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Silicon Laboratories, Inc. (NASDAQ:SLAB)

Q2 2010 Earnings Call

July 28, 2010 8:30 AM ET

Executives

Shannon Pleasant – Director, Corporate Communications

Necip Sayiner –President and CEO

Bill Bock – Chief Financial Officer

Paul Walsh – Chief Accounting Officer

Analysts

Adam Benjamin – Jefferies

Craig Ellis – Carris & Company

Anil Doradla – William Blair

Eric – Stifel Nicolaus

Sandy Harrison – Signal Hill

Alex Gauna – JMP Securities

Srini Pajjuri – CLSA

Arnab Chanda – Roth Capital

Craig Berger – FBR

Operator

Welcome to the Silicon Laboratories' second earnings – I’m sorry. Welcome to the Silicon Laboratories' Second Quarter Earnings Call. Thank you so much. At this time, participants are in a listen-only mode. (Operator Instructions) Today's conference is being recorded. If you have objections you may disconnect.

And now, I'll turn the meeting over to Ms. Shannon Pleasant. You may begin when ready.

Shannon Pleasant

Thank you and good morning. This is Shannon Pleasant, Director of Corporate Communications for Silicon Laboratories. Thank you for joining us today to discuss the company's financial results. The financial press release, reconciliation of GAAP to non-GAAP financial measures, and other financial measurement tables are now available on the investor page of our website at www.silabs.com. 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 888-484-8258.

I'm joined today by Necip Sayiner, President and Chief Executive Officer; Bill Bock, Chief Financial Officer; and Paul Walsh, Chief Accounting Officer. We will discuss our financial results and review our business activities for the quarter. We will have a question-and-answer session following the presentation.

Before we begin, let me comment regarding the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Our comments and presentation today will include forward-looking statements or projections that involve substantial risks and uncertainties. We base these forward-looking statements on information available to us as of the date this conference call. This information will likely change overtime.

By discussing our current perception of our market and the future performance of Silicon Labs and our product review today, we're 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 10-Q that will be filed this week that identify important factors that could cause actual results to differ materially from those contained in any forward-looking statements.

Also, the non-GAAP financial measurements which are discussed today are not intended to replace the presentation of Silicon Labs GAAP financial results. We are providing this information because it may enable investors to perform meaningful comparisons of operating results and more clearly highlight the results of core ongoing operations.

I would now like to turn the call over to Silicon Laboratories’ Chief Financial Officer, Bill Bock.

Bill Bock

Good morning, everyone. An all time high in revenue of $134.6 million was the catalyst for a number of records in Q2 resulting in an outstanding quarter for the company. We also crossed the $500 million revenue milestone on a trailing 12-month basis, another first for the company.

Earnings per share far exceeded expectations, due to a very strong operating performance, which I will outline in detail. We also had a tremendous quarter in terms of share repurchase activity as we took advantage of what we believe is a depressed stock price.

Let me start with the current quarter GAAP results, which include approximately $10.7 million in non-cash stock compensation charges. Second quarter GAAP gross margins increased 150 basis points substantially to 67.5%.

R&D investment for the second quarter was up slightly to $30.5 million. SG&A increased to $29.7 million. GAAP operating income was nearly 23% in the quarter. Other income was negligible. The GAAP tax rate was 31% as it included a one-time charge related to the acquisition of Silicon Clocks, which we announced in April.

Fully diluted earnings per share, therefore was $0.44, more than double the result in the same period last year. It's worth noting that our stock compensation expense was just below 8% of revenue, representing solid progress toward our goal of 6%, on all fronts, an outstanding quarter.

Turning to our non-GAAP results, revenue of $134.6 million represented 6% sequential growth and was driven primarily by strong performance from our broad-based products, including the fourth consecutive record quarter for MCU. This mixed shift and increasing concentration of distribution versus direct customers contributed to an increase in our average selling price for the quarter.

This led to an outstanding gross margin result, a post divestiture record of 67.8%. We expect gross margin to decline sequentially as we enter the second half of the year due to seasonal strength in our consumer-oriented products, but we anticipate we will continue to achieve better than model margin performance in the third quarter.

Operating expenses declined as a percent of revenue to 37%. Specifically, R&D increased only slightly to $26 million or 19.4% of revenue, below our forecast. This was due in part to first revision successes that allowed us to eliminate some scheduled takeouts and related costs.

