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Silicon Laboratories (NASDAQ:SLAB)

Citi Technology Conference

September 06, 2012 11:00 am ET

Executives

Tyson Tuttle - President and Chief Executive Officer

Paul Walsh - Senior Vice President and Chief Financial Officer

Analysts

Terrence Whalen - Citigroup

Good morning. Welcome to Citi's Technology Conference Day Three. I am Terrence Whalen. I am Citi's Specialty Semiconductor Analyst. It's a pleasure to have Silicon Labs here today with us. With us from Silicon Labs is CEO, Tyson Tuttle, and also CFO, Paul Walsh. Welcome.

I think that format this morning will be that Tyson will start with a brief 10 or 15-minute presentation. I have got a couple of questions as well, and then we'll make sure that we have adequate time for audience questions as well, so Tyson, welcome.

Tyson Tuttle

All right. Thank you very much. Thank you, everybody, for attending. Get right into it here. Silicon Labs is a highly diversified company for its size. We've got about $500 million revenue last year. We're about a $600 million year run rate now. We had a record quarter in Q2 and guided up to recorded quarter in Q3, so we're growth company. We target about 15% CAGAR, 62% gross margin, 25% operating income, so we're highly profitable, a lot of discipline around cost and around margins within the company and where really the growth is propelled by product cycle, so we have a lot of growth in the portfolio, we've been investing a lot in that and have got 80% of our product portfolio today is in growth mode, and the diversification is really centered around a lot of different types of products. We'll get into more of that in a little bit spread across communications industrial and consumer applications, so going after lots of different markets and we'll get into that.

The heart of our success is really in our engineering and in our approach to developing products. We develop mixed-signal ICs, so these are devices that interface between the analog world that we live in and the digital world of computing, and we have been replacing more analog discrete applications and solutions with standard CMOS solutions, so this is standard digital CMOS process technology and applying that in unique ways where we can combine the analog and the digital together into a single chip layer on software and systems expertise into that and then target that at a wide variety of different applications, so we've had a track record of success across a lot of different product areas that have driven the growth of the company. Today, you'll see of those across the bottom of the slide from our Access business and our RF timing related devices into our Microcontrollers and our Broadcast business, so these have been products that have come out of this, and these are hard to duplicate products. These are usually the first to market with this type of an integration with this level of performance and hard to duplicate, lot of IP, over 1,200 patents within the company.

Our strategy of growth is really four-fold. First we are targeting some very large markets with our solutions, and these markets give us a lot of room to growth, and also because they are large, we're minimizing market risk and we are focused on gaining market share within those. Then as we come into a market, we are coming in with a disruptive type of a product, so these are very differentiated products where we can come in with a unique solution that can gain share quickly and get into a product cycle where again that's going to help gain market share and drive growth.

Another key aspect of growth is to be able to efficiently use every dollar of R&D, and so as we've gotten into more of the broad range of applications and leveraging a common technology platform, every dollar of R&D we have been able to drive into a wider variety of products, so using a common technology base and being able to leverage that into a variety of application, so lot of times using software programmable devices, which we are able to target multiple market segments and multiple products out of a single CMOS solution. Then as we go from one product to the next leveraging as much of the IP from one area to another, so that's an important part to be able to drive product momentum and to drive expansion of the portfolio efficiently from our R&D expense.

Then if you look at the markets that we are going after, we are really targeting broad-based markets that are stable, that we think that we have got a competitive advantage long-term that we've got the ability to do integration, the ability to sustain that over a long period of time and a lot of o the markets that we are going after have longer product life cycles and we will have products that have 5 to 10-year life and that enables us to drive our R&D and the new product introductions into growth as opposed to replacing the existing business that we have. If you look at the portfolio of our products now and where we are investing, the sustainability of that helps us drive growth and also drives a higher level of stability of the business.

We drill in a little bit further into our product lines; we really break this into three categories. We've got our Access business, which is our more of a legacy business and voice-over-IP, fax, point-of-sale and that's essentially a stable business going forward. It's about 20% of revenue in Q2, and on a $1 basis you can model that as being fairly stable over time. We've seen some decline on the modems and set-top box applications and that's largely behind us, so the voice-over-IP and the remaining modem business is stable.

Our Broadcast business was about a third of our business in Q2, and that's in a growth phase. We've seen our handset FM tuners has not been a focus and has now small percentage of revenue and we've been focusing in the audio business on consumer applications, boom boxes, iPod dock, some theater systems, where we have a nice share and emerging business in automotive radios and then on the video side, flat-panel TVs, and again about a 30% share and some room to grow in that market as well, so we think that over time that business is back into a solid growth mode really around the corporate target of 15% growth is certainly achievable over the medium and long-term.

