Jalene Hoover - Silicon Laboratories, Inc. John Carter Hollister - Silicon Laboratories, Inc. George Tyson Tuttle - Silicon Laboratories, Inc..

John Vinh - KeyBanc Capital Markets, Inc. Cody Acree - Drexel Hamilton LLC Anil Kumar Doradla - William Blair & Co. LLC Tore Svanberg - Stifel, Nicolaus & Co., Inc. Craig A. Ellis - B. Riley & Co. LLC Harsh V. Kumar - Stephens, Inc. Matthew D. Ramsay - Canaccord Genuity, Inc. Rajvindra S. Gill - Needham & Co. LLC Suji Desilva - ROTH Capital Partners LLC.

Good morning. My name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to Silicon Labs' Second Quarter 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

I would now like to turn the call over to Ms. Jalene Hoover..

Thank you, Sarah, and good morning, everyone. Thank you for taking the time to dial in. Tyson Tuttle, President and Chief Executive Officer; and John Hollister, Senior Vice President and Chief Financial Officer, are on today's call. We will discuss our financial performance and review our business activities for the second quarter.

After our prepared comments, we will take questions. Our earnings press release and the accompanying financial tables are available on the Investor Relations section of our website at www.silabs.com. This call is also being webcast and a replay will be available for four weeks.

Our comments 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 of this conference call, and that information will likely change over time.

By discussing our current perception of our markets, the future performance of Silicon Labs, 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 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 which identify important factors that could cause actual results to differ materially from those contained in any forward-looking statements. In addition, it is not our intent that the non-GAAP financial measures discussed today replace the presentation of Silicon Labs' GAAP financial results.

We are providing this information to enable investors to perform more meaningful comparisons of operating results and to more clearly highlight the results of core ongoing operations. I would now like to turn the call over to Silicon Labs' Chief Financial Officer, John Hollister..

Thanks, Jalene. I'm pleased to report that we achieved $190 million in revenue for the second quarter, exceeding our guidance range and establishing a new all-time record.

This result represents 9% year-on-year growth in total revenue and 12% year-on-year growth in product revenue, excluding $5 million in patent sale revenue that we recognized in Q2 of last year.

These strong second quarter results mark the fourth consecutive quarter of achieving model performance of greater than 10% in year-on-year product revenue growth.

Leading our strong second quarter performance, revenue from our IoT products increased $10 million during the quarter to $98 million, representing growth of 11% sequentially and 27% year-on-year.

IoT's performance exceeded our expectations and was driven by higher sales of our market-leading 15.4 ZigBee mesh networking products in the connected home, smart metering and connected lighting markets, as well as the broad-based IoT market. We also experienced growth in our sub-gigahertz, Bluetooth, and MCU products.

Infrastructure was $38 million in Q2, up 6% sequentially as expected. Total infrastructure revenue was down from the same period in 2016 due to last year's $5 million patent sale. Excluding the patent sale, product revenue increased 7% year-on-year led by continued strong adoption of our isolation products.

We saw roughly flat performance from timing in Q2 due to continued overall weakness in the long-haul optical networking market, particularly in China, partially offset by strength in industrial and data center. Second quarter broadcast revenue was $37 million, and access ended at $17 million, both down 2% sequentially.

Geographically, we saw growth in all regions in the second quarter, with Europe continuing to lead with a double-digit year-on-year increase in sales. By end market, we saw the strongest performance in industrial, nearing half of our revenue, due to record performance in both IoT and isolation during the quarter.

We also saw increases in automotive and consumer whereas the communications market was down sequentially in Q2. Distribution revenue for Q2 increased to 71% of total revenue, and no single customer accounted for greater than 10% of our sales.

Our top 10 customers represented 21% of first half revenues, down from 25% for 2016, reflecting an increasingly broad-based customer base. Non-GAAP gross margin ended above expectations at 59.7% on favorable product mix. Q2 non-GAAP operating expenses were flat to Q1 as expected, ending at around $74 million.

Non-GAAP R&D expenses were $42 million and SG&A expenses were $33 million. Year-over-year, operating expenses were up only 2% versus a 12% increase from product revenue which allowed us to deliver non-GAAP operating income of $39 million or 20.5% of sales, in line with our target operating model.

Our second quarter non-GAAP effective tax rate was 11.9%, slightly above expectations, primarily due to higher taxable interest income. During the quarter, we delivered strong non-GAAP earnings per share of $0.79, well above our guidance range, due to upside revenue and favorable gross margins.

This compares to $0.75 non-GAAP EPS realized in Q2 2016, but please recall that the 2016 patent sale item had an approximate $0.09 positive effect on last year's results. So apples to apples, we saw about a 20% increase in earnings year-on-year. Our diluted share count in Q2 was 43.2 million shares.

We continue to have $100 million in share repurchase authorization outstanding. On a GAAP basis, second quarter gross margins were 59.5%. GAAP operating expenses were flat at $92 million, and we generated GAAP operating profit of $21 million or 11% of revenue.

Stock compensation expense was $11 million for the quarter; and amortization of intangible assets was $7 million, both in line with expectations. GAAP earnings ended the quarter at $0.38 per share, which was above the guidance range. Turning now to the balance sheet.