In the coming quarter, we expect R&D to increase and be more aligned with our typical range of 20% to 21% of revenue. SG&A increased $23.8 million or 17.7% of revenue. The drivers behind the increase included higher than anticipated variable compensation, as well as success in hiring applications engineers.

Successful recruiting across the organization of about 40 new hires was somewhat back end loaded, so we didn't realize the full impact in the quarter. We expect to continue to hire technical talent to support new opportunities that will contribute to an increase in operating expenses of approximately $2 million in Q3.

Operating income for the second quarter was a record 30.7%. Other income was not material, as a modest foreign exchange loss on the euro effectively offset interest income on invested cash. The tax rate was at our new, lower level at 17.6%.

Net income increased to $34.1 million for the quarter or 25.3% of revenue. Resulting Q2 diluted earnings per share was up by $0.10 to $0.72, well above expectations and a very strong operational result.

I commented earlier that we crossed the $0.5 billion threshold in revenue. Looking over the past 12 months on a non-GAAP basis, we achieved $514 million in revenue with 66% gross margin and operating income of nearly 30%, earnings per share was over $3. The company has become increasingly more diversified and is demonstrating significant earnings power. This translates into outstanding cash flow, which leads me to the discussion of the balance sheet.

Accounts receivable increased to $76.3 million or 51 days on the strength of the record revenue performance. We have no known collection or bad debt problems. We were also able to increase inventory as forecasted, ending the quarter at $29.1 million, up $1.4 million from the prior period. Turns for the quarter continued to be very high at $6.

Channel inventory ended down slightly on a day’s basis at 47 days, but about flat on an absolute dollar basis. Our plan will be to grow inventory as we move into a seasonally strong period of the year.

We ended the quarter with $380 million in cash, which is actually a decrease of $67 million. While cash flow from operations continued to be strong at $53 million for the first half of the year, we became very aggressive in the repurchase of our shares. Share repurchase activity totaled $75 million in Q2, reducing our diluted weighted average share count to $47.4 million for the quarter.

Since our program began in 2006, we have now invested over $600 million, repurchasing 18.2 million shares at an average price of below $34. Given our confidence in completing the remainder of the authorization this year, the Board of Directors approved a replacement program of $150 million through the end of 2011.

I'll now turn the call over to Necip Sayiner.

Necip Sayiner

Good morning. We're pleased to announce this larger share repurchase program. The compression we've seen in Silicon Labs multiple relative to our operating performance and earnings growth makes it clear to me that buying our stock continues to be one of the best uses of our cash.

The profile of our business continues to improve in Q2. The results demonstrated the increasing diversity of our business. Our top 10 customers accounted for just 33% of revenue, down from 39% last quarter and 45% a year ago.

Our increasing customer market and product diversity has served us well throughout the current cycle and when combined with growth from new products has enabled us to outperform relative to the market and many of our peers.

As forecasted, the broad-based business became the largest percentage of our revenue in Q2. Growth in new product areas is also enabling continued strength in our broadcast business and new opportunities in our access business.

We introduced a steady stream of new products in the quarter including new video ICs, timing products, low power MCUs, isolation products and embedded wireless solutions. Underscoring the investment we're making in our new product pipeline and future growth.

With such a strong start to 2010, we are on track to deliver higher revenue and earnings growth for the year than we initially projected. We'll provide an update to our product line growth target set back in January in the context of our discussion of each business.

I'll start with the broadcast products, which grew modestly sequentially and represented about 32% of revenue in Q2. While revenue declined as expected in handsets due to lower unit shipment and ASP declines, the overall audio business was up nearly 5% sequentially. This growth was due to our strength in consumer-oriented, non-handset products, which represented the majority of the audio revenue in Q2 for the first time.

Of the record 219 design wins we secured for audio products in Q2, nearly 70% were for consumer applications outside of handsets, including portable radios, boom boxes, PNDs, docking stations, et cetera.

Another meaningful portion came from automotive applications which represent a high margin, long life cycle business. We continued to win handset designs as well, substantiating our expectation that the declines in that business will be orderly.

In video, we enjoyed our first million dollar quarter with the TV Tuner. We're expecting a solid ramp with the lead customers in the second half of the year. Our effort to penetrate the market leading TV makers is going very well. In Q2, we added a third Top Tier TV brand to our list of strategic design wins for the silicon tuner.

We also introduced our 2167 demodulator, able to support satellite, terrestrial and cable broadcasts in a single IC. It has historically required multiple demand in a number of external components for similar functionality. This demodulator can be paired with our silicon tuner and is also compatible with traditional can tuners, enabling us to capitalize on design win opportunities ahead of silicon tuner adoption. The new demod is also applicable for market beyond iDTVs, including set-top boxes and PC-TVs.