The big focus of our R&D, and it think that what is the future of the company is in our broad base product really our embedded systems, our microcontrollers, wireless, isolation and power, and then in the timing business. These are addressing very large markets. Again, there is a $9 billion SAM for those. We've just introduced our 32-bit microcontroller products and are integrating wireless along with some of the power and green energy applications and lot of exciting growth potential there, so that's in 20%, 30% growth certainly over time, and lots of different opportunity for us on the broad based drive.

If you look longer term, some of the key technology trends that we've got that are going to propel our business and drive the demand for mixed-signal ICs and we are very positioned to play. If you look at a lot of the green technology applications, the need for energy efficiency, the need for low power devices that are powered off a solar energy harvesting or off the batteries and these are places where our differentiation in our technology uniquely apply, so we believe that for a lot of the embedded applications for home automation, for security, for metering, for a lot of the alternative energy applications there's just an explosion of applications for this. Over the next 5 to 10 years, this is going to be a huge growth area for us driven by the need to improve the energy efficiency of all these devices. How much electricity is used, there's 2 trillion devices plugged into the AC line, a lot of which will be redesigned and will contain silicon that Silicon Labs can supply.

Another macro trend that I think fits very well with our strategy is the internet of everything. All the things that are connected to the internet and connected to each other, we have a unique wireless technology ZigBee, and a lot of the sub-gigahertz wireless technology that we are investing in and that combined with our microcontrollers and our embed systems going into a lot of these new applications that are again things in our lives that are being connected to each other and being redesigned and driving a lot of growth and this is an area that's forecasted from a unit basis to be larger than the cell phone market in the next few years, so that is another big focus for us.

Then you've got the bandwidth expansion, the ever growing need for bandwidth. You've got Netflix, you've got smartphones and applications and the cloud and that requiring bigger and faster pipes and that fits into our timing business and a lot of the wireless infrastructure and we are very positioned to take share in that and to leverage that as both the telecom business grows and as these evolve faster and faster in upgrade cycles in the equipment side, so these are three of the technology trends that I think are going to propel Silicon Labs and the need for mixed-signal ICs that we are designing going into future.

This is my final slide, and then we'll open it up for some questions. Our record revenue levels in Q2, forecasting a record quarter in Q3, and the environment is shaky out there, but in terms of our overall business, we feel confident about where are. The broadcast demand is holding. We've got a lot of strength from our Korean customers there. On the video side, there is a lot of 2013 design win momentum. We've been locking-in the design wins for 2013. That looks like that's holding on. It's going to drive nice growth into 2013. The broad base business, the growth in that business is on track. Really it's a market share gain story. Our growth is not dependent on necessarily the end markets, but is on our ability and the product cycles that we've got in microcontrollers and timing, the emerging wireless applications, isolation, all those are contributing to the growth on a broad-base side and we think that's on track. We've got a record levels of product introductions across the company and those market share gains I think are what are going to deliver better than industry growth here for 2012, and I think going into 2013, certainly our intention is to continue to outgrow the industry and outpace the industry.

With that I would like to open it up to some questions.

Terrence Whalen - Citigroup

Sure. Absolutely. I would like to start off with a couple of questions and then we can go to the audience.

Tyson Tuttle

All right.

Terrence Whalen - Citigroup

Okay. Terrific. Then another other question on growth. I think your growth target is upwards 10% or 15% over a longer term period. Is that correct?

Tyson Tuttle

Our growth target is 15% and greater. Maybe I could let Paul comment on some of the financial target.

Terrence Whalen - Citigroup

Sure. Maybe with revenue and profitability, Paul.

Paul Walsh

Sure. As Tyson alluded to our model beginning of the pitch, but our top line growth model is about 15% on a compounded annual basis, maintained gross margins around 62% and to drive towards 45% operating income.

Terrence Whalen - Citigroup

Okay. Wonderful. Then if I look at next year specifically, I think street estimates have you grown about 6% or 7%, so well below half the rate of your target growth. Do you see any impact I mean that would allow you to not achieve your target growth rate next year?

