib Shah – Longbow Research: Hi, guys. Congratulations on the quarter. Necip, can you talk about the potential for your FM tuner business in the top two handset OEMs next year and what the competitive landscape looks like in that segment? Necip Sayiner – President, Chief Executive Officer, Director: We're serving the handset market pretty broadly, Tayyib. Now, you have seen in 2007 with some of the market share shifts amongst those OEM, OEMs. We've still been able to increase our share because we are really serving many of those OEMs, either directly or through their OEMs. The, going forward, I remain positive about our current situation with all of these handset OEMs. In the third quarter, we have seen strength in Korea with the handsets and we expect Korea to remain strong for us in the fourth quarter. Also couple other, top 5 OEMs we expect to be up as well in the fourth quarter. But I, I need to emphasize that the non-handset piece of our audio business, is growing faster and as we discussed in the prior question, becoming a larger portion of our growing business, and I would expect that trend to continue. Tayyib Shah – Longbow Research: Thank you. And can you also update us on the ProSLIC adoption in the central office for traditional phone line infrastructure and when that revenue is likely to start ramping? Necip Sayiner – President, Chief Executive Officer, Director: Well, we are driving revenue from our quad ProSLICs in central office applications today. And some of these design wins that we have won a while ago have started ramping. A couple of them have been delayed to 2008, so some of those programs with those customers will ramp in 2008. Tayyib Shah – Longbow Research: Thank you.

Our last question comes from Romit Shaw from Lehman Brothers. Romit Shaw – Lehman Brothers: Yes, thanks a lot. Necip, with the base band business out of the mix, would we still expect the March quarter to be seasonally down, or now gone and some of the new product momentum, is it fair to say that Silicon Labs should grow sequentially in every quarter in 2008? Necip Sayiner – President, Chief Executive Officer, Director: No, I think first quarter you should expect to be seasonally lower. This would be most pronounced in our broadcast business, where we are serving not only the handset segment, but also the consumer segment and highly seasonal personal navigation device segment. Those end markets, as you well know, go through a very strong seasonality in double-digits over 4Q and we are not going to be immune to that seasonality. Romit Shaw – Lehman Brothers: Okay, and thanks for that. Bill, the stock buyback program, is it agnostic to price, because if my math is correct at the current price, buying back the stock is not necessarily that accretive to earnings. William G. Bock – Chief Financial Officer, Senior Vice President: Your analysis is essentially correct. The cross-over point between accretive and dilutive share repurchase is in the mid-40s. Our program does have flexibility to price and obviously we would be more aggressive buyers at lower prices, but the program has been purchasing during the last three months at current price levels. We expect to be in the market during 4Q. Romit Shaw – Lehman Brothers: Okay. Thanks. Shannon Pleasant – Director of Corporate Communications: All right. Thank you very much for joining us. This now concludes today's call.