For the broadcast business overall, we expect the consumer audio business to grow sequentially throughout the year, more than making up for the anticipated declines in handsets. Video is expected to grow steadily in the back half as well. So our earlier projections for the broadcast business in 2010 remain largely intact.

The access business was down by 1% sequentially, representing 29% of revenue, a modest sequential decline in both embedded modems and slicks was offset by ramp that began in our power over Ethernet business with key customers in both Ethernet switches and client applications.

In the quarter, we experienced weakness with residential gateway customers, who are serving telecom operators in Europe. It appears this situation will continue well into Q3 with end demand remaining soft and these customers and their contract manufactures working off inventory. It is worthwhile to note that this inventory issue is not systemic but a spot issue.

As previously expected, modems are forecasted to continue to be soft, primarily due to declining ASPs and set top boxes. Power over Ethernet, however, is projected to grow throughout the year as design wins move into production.

In spite of current weakness, we continue to believe that the mid-to-high single digit 2010 growth projection we set for the access business remains achievable. The upside to our earlier projections continues to come from the broad-based business, which was up 18% sequentially in Q2 and 85% year over year.

Broad-based products for the first time represented the largest portion of company revenue totaling 75%. The embedded mixing of product represented about 75% of the broad-based business with the MCU products delivering another record quarter. The MCU business experienced nearly 40% sequential growth in USB driven by application spending from touchscreens to security peripheral.

The USB also represented the largest percentage of new MCU design wins in the quarter. Demand from customers developing medical products provided new incremental growth drivers. Medical applications represent about $180 million 8-bit MCU opportunity in 2010. And we're increasingly finding opportunities in this segment.

More broadly, ASP's lifted in our general purpose MCU'S as customers shifted to more advanced products to add to its increasing software complexity in their designs. MCU development get shipments of more than 10,000 are significantly outpacing competitors as a ratio of revenue, an indicator to us of a strong growth trajectory for our business. And we added 36 new automotive design wins. A good thing though that we're developing this young business into a strong future growth area.

On the new product front, we introduced the latest in our ultralow power MCU family which offers the lowest power across all operating models. This latest family also includes touch sense features. You'll continue to see us leverage our low-power MCU core across our new products, enabling us to extend our low-power advantage into a variety of end market as we are doing today in embedded wireless and touch sense.

In regards to our human interface products, we made progress on wins for our QuickSense family during the quarter securing 20 new designs, about half of these are expected to go into production this year. By end market, about 80% of the design wins are for consumer devices with the remainder being industrial and handset-focused wins.

With isolation products, we are on a path to double the number of design wins versus 2009. We're seeing particular success in green power opportunities, for example, with metering and solar power customers. We announced a meaningful win during the quarter with Elster, a leader in advancing metering infrastructure.

New products launched in Q2 including isolated gate drivers and 5,000 volts rated isolators will add to our momentum and further expand our serve market. Wrapping up the EMS business, we had a strong quarter for our wireless products due to strength in demand for our easy radio products.

We also just introduced our new 4010 RF transmitter, the industry's first remote control on a chip. It's ideal for RKE, garage door openers, home automation and other remote control applications. This product, like the rest of the new products we're highlighting today is the output of a concentrated effort to expand our portfolio into attractive sub segments of key markets to increase our share.

The timing products which represent the remainder of the broad-based business, also had a record quarter, growing sequentially again. Port demand supported growth in clocks and we continue to benefit from healthy demand from networking gear.

We're also positioning ourselves to capitalize on competitors' increasing lead times for traditional timing devices. For instance, we believe our ability to deliver oscillators in two weeks or less may allow us to accelerate share gains. To further enable customers to transition from incumbent solution to our products, we're adding services and support.

For example, in Q2, we launched an online design service to help customers design their clock trees, a critical element of any communications system. And we're adding new products, including the 5317 launch in Q2. Consistent with the rest of our portfolio, the 5317 simplifies the timing architecture for customers, replacing fixed frequency discreet designs with a single chip.

Our solution reduces the bill of materials, is very straight forward design win and takes the complexity out of architecting a clean clock. The continued expansion of our footprint in communications equipment combined with the industry's shortest lead times makes us a more valuable supplier to networking customers.

In combination for our broad-based business, we had targeted about a 40% growth rate for 2010. Given the strength we have seen in the first half, we're now expecting more than 50% growth for the year.