We ended the quarter with $667 million in cash and investments, up $40 million sequentially. For the six-month year-to-date period, we generated strong operating cash flow of just over $80 million. Accounts receivable ended at $75 million or 36 days sales outstanding.

Our inventory balance grew $6 million sequentially to $67 million in anticipation of continued growth, and represents inventory turns of 4.6 times which is aligned with our operating targets. I will now cover guidance for the third quarter.

We expect revenue in the third quarter to be between $193 million and $199 million, with continuing growth in IoT. We also expect our broadcast products to grow in Q3 due to typical consumer seasonality. We expect infrastructure to be flat for the quarter, and access to decline.

We expect our non-GAAP gross margin to be approximately 58.5% based on product mix, and our non-GAAP operating expenses to be in the range of $74.5 million to $75 million. We expect our non-GAAP effective tax rate to be around 11%, and non-GAAP earnings per share to be in the range of $0.78 to $0.84.

On a GAAP basis, we expect gross margin to be approximately 58.5%. We expect GAAP operating expenses to be in the range of $92.5 million to $93 million for the quarter, with stock compensation at $11 million and amortization of intangible assets at $7 million.

We expect our GAAP effective tax rate to be 11%, and GAAP EPS to be in the range of $0.35 to $0.41. I will now turn the call over to Tyson..

Thank you, John. Our second quarter 2017 financial results reflect outstanding year-on-year progress with 12% growth in product revenue. In June, I was honored to give the keynote at the Design Automation Conference in Austin on the topic of accelerating the IoT. The Internet of Things is among the biggest opportunities of our lifetime.

For the IoT to accelerate, devices need to be connected, networked, and capable of evolving over time. By 2025, it is expected there will be as many as 70 billion connected devices which will contribute up to $11 trillion to the world economy.

This trend provides a multi-decade runway of sustainable growth and opportunity for Silicon Labs as we leverage the existing infrastructure of ubiquitous networks, connectivity protocols, cloud services, and smartphones to deploy our Silicon software and solutions across thousands of applications and tens of thousands of customers.

Adding connectivity and leveraging this infrastructure gives companies the opportunity to develop new business models and revenue streams around old-school devices like power tools, utility meters, garage door openers, and light bulbs.

These opportunities, including developing new service offerings, adding new features to products, upgrading functions, and enhancing security. Our IoT products are benefiting significantly from these trends with second quarter IoT revenue achieving a major milestone, surpassing 50% of total revenue for the first time.

Propelled by strength in our wireless products in Q2, IoT delivered a sixth consecutive record revenue quarter, achieving 27% year-on-year growth, well above our 20% strategic growth target.

During the quarter, we saw particular strength in sales of our 15.4 ZigBee mesh and proprietary wireless technologies into the industrial end market for use in home automation and security, lighting, and other industrial applications.

Ecosystem providers such as Google, Samsung, Amazon, and Comcast are driving widespread adoption of applications in home automation and security. Our close relationships with many of these key players are driving demand for our solutions in end node and gateway devices.

As the IoT matures, mesh networks are playing an increasingly important role in providing greater range, reliability, and battery life for end nodes.

We are seeing growing deployment of our 15.4 mesh networking technology in Wi-Fi-enabled hubs, routers, and gateways which is a significant step to providing ubiquitous connectivity for low-power end node devices throughout the home.

Lighting, for example, offers an enormous opportunity for mesh networking with 2.5 billion light bulbs sold per year worldwide. Silicon Labs is the leading supplier of silicon and software for mesh networking applications.

We have more than 15 years of experience in developing standards-based solutions for customers, and have shipped more than 100 million mesh networking SoCs and modules to-date.

To help developers simplify the design of mesh network devices for the IoT and accelerate time to market, earlier this month we introduced a comprehensive suite of hardware and software to support the new Bluetooth mesh specification.

Addressing smart home, lighting, beacons, and asset tracking applications, our new Bluetooth mesh offering includes development and network analysis tools, a software stack, and a mobile app.

By expanding our mesh networking portfolio to the Bluetooth market, we offer a complete multi-protocol solution that gives customers the flexibility to use the right mesh technology for their application needs.

We expect to see a wave of new devices hit the market quickly, leveraging our common platform to create multi-protocol mesh networking applications which extend range and reliability and provide built-in smartphone connectivity.

For example, a light bulb designed with our solution can support ZigBee, Thread, or Bluetooth mesh, all on a common hardware and software platform. We offer the most comprehensive multi-protocol portfolio, including software stacks, SoCs, and certified modules.

As applications become more complex, the need for higher performance, lower power, and more feature-rich solutions increases. We continue to refresh our MCU product, and just this week launched a new member of our energy-friendly EFM32 Gecko portfolio, offering the most advanced capabilities and largest memory footprint in the low-power MCU market.

Targeting smart metering, building automation, asset tracking, and personal medical applications, Silicon Labs' latest Giant Gecko MCUs combine very fast processing performance, extra-large memory options, a host of peripherals, hardware accelerators, and comprehensive software tools including our industry-leading Micrium OS.