Paul Walsh

Right. We never know where the end markets are going to be. We are certainly focused on market share gains and you look at where we are positioned on the broad-based products, the introduction of 32-bit, the continued momentum that we are going to have on a lot of the applications for wireless and power there and then on the timing side, the expansion of the timing portfolio, we are well positioned to grow. We've got both, the automotive and the TV-tuner on the broadcast side are going to put that into a nice growth mode and we've got stability on the access side. Where that lands? We aren't providing specific numbers at this point, but we feel quite bullish about the business going into 2013.

Terrence Whalen - Citigroup

Then, Tyson, I think the broad-based business obviously has grown nicely. It's a very attractive part of the revenue. At what point do the 20% to 30% growth target become difficult to achieve at a different at a different scale? How far down the road is that could we still grow this 20% to 30% for two or three years to come?

Tyson Tuttle

We are hitting $1 billion a year in revenue. Maybe we can have the conversation again, but if you look at the market share that we've got in the microcontroller embedded systems time area, we've got single-digit percent. It's a $9 billion SAM that is less than $500 million today, so we've got a long way to go in terms of market share gains, so we don't have supply constraints. We have a very scalable. We're fabless, we have very large manufacturing partners, so we can scale on the supply chain side and it's really getting the right product portfolio together and to make it scalable both, from a sales channel perspective and from an R&D perspective to grow the portfolio and to grow the business over time, so I don't see anything structurally that in the near-term in terms of market share penetration or in our ability to scale internally is limited by the product introduction momentum going forward.

Terrence Whalen - Citigroup

Okay. Terrific. Then if I think about the TV tuner business in particular. That business has grown quite nicely. What kind of lead does that business have? What are the next phases of growth for TV tuner, and also how do you think eventually that business potential is unsetting as we can sort of naturally expect with that type of an application-focused product.

Tyson Tuttle

Yeah. That's been a tremendously successful product. I mean, we've got about 30% unit share in TV, so if we look at that over the next couple of years, we've got conversion of still a lot. It's about 50% penetration in silicon tuner this year overall, and so we've got additional 50% of penetration in silicon tuners into TV, so that's a unit share for us. We've also focused our initial designs on the tier-1 makers of Samsung, LG, remember the Japanese suppliers outside of Sony, so going into Taiwan, going into China, there is a lot of opportunity for expansion kind of at the low end of that market and driving that conversion over to silicon tuners and most of those suppliers today are using discrete solutions, and so we've locked-in most of the 2013 models now and we are going to have nice market share gain going into next year, and I think that that you will see that again in '14, so we've got a couple of years of growth both, in a unit and a dollar perspective.

Then I think we've got a business that is going to be sustainable over a long period of time. If you look at the integration trends, the tuner is not going to get integrated into an SoC. I can say that it's a very difficult with a high technical barrier to entry, there's a lot of IP in this area which is really makes it hard to enter this market. There is a high barrier to entry and it's not going to get integrated into another device, which is if you look at the FM tuners and handsets, we've decided not to go after the combo devices, but here you are not going to have that. I think they are going to have tuners and televisions for the next 10, 15 years and I can see us being a substantial supplier of those. Eventually, that will pass with the turn off to a broad-based products and all the other growth sectors in the investment levels will come down there, but it's a highly profitable long-term business for us.

Terrence Whalen - Citigroup

Okay. Regarding that point on profitability, can you talk a little bit about that getting that product off the gross margin curve? Where we are in terms of what generation product and what are the cost opportunities you have to maintain or even expand gross margin there?

Tyson Tuttle

Overall as a company, we have a strong focus on the cost, and so we have to drive a lot of our engineering discipline is in making that devices small and is in making them low cost, so we are on our fourth-generation TV tuner, which is now just entering production. This is going from third generation, which has been most of the production this year to the fourth generation. It's a substantial cost down. That will be the majority of volume next year, so as we go into 2013, the video business has been below the corporate margin, the margins there will improve. We don't expect them to get all the way to the corporate target, but consumer high volume market is going to be quite expectable, so we think we have a very compelling cost position going into 2013 and have some additional optimization of that we believe that this is compatible with the corporate financial model both, in terms of the growth margin line and the contribution that it puts back to the company.

Terrence Whalen - Citigroup

Once we are maybe a saturated point of market share there, once you continue to grow over the next several years, what other functionality can you add to that bucket to help offset price pressure, price declines in that bucket?

Tyson Tuttle

Right. We certainly partnered with a lot of the Tier-1 TV makers and integrated and done custom devices that fit in with their architectures, and so to the extent that we have opportunities with the Tier-1 makers to optimize the system partitioning that both provides us sticky solutions, but also can drive a higher level of the air functionality and ASP.