Now for the guidance, for the third quarter, we expect the assets business to be down and both broadcast and broad based to be up sequentially. We, therefore, expect revenue to be $136 million to $141 million.

We expect gross margin to remain strong at around 66%. We anticipate R&D investment will be up by $2 million sequentially and SG&A will remain flat.

On a GAAP basis, we are projecting $0.50 to $0.55 and on a non-GAAP basis, excluding stock compensation expense, we expect third quarter earnings of $0.69 to $0.74. Now I'd like to take your questions. Shannon?

Shannon Pleasant

Thank you, Necip. We will now open the call for the question-and-answer session. So that we can accomodate 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 instructions for our call participants.

Question-and-Answer Session

Operator

Thank you so much. (Operator Instructions) Our first is from Adam Benjamin of Jefferies. Your line is now open.

Adam Benjamin – Jefferies

Hey, guys. Couple questions, first on the broadcast business. You mentioned -- I think I got it right, that it was up slightly, Necip, but the consumer for the first time represented greater than 50% of mix. I think last quarter you talked about a 60-40 toward the handsets, so it seems like a dramatic shift toward consumer. Just curious, if I got that right and if you can give some more color there?

Necip Sayiner

Yeah. You got it right. More than 50% of revenues is now coming from consumer audio. Compared to our expectations, we have seen handsets, handset units declining a little bit more and the AM/FM units and terrestrial station in to new customers moving forward faster. And I think that dynamic is also evident in the gross margin profiles for the business.

Adam Benjamin – Jefferies

Got you. And then following up on the gross margin, you know, it seems like you’ve asked every quarter if you guys are willing to change that dynamic, it sounds like the mix away from handsets which is probably more toward the lowest end of your gross margin range, definitely provided the benefit in the quarter.

If you can give some more color, Bill, whether there were other puts and takes and then just going forward, that should continue to be a lower percentage of the mix as it continues to decline and some of the newer businesses and broad-based grows faster. I know you're not looking to raise your target, but why shouldn't it settle in closer to these levels than some of the lower 60s that you've talked about previously?

Bill Bock

Yeah, Adam, I think that what we saw in the quarter was with the broad-based businesses, achieving such scale and an accelerated shift to consumer electronics versus handsets and audio, the margins were outstanding. I also commented that we had a higher concentration of businesses through the distribution channel, which means a smaller portion of revenue to large consumer customers and that helped margins, as well.

So as we're looking into the second half of the year as Necip pointed out, we're continuing to be willing to suggest that margins will exceed our target model and it will likely be around 66% in the third quarter. So the mix dynamics that you're alluding to should continue in the second half of the year.

We're not at a point right now where we want to go through a revision of our financial model because this is supposed to be a multi-year model for us and is the -- a metric around which we make our investment decisions but we're clearly enjoying a really strong gross margin performance presently.

Adam Benjamin – Jefferies

Got you. And then one last question, Necip, maybe on the video business. You talked about another tier one that you're adding to the mix. Can you just kind of give an update on that business and kind of how you're thinking about it really for next year as there's a broader move to silicon tuners.

Necip Sayiner

I think the traction we are seeing with the customer base is very encouraging. As I reported 90 days ago, all top brands are evaluating our silicon tuner solution. In the last 90 days, we have expended the number of wins we had with the customers, we had one. We have added a new model for Fall 2010 in Japan with 3DTVs. We have another win, again in Japan, for a European model with one of the leading TV brands.

We have a new win at one of our Korean customers for a 2011 model. So what we're seeing across the board is due to the performance we are able to bring to the table. A much more open mind to evaluate the technology and I think the adoption rate will be relatively fast as I projected in our last earnings call. And I view video as being one of the major growth drivers for our top line along with the embedded mixed signal business into 2011 and also 2012.

Adam Benjamin – Jefferies

Great. That's all I have, guys. Thanks a lot.

Necip Sayiner

Okay.

Operator

Our next request is from Craig Ellis of Carris & Company. Your line is open.

Craig Ellis – Carris & Company

Thanks for taking the question. Nice job on the gross margin, guys. Necip, just following up on the TV tuner product, are you seeing any change in the competitive landscape as you see customers increasingly willing to design those solutions in and ramp into 2011?

Necip Sayiner

There are a number of competitors entering the market. Our customers give us the feedback that from a performance standpoint our solution is clearly better than every other silicon tuner out there today. So our primary competition continues to be incumbent can tuner solutions.

