Silicon Laboratories Inc. — Form 10-Q Summary
Period clarification: The request metadata says 2016 Q2, but this filing reports the quarter ended July 1, 2017, and compares it with the quarter ended July 2, 2016. Financial statements are unaudited.
Business context and reporting period
Silicon Laboratories designs mixed-signal semiconductors and software for IoT, broadcast, infrastructure, and access markets. It is a fabless semiconductor company reliant on third parties, primarily in Asia, for manufacturing, assembly, and testing. The filing covers the three and six months ended July 1, 2017.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $190.1 million | $174.9 million | $369.1 million | $336.9 million |
| Gross margin | $113.2 million; 59.5% | $108.3 million; 61.9% | $218.4 million; 59.2% | $203.8 million; 60.5% |
| Operating income | $20.9 million | $17.6 million | $33.6 million | $24.5 million |
| Net income | $16.6 million | $15.6 million | $32.0 million | $21.4 million |
| Diluted EPS | $0.38 | $0.37 | $0.74 | $0.51 |
| Operating cash flow | Not separately reported for the quarter | $80.6 million | $60.4 million |
Q2 revenue rose 8.7% year over year; six-month revenue rose 9.6%. IoT was the main growth driver: Q2 IoT revenue increased 27.3% to $97.7 million, while Broadcast, Infrastructure, and Access revenue declined. For the six months, IoT revenue increased 25.7% to $185.6 million. Product unit volumes rose 21.0% in Q2 and 19.9% in the first half, while average selling prices fell 7.8% and 7.5%, respectively.
Gross margin dollars increased, but gross margin percentage declined, reflecting product mix and the prior-year quarter’s $5.0 million patent sale, which had no associated cost of revenue. Operating expenses were $92.3 million in Q2 and $184.7 million for the first half. Six-month net income benefited from a tax benefit of $0.7 million, compared with tax expense of $2.0 million in the prior-year period; the filing attributes lower tax expense primarily to stock-based compensation tax benefits and U.S. R&D tax credits. Q2 interest expense rose to $4.7 million, largely due to the convertible notes and amortization of debt discount and issuance costs.
At July 1, 2017, cash and cash equivalents were $210.6 million and short- and long-term investments totaled $456.5 million, for combined cash, cash equivalents, and short-term investments of $661.7 million as cited by management. Current assets were $851.5 million versus current liabilities of $143.2 million. Accounts receivable was $75.5 million (36 days sales outstanding); inventory was $67.4 million (79 days of inventory), up from $59.6 million and 73 days at year-end 2016.
The company issued $400 million principal amount of 1.375% convertible senior notes due 2022 and used $72.5 million of proceeds to repay its credit-facility borrowing. The notes’ net carrying amount was $335.6 million; their disclosed fair value was $414.8 million. No credit-facility borrowings remained at quarter-end, though a $300 million revolving facility remained available, subject to its terms and covenants. The company reported compliance with facility covenants.
Material changes and unusual items
- Revenue and operating income increased year over year, led by IoT growth; declines in other product categories partly offset that growth.
- Gross margin percentage fell 2.4 percentage points in Q2 and 1.3 points for the first half.
- Cash and investments increased substantially from year-end, alongside issuance of the convertible notes and purchases of available-for-sale investments.
- On January 20, 2017, the company acquired Zentri, a low-power connected-Wi-Fi IoT technology company, for approximately $18.1 million, including contingent consideration. The purchase-price allocation was preliminary.
- The company terminated its interest-rate swap when it repaid the credit facility and reclassified $1.8 million of previously accumulated gains into earnings in the first half.
- No common shares were repurchased in the first half of 2017; a $100 million repurchase authorization remained available through December 2017.
Outlook, risks, and contingencies
Management’s Q3 fiscal 2017 outlook was revenue of $193–$199 million, gross margin of 58.5%, operating expenses of $92.5–$93 million, an effective tax rate of 11.0%, and diluted EPS of $0.35–$0.41. Management expected R&D expense to increase and SG&A expense to decrease in Q3. Fiscal 2017 capital expenditures were estimated at approximately $18–$22 million. Management said liquidity, investments, and available credit were sufficient for at least the next 12 months.
Key risks include semiconductor cyclicality and pricing pressure, lengthy customer qualification and sales cycles, reliance on third-party manufacturing and assembly capacity concentrated in Asia, distributor concentration, inventory exposure, and product-development and IoT-standard adoption risks. Three distributors each accounted for more than 10% of first-half revenue; 71% of revenue came through distributors. No individual end customer represented more than 10% of revenue, while the ten largest customers together represented 21%.
Tax contingency: Norway’s tax authority proposed an adjustment to the company’s 2013 taxable income that could result in approximately $33 million of additional tax, excluding interest and penalties. The company disputes the proposed assessment and intends to challenge it; an unfavorable outcome could materially affect the financial statements. The filing does not quantify a likely outcome. The Cresta patent proceedings remain stayed or subject to appeal; the company cannot predict their outcome or financial impact. Other legal matters were not expected by management to have a material adverse effect.
Approximately $6.0 million par value of auction-rate securities remained illiquid because auctions had failed; fair value was $5.4 million, and contractual maturity was in 2046. Management reported no other-than-temporary impairment. A 100-basis-point decline in investment yields was estimated to reduce annual interest income by approximately $6.1 million. The filing also notes that adoption of the new revenue standard was expected to accelerate recognition of distributor sales; the company was evaluating the overall impact.
Important facts for investors to verify
- Confirm the reporting-period discrepancy: this is a Q2 2017 filing, not a Q2 2016 filing.
- Track whether IoT growth continues to offset weakness in Broadcast, Infrastructure, and Access, and whether lower average selling prices pressure margins.
- Monitor the Norwegian tax reassessment, including potential interest and penalties, and subsequent developments in the Cresta litigation.
- Review the convertible notes’ cash-settlement terms, potential dilution, and the effect of noncash discount amortization on reported interest expense and EPS.
- Assess inventory growth and days on hand, distributor exposure, and the company’s reliance on third-party suppliers and Asian production capacity.
- Compare Q3 results with management’s stated revenue, margin, expense, tax-rate, and EPS outlook.