We've also got some adjacent markets that this technology can apply to, so there are some opportunities for additional SAM expansion there, but I think if you look at the big opportunities for the company that the embedded systems area, the timing area, the size of those markets versus the size of this market, and it's really just, it's a decision about okay, do I invest in this market where we've already got majority share and a competitive cost effective solution or do I invest in these other areas that have a higher payback, and so over time that needle will move over and the growth will be driven, I think, by these much larger diversified markets, but it doesn't mean that this is not an attractive place for us to stay.

Terrence Whalen - Citigroup

Sure. Okay, and that's a good segue actually to, I think broad-based in my model is about 50% of sales this year in calendar '12. Any indication on amount of R&D you are allocating of the business to broad-based?

Tyson Tuttle

For Q2, we were at 45% of revenue out on the broad-based product. It will come in somewhat for the year between less than 50%, between 40% and 50%, and we certainly have more than half of R&D focused in that area, so timing has been a very heavy investment for us. We've got some investments and to replace crystal. We've got a lot of investment in the 32-bit microcontroller platform and the integration of wireless with that and in building infrastructure of tools and support to be able to support that broad range of application, so we've been diversifying the timing portfolio, really diversifying the microcontroller portfolio, driving cost reductions in all of that and that's been a big focus of R&D, so that is half of R&D today in that area a little bit less than half of our revenue comparing broad-based.

Terrence Whalen - Citigroup

Okay. Then with regard to thinking about the opportunity and microcontrollers and wireless versus timing, is one more superior growth rate? I mean, it seems like timing is going to be a little bit more tied to CapEx overall perhaps while MCU is more just a pure share gain opportunity, is that a good way to think about that?

Tyson Tuttle

No. I think that they both are share gain opportunities. You look at the timing market outside of mems, outside of the crystal replacements and that's about $2 billion, and we've got a sub-$100 million in timing today, so we've got a lot of share gain. I think we've got a shot at being. You look at our portfolio, the differentiation of those parts, the functionality that we achieve, the complete range of parts from high end to the low end that we've been able to drive and there is no reason why we can't continue to take significant share there, so that $75 million over the next two, three, four years could double or triple even if we do our job right there, so there is a lot of market share gain to be had on the timing side. I really look at these as our two big engines that are driving and propelling the company forward.

On the embedded system side, again, you've got a very large 8-bit market where we've been able to drive market share growth and drive growth even in a declining market, so we've been taking share there and we've been able to take a lot of that IP and drive into the 32-bit market, and starting from zero that's going to be just layering right on top of that. They were one of the few companies positioned to be able to put wireless technology and embed that in a low cost high volume way for some of these emerging applications, so two very exciting areas for us that are not going to just be dependent on the end market growth, but are going to be really driven by our success in being able to take share from other solutions in the market.

Terrence Whalen - Citigroup

Then in timing in particular, I think it's pretty fascinating business, the ASPs are pretty wide variety whether it'd be in different end markets like data comm. or consumer. Can you talk about where you see the development of growth and the development of the margin opportunity for that business in the next three years or so?

Tyson Tuttle

Right. If you look at our design wins, 25% of our design wins were in more industrial type broader types of applications and timing, which have healthy margins and ASPs. We've also got a lot of traction in some of the higher volume consumer segments, but at the same time we've got a very compelling cost position and then I think we've got additional lot of design wins at the high end, so if there is a rebound in demand in the telecom area and the high-speed networking area, we will be very well position to take advantage of that, but even in the absence of that the design win momentum in the share gain is going to still drive growth at the high end. We've been broadening that portfolio oscillators, clocks, buffers to be able to deliver complete timing trees into a wide range of applications and even within those customers driving down into some of the mid-range applications that's part of the share growth as well there, so it is a very attractive business from growth perspective for us.

Terrence Whalen - Citigroup

Okay. I have several other questions, but I wanted to give an opportunity to anyone in the audience to ask a question as well.

Question-and-Answer Session

Unidentified Analyst

Thanks. Question on the TV tuner business. Just to be clear, when you talked about the 50% penetration silicon tuners, what is it for just the Japanese non-Sony customers?

Tyson Tuttle

Okay. Let me just clarify, so the 50% is in 2012, about half of the TVs will have a silicon tuner. About 30% of the TVs will have the Silicon Labs' tuner. In Japan, the Sony has their own solutions, so outside of Sony you've got Panasonic, Toshiba, Sharp, and those are all customers of ours, and I would say that the penetration of silicon tuners in Japan is probably somewhat higher than that 50% number. I don't have the precise number for you though, but Sony is essentially all silicon tuner and then Panasonic, Sharp Toshiba is majority, so it's a combination of discrete tuners and silicon tuners, but probably more like two-third share. That would be my guess. That's only a guess.