We are not taking that performance lead for granted. We’re continuing to develop new items on our roadmap, some of which we will be bringing to market shortly. But we are engaged with those customers, not just for the new term opportunities of 2011, but on roadmaps including 2012 and beyond. So I see that willingness to adopt the silicon tuners to be very encouraging and I think we are enjoying a competitive lead at this point.

Craig Ellis – Carris & Company

Okay. And then a clarification, at the end of the broad-based business comments, you talked about a close to 50% for the year. Was that for timing or was that for both timing and MCU's?

Necip Sayiner

Comment is for the aggregate broad-based business but equally applies to embedded mixed signal and timing.

Craig Ellis – Carris & Company

Okay. And then just lastly, there was mention of an isolated inventory issue on the access side of the business. Can you just provide some further color on why the company thinks that's relatively isolated and when do you think that inventory issue will be resolved?

Necip Sayiner

Issue that we've seen is with two telecom operators in Europe, namely Telecom Italia and Deutsche Telekom. It appears that they do have more inventory with them and our customer who are serving them than the current demand requires. The input that we have received from all those customers suggest that the demand for the third quarter for those operators is going to be very soft.

So hence we are looking at a down quarter for access in spite of the ramp we are enjoying with PoE. I don't have any other data points, Craig, that would suggest this inventory problem to be broader. That's why I made the note in my remarks that we see this as an isolated issue.

Craig Ellis – Carris & Company

All right. Thanks for that, Necip.

Operator

Our next request from Anil Doradla of William Blair. Your line is open.

Anil Doradla – William Blair

Yeah. Can you -- Necip, can you comment quickly on some of the issues on the macro front. You know, are you seeing anything on the inventory? And also on the handset side with, you know, a large customer, can you talk about the dynamics. There's been some talk about some softness out there. Can you comment on that, too?

Necip Sayiner

Are you referring to our larger -- largest customer on handsets?

Anil Doradla – William Blair

That's correct.

Necip Sayiner

Okay. Let me take that question first. We continue to enjoy a majority share with Samsung. We continue to get designed into their new models, including some of their leading smart phones that they'll be bringing to market in the second half but also the more generic feature or entry level phones.

Samsung has been one of the customers that adopted our lower ASP solution that we brought to market last year. So some of the revenue declines in our handset business also has to do with the lower ASP. Those lower ASP products do not commensurately carry a lower growth margin but they are at a lower ASP impacting the revenues. They continue to be very quick adopters of those new products. Our units in the first half with that customer remains about the same, quarter on quarter.

With respect to your first question on inventories in general, we don't see with our customers and our distribution channel an increase in inventories that is out of place. As Bill reported, days of inventory with the distribution channel actually came down slightly, albeit flat on a dollar basis and we had wanted to increase our inventories given how low they have become at the end of the first quarter. But we're not seeing other than that spot issue I mentioned in Europe, we're not seeing any build-up of inventories in our channel.

Anil Doradla – William Blair

Thank you.

Necip Sayiner

You're welcome.

Operator

Our next from Tore Svanberg of Stifel Nicolaus. Your line is open.

Eric – Stifel Nicolaus

This is [Eric] calling in for Tore. Just want to follow up really quick on the gross margin earlier. It seems like it is trending above your target rate and it seems like it probably going to be there in the foreseeable future. When do you expect to normalize back to your target range or is this -- you think this might settle -- we might start looking at a more normal rate at a higher rate?

Necip Sayiner

Eric, I think you can assume this higher rate is intact for the third quarter and likely through the second half of the year. We will re-evaluate gross margins when we get to the January call, when we set some expectations for 2011.

Generally speaking, you know, we think that the target range that is 62 to 65 is appropriate for our business in the long run. As I commented to the earlier question, we're just certainly in an environment right now where we are over performing and we expect that to continue for the next couple of quarters.

Eric – Stifel Nicolaus

Great. Thank you. Thanks for clarifying that. Your new product you recently announced, introduced a single chip DVD mod. I didn't catch it. Is it shipping and what is the general interest been like with customers, if you can kind of give a little color there.

Necip Sayiner

That product combines terrestrial cable and satellite and particularly DVB-S2 which is the most up-to-date satellite modulation scheme. The modules that have brought all this functionality together to date had to use multiple devices. So being able to offer this all in one chip is creating some interest with some of our customer base. But this is a product we just brought to market. So it's not shipping. However, we’re competing for design wins for 2011 models.

Eric – Stifel Nicolaus

Okay. Thank you. That's all I have.

Necip Sayiner

Okay.

Operator

Next from Sandy Harrison, Signal Hill. Your line is open.

Sandy Harrison – Signal Hill

Yeah. Thanks for taking my question. As far as you made some comments in your prepared remarks about being able to turn some product pretty quickly and capture some market share. Have you guys -- did you have some additional inventory? You have supply that kicks out maybe a little bit more fill in on how you guys are able to do that?

Necip Sayiner

Well, if I understand your question, within the quarter we got some upside business in our broad-based business and if you ask me in the month of May we had quite a bit of delinquency to customer request dates. But, we strived to catch up demand by the end of June and June by virtue of that was a heavy shipping month, and partially explains why our account receivables went up.

Sandy Harrison – Signal Hill

Got you. And then on the networking market, looks like you guys throughout a couple of your different product lines to touch, especially in timing, you guys have done pretty well there. What's your view on the networking? We've had some pretty strong quarterly growth in the enterprise phase and reporting so far has been pretty encouraging. What's your view on how that market goes and how we finished the year and what your customers are telling you from a networking perspective?

Necip Sayiner

Actually, I've had the opportunities to touch a couple of large customers in the networking space in North America in the last couple of weeks. And the outlook for their business continues to be very positive and even more positive for us. They are very willing to proliferate the solutions that we have particularly the timing solutions and to some degree the (inaudible) solutions within their platforms.

So the input that we have received from a macro point of view from our customers continues to be solid. And I think our positioning, especially with the lead times that you alluded to for our timing product continues to be very, very attractive.

Sandy Harrison – Signal Hill

Okay. Thanks for taking my questions, guys.

Bill Bock

Okay.

Operator

Next from Alex Gauna, JMP Securities. Your line is open.

Alex Gauna – JMP Securities

Thanks for taking my questions and nice quarter. I was wondering if you could go into, I know you've given the guidance for the third quarter, but with regard to your mix moving more toward some of that consumer and multimedia. Can you characterize exactly or approximately how you view some of the consumer FM and your video tuner gross margin opportunity?

I know you mentioned the ability to reduce costs without sacrificing gross margins with what you're doing in handsets. What is that and can you compare it to the upside opportunity perhaps coming from higher gross margin products, and power Ethernet and timing?

Necip Sayiner

Okay. Let me take, let’s start this and we can follow up if it's not adequate. Let me first address the broadcast audio. I think what we're seeing in the third quarter is, handset units to continue to decline and with the move to lower ASP products as I mentioned, I think we'll see a definite reduction in revenue. So much so that, I think the handset revenues will likely be no more than 10% of our company revenues in the third quarter.

To offset that, we are looking at a continued increase in our revenues from AM/FM coming particularly from China, the ODM base there and domestic consumption there for our AM.FM product. We'll see a solid ramp with our TV tuners particularly in Japanese customers in the second half. We'll start shipment of a demodulator product into one of the Taiwanese ODMs in the quarter and our large portable media player customer, of course, is ramping seasonally in the third quarter. So the net of all that is, continued increase in audio revenue albeit maybe not commensurate with the type of sequential growth we've shown in prior years.

On the broad-based side, I think, there's some mix in our embedded mixed-signal business that would suggest slightly lower gross margins for the quarter and that's contributing to the margin projection we have for you but I don't see this to be a trend. Many of the trends that were observed earlier in the call both with respect to handsets and broad-based business becoming a larger portion of our revenue are, I think, all accurate.

We will see some early shipment, additional expenses that will hit the gross margin line with so many new products ramping. TV tuners, our easy radio product and so on. So some element that might pull the gross margin lower in the second half but all the trends indicated so far are accurate.

Alex Gauna – JMP Securities

Okay. And as a follow-up, I know you broke out quick sense from a design win perspective being perhaps 80% consumer to 20% industrial and smartphone. Do you expect the revenue mix to be approximately that or there's some design wins on the handset side that could boost that? And with Samsung as or handsets as a less than 10% contributor on the FM tuner side, do we see a shift in your seasonal patterns for the December quarter? Thank you.

Necip Sayiner

You know, only a small number of those design wins are going to generate revenue for us in the second half, Alex. And, it's too small base at the moment to really dissect it to be able to tell you how much of it is from handset versus not. I think in general obviously handset wins tend to generate more revenue per design win than industrial wins but both are equally important for us. I think we want to drive volume on the handsets, but we do see a lot of untapped opportunity on the industrial side.