Unidentified Analyst

Got you. Then the 2013 model design wins locked in. What does that push that 50% silicon penetration to?

Tyson Tuttle

In Japan or overall?

Unidentified Analyst

Overall.

Tyson Tuttle

I think that if you look at the trends there, in the overall market it's certainly going to be well north of 50%. It might be two-thirds next year. Something like that. That would be a conservative number, I would think. There's still going to be a lot of discrete tuner shipped in 2013.

Unidentified Analyst

I wonder if you could talk about the microcontroller business a bit more. The overall microcontroller for you has been a little less growth than it was a few years past, but I am sure there's a lot going on beneath the surface. I wonder if you can talk about which specialty microcontroller markets, the target markets you are going after and sort of expand on that.

Tyson Tuttle

Right, so we've been successful. We have a very strong USB line, we have a very strong low power line and very strong precision mixed-signal line. Precision and that's on the 8-bit side, and then we've got a very unique capability on the wireless side, so if you look at the ARM Cortex-M0+, M3, and those types of solutions, we don't necessarily look at it as where is the overall 32-bit space. We are looking at specific areas within the microcontroller market where we have a high level of differentiation and can come in with really a disruptive solution that integrates not just the microcontroller functionality, but a lot of the other specific interfaces either RF or sensor or actuators driven by those three market trends that I was talking about where we can come in with something that other people are not able to compete with, where you've got either spec or an integration that's unique, so that low power aspects, the precision analog and the RF would be the places where probably two dozen market segments that various types of devices go into and those are our specific focus for the growth of the microcontroller business, so it's not looking at, per say, the size of the 32-bit space. It's really market share within that space and that being a very large SAN box play.

If you look at our revenue today, which is primarily 8-bit, in 2011, we did grow that business mid-to-high single digits while the 8-bit market overall declined anywhere from 8% to 12% depending on different estimates, so there's essentially a lot of share gain there just as a highlight.

Unidentified Analyst

Can you explain a little bit about why the silicon tuner won't be integrated over? First you said, I think, it won't be integrated in the TV, and then you said maybe 10 to 15 years it won't. I don't know why won't it be integrated?

Tyson Tuttle

All right, so what I meant is that TVs will continue integrate the tuner functionality for the foreseeable future and that will specifically require analog and digital functionality, so you've got analog broadcast in various regions around the world. They are not turning that off in Mexico or Canada, or even low power cable in the U.S., and so you've got a variety of standards. It was really what the last high volume market for discrete that was stood integration, so it's that 20 companies have tried to integrate TV tuner into silicon and have failed, because you can't get the cost and the performance and really we were the first company to be able to achieve the level of performance required, so it's a hard problem. You've got a 1 million to 1 ratio of signal to noise that's required. It's a very difficult technical problem to be able to get level of integration and functionality and performance out of the low cost CMOS device, so that functionality is difficult to integrate with something else.

Then you've got the processor in a TV driving down Moore's Law, and you are integrating more and more functionality in terms of apps and video processing and that is really on a separate technology base from where the RF makes sense. Then if you try to put them together, it's just physically impossible in terms of all the noise in reference to put them on them on the same device. It's just fundamentally my belief that the tuner, it's' not possible to integrate that tuner into another device since and still maintain the performance.

Unidentified Analyst

Is it the ideal process technology for the tuner itself is a, I don't know, 90-nanometer or something, and so if you went to 20-nanometer, you just couldn't do it? Is that sort of essential to your explanation?

Tyson Tuttle

We are 55. Our fourth gen tuner is at 55. We've gone from 110 to 55. Gone from third to fourth generation, and that's really an ideal node for quite some time in terms of performance and cost for the tuner function. If I took the tuner and put it onto a larger SoC, I would increase the cost, because the cost per millimeter of those is more and you would also have a very hard time in terms of getting the performance with the finer line geometry as well as if you try to integrate it with these huge processors. It just really is physically impossible to do that integration, so it's going to be a standalone part outside as a large SoC in a television really for the foreseeable future.

Terrence Whalen - Citigroup

I think, we are at our time left, so thank you very much, Tyson. Thank you, Paul. Much appreciate it.

Tyson Tuttle

All right. Appreciate your attention.

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