You know, in terms of the second part of your question with respect to 4Q. I will not be able to answer that question accurately without divulging what our large customers would do in the fourth quarter with respect to their shipments although we have some visibility to that obviously, it wouldn't be appropriate for me to comment on that.

Alex Gauna – JMP Securities

Understood. Thank you.

Operator

Thank you. Our next is from Srini Pajjuri, CLSA. Your line is open.

Srini Pajjuri – CLSA

Thank you. Good morning, guys. If I take your guidance for the segment that you gave us for the full year, looks like it is implying in a mid to slightly higher than mid-single digit growth for Q4, I just want to make sure I'm doing the maths right. And if that is correct, what segments do you expect to do well in the fourth quarter? And wondering if that is mostly seasonality or if you're expecting any new product ramps there?

Necip Sayiner

Are you asking about the fourth quarter?

Srini Pajjuri – CLSA

Yeah.

Necip Sayiner

Revenues, I didn't think I was commenting on that particularly. What I am saying is for the full year, when I look at access, we'll be able to maintain mid-to high single-digit growth that we projected even in spite of the weakness. On broadcast, we had suggested the audio business will be 10% or better growth for us. And broadcast overall would likely grow in the mid-teens. I think that's largely intact. And we see the broad-based business, providing the upside. I'm not yet prepared to give you guidance on 4Q. I can tell you, however, that, we'll see the audio business be seasonal from what we see today. In 4Q and the video business will continue to ramp from third-quarter levels.

Srini Pajjuri – CLSA

Okay. Great. And then you said you expect the handsets portion of the audio business to be not more than 10% in third quarter. Can you give us some idea as we look out to the next year, how should we think about that business. Will it decline to minimal levels by end of next year or will it stay at that 10% level?

Necip Sayiner

I just want to clarify my comments. I said that, with, the projected third-quarter revenues for handsets that will be approximately 10% of the total company revenues. Okay. Just to make sure for everyone’s benefit. We'll see that business continue to decline at an orderly rate into 2011. The design wins, the rate of design wins, we are getting with our customers support that. And I also reported – really a record number of design wins for the audio business across the board. So that continues to support our expectation that the consumer audio increases will more than offset that. So there's nothing in the last 90 days that changed our review in that regard.

Srini Pajjuri – CLSA

And then you mentioned that you somehow price pressures on the set-top box market. I’m just wondering, given, it looks like the set-top box market in general is doing fairly well. Just wondering what's causing those price pressures and if you expect them to continue into the next few quarters?

Necip Sayiner

Well, I think what we are seeing for our modems and set-top boxes, essentially is a market where there's some modest ASP declines, with really no unit increases to offset that. So when we look at our modem business, embedded modem business, for the year we are seeing a slight decline in revenues year-on-year, which is exactly what we have projected in the beginning of the year. That's partially due to a better start to the year than we had expected, so the second half is certainly weaker. But there is really nothing out of the ordinary in the ASP decline side. I didn't mean to suggest that it's a new phenomena.

Srini Pajjuri – CLSA

Okay. And then one last one for Bill. Bill, you said that you spent about $75 million in share buybacks and you did mention that, the multiples I guess it was – Necip did mentioned that multiples are relatively cheap. And obviously the estimates are going to go higher today and the multiples are probably going to be even cheaper. So my question is, are you likely to be equally aggressive in the near-term as you were last quarter? Thank you.

Bill Bock

Well, I'm not sure I'm going to report a specific number, but I would expect with the new $150 million authorization. The purpose behind the board providing that authorization is to put us in a position where we can take advantage of dips in the stock price. So I expect we'll be active in the market during 3Q.

Srini Pajjuri – CLSA

Thank you.

Operator

Thank you. Our next is from Arnab Chanda, Roth capital. Your line is open.

Arnab Chanda – Roth Capital

Thank you. First question -- If you look at your gross margin profile, you obviously have a lot of different products now. But is there a dramatic difference between FM audio business going into handsets? Is there a dramatic difference or range with the rest of your product lines? If that is the case, it's an elevated level in longer term or do you think maybe there's some beneficiary in unit pricing or mix that are unusual and output cost?

Bill Bock

So, Arnab, I think that it's the same question that I addressed earlier. We're very comfortable that the mix shifts that we have seen support continuation of above model gross margin performance for the remainder of the year. We will provide additional color on gross margin expectations for 2011, when we get to our call in January, but right now, all of the dynamics are playing to our favor. We have a mix shift in product, a mix shift in distribution channel and a great execution from our operations team that are yielding these above model performances.

Necip Sayiner

Maybe I can provide one additional perspective since we've receive a number of questions on gross margins going forward. If you look at where we're most likely to see upside revenue in 2011, those areas are in embedded mixed signal in video and in timing. All those products, video because of the end market that we are addressing, are projected to be below corporate average. Embedded mixed signal, you can think of as above our corporate average and timing is certainly above average.

So going from where we are today to 2011, with those three product lines showing considerable growth, depending on the mix between those, you'll see a move in gross margins. I mean, all the trends that we are highlighting, you're asking about, are accurate. What we tried to do on a quarterly basis is to provide ideal projections based on bottoms-up approach, looking at each and every product and how much of it we're planning to ship in the quarter. And we concur that more often than not either our ASP assumptions or our ability to continue to improve costs appear conservative in the beginning of the quarter than at the end. But we do try to give you the best view we have of the margins at any point in time.

Arnab Chanda – Roth Capital

Thank you, Necip. A question about -- If you look at your microcontroller business or your human -- let's talk specifically about the human sensing application. You must have pretty -- exciting and maybe industry-leading portfolio with both the ability to have micro as well as sort of analog sensors. What plans should we be looking at, in terms of revenue ramps there? Are there specific types of end license or models that we should be look for to sort of gadgets are best at?

Necip Sayiner

In human interface, I think we have brought to market a series of solutions to date, but have a pretty exciting roadmap going forward that is taking shape, based on the feedback that we continue to receive from the customers. We have also indicated when we completed Silicon Clocks acquisition three months ago that the immense technology that we are acquiring, we would like to apply to other applications beyond timing over time. And we're making internally, some progress on that front but we're still quite a ways away from being able to talk about it publicly.

Arnab Chanda – Roth Capital

And then one last question. You talked a little about delinquencies in May, seems like things did improved in June. If you look at lead times as well as sorts of ability to meet supply, where are you now versus maybe a quarter or two ago and when do you think they're going to be normal in terms of being able supply, customers at the right lead times they're looking for?

Necip Sayiner

I think we have been operating in an environment where it's particularly difficult to meet the demands, upside demands within lead times within a quarter of our customers. And that was part of the struggle in the months of May and June. At this point, neither in second quarter nor in the third quarter, our revenues are being limited by supply, but it is an ongoing challenge to meet the demands, changing demands of our customers, especially in the broad-based business.

Arnab Chanda – Roth Capital

Thank you.

Operator

Our last question now is from Craig Berger of FBR. Your line is open, sir.

Craig Berger – FBR

Hey guys, thanks for taking my question. Nice job on the results. Wanted to -- Haven't heard you talk much about AM/FM, within the context of the audio business. Can you just update us on, maybe on how big that piece is of the audio business, what the design wins look like and how much of that is going into automotive and then a follow-up. Thanks.

Necip Sayiner

Okay. We reported a record 219 design wins. That's really substantially above any number we've talked about before. And large amount of that, Craig, is coming from consumer audience, particularly AM/FM products. I would say still a majority is coming from applications such as clock radios, boom boxes, docking stations and this is across the board in North America, Europe and Southern China.

An increasing number of the automotive design wins, that's obviously very good to see our automotive qualified AM/FM parts, are getting traction and they do have a longer gestation period into revenue. But we're enjoying an increased level of activity there. So net-net, I think the audio business is executing on its plan to change the complexion of the business over this year and next.

Craig Berger – FBR

Thank you. And then as a follow-up, within your broad-based business, can just give us an idea of how big some of the components are, what the make-up is of that business between microcontrollers, clock and timing, others and then as part of that, when you look at your microcontroller business, do you think you need 32 bit? What are your plans there? Thanks.

Necip Sayiner

Okay. So the largest portion of revenue in the broad-based is MCU. Certainly, greater than 50% comes from MCU today. It's followed by timing. And then the emerging businesses in short range wireless and isolation. In term of our strategy in MCU, we have not made any announcements. However, as we look to expand, our served market to us at 32 bit offering appears to be the next natural step. I think we're covering a lot of the 16-bit applications to date with our high-end 8-bit engine. And a 32 bit offering would be the next natural step.

Craig Berger – FBR

Thank you.

Shannon Pleasant

All right. Thank you very much for joining us this morning. This now concludes today's call.

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Source: Silicon Laboratories, Inc. Q2 2010 Earnings Call Transcript
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