Also in Q2, we launched the CP2615 USB-to-I2S bridge chip, providing a simple turnkey solution for transferring digital audio data and offering plug-and-play USB connectivity.

Our bridge device enables developers to focus on their end applications instead of firmware development, and accelerates time to market for a wide range of power-sensitive, space-constrained USB audio applications including headphones, speakers, MP3 accessories, and navigation systems.

In May, Somfy, a global leader in motorized window coverings for smart homes and buildings, honored Silicon Labs with their Supplier Innovation Award.

Our EFR32 Wireless Gecko SoCs are used in a wide range of Somfy's products, enabling flexible control through multi-protocol connectivity, including ZigBee and Thread for mesh networks as well as proprietary protocols.

Using Somfy's products, their customers can easily control their blinds and shades with a smartphone, integrating their window coverings into a connected living experience Now, I'd like to move on to infrastructure which includes our timing and isolation products.

Our isolation devices are among our fastest growing products, underscored by record Q2 design wins and achieving a tenth consecutive record revenue quarter. We continue to see broad-based adoption in systems requiring high-voltage protection for electric and hybrid electric vehicles, solar inverters, motor control, and power supplies.

Digital isolation is becoming mainstream, offering higher performance and longer lifetimes than legacy optocoupler solutions. Silicon Labs' superior performance and robustness have allowed our isolation products to gain share and outgrow the market.

Despite macro softness in the first half of the year, increasing demand for network bandwidth and faster data rates continues to drive the need for higher performance timing products.

During the quarter, we introduced a new family of high-performance crystal oscillators, providing the industry's lowest jitter and most frequency-flexible XO solution for a wide range of applications including optical networking, hyperscale data centers, and mobile fronthaul and backhaul networks.

Silicon Labs' newest oscillators also provide the shortest lead times in the high-performance frequency control industry. Five years ago, we accelerated our focus on the IoT through a combination of organic investment and strategic acquisitions.

This quarter, IoT surpassed 50% of total revenue, driving target model performance and year-on-year product revenue growth, gross margin, and operating income. Our strategy is coming together as we focus on core strategic growth drivers and capture share in target markets. Thank you for your time and attention.

Before we take your questions, I'd like to turn the call back to Jalene..

Thank you, Tyson. Before we open the call for the question-and-answer session, I would like to announce conferences that we will participate in during the third quarter, including KeyBanc Capital Markets' 19th Annual Global Technology Leadership Forum in Vail on August 7, and Citi's Global Technology Conference in New York on September 6.

We would now like to open up the call for your questions. To accommodate as many people as possible before the market opens, we ask that you please limit your questions to one with one follow-up..

Your first question comes from the line of John Vinh from KeyBanc Capital Markets. Please go ahead..

Hi. Thank you for taking my question. John, a question for you on the guidance for infrastructure. You guided flat. So it seems like the metro long-haul correction is still kind of weighing on your outlook.

Can you just confirm that your outlook does assume that that's still going to be mainly in Q3? And do you currently have any sort of visibility in terms of when things start to stabilize and when we get past this correction? And I assume isolation continues to grow in Q3 as part of your assumptions there..

Yeah, John. So we haven't broken that out as far as the split, but it's fair to assess some continued pressure due to macro factors in the optical space. We'll see how long that plays out.

If history is a guide to us, we would expect that to be a relatively short-term phenomenon and we see over time strong growth drivers in this space, not only in optical but also in wireless as well as in the data center and in industrial applications. But the first part of your assessment is accurate.

There is some continuing headwinds related to macro softness in that market..

Great. And Tyson, a follow-up question for you. You talked about obviously being a clear leader within kind of mesh network.

Can you just update us with your current thoughts on Thread and how that plays out and starts to ramp? Do you think that Thread ultimately becomes a replacement for ZigBee, and is there an opportunity for you to increase your footprint and content there relative to ZigBee due to the higher complexity and also to potentially increase your market share there in mesh?.

We're seeing strong adoption of our ZigBee products in particular into a variety of markets, including home automation and security, and the multi-protocol capability of our platform which allows customers to use ZigBee, Thread, and Bluetooth sometimes in a simultaneous fashion where you can have smartphone connectivity as well as being connected to the mesh network is a very attractive feature.

If you look at the migration of the standards from ZigBee to Thread, there are a number of advantages of Thread, including IP-based connectivity, enhanced security, and a number of other factors there in terms of the application layers and the porting of the ZigBee application layer on top of Thread.

It makes the migration of applications from ZigBee to Thread seamless as essentially an over-the-air update. So any end node device that is designed with our solutions using ZigBee can support Thread over time as that market matures. We've started to see the deployment of border routers and gateways.

For instance, eero just announced a Wi-Fi-enabled mesh Wi-Fi system that also includes the Thread protocol, and it's our view that a number of end node devices will be appearing in the market as we move forward supporting the Thread protocol.

I would also note that it's possible to have devices talk to both a Thread and a ZigBee network using our solutions, and so we're working on a number of multi-protocol solutions that would be able to support both ZigBee and Thread to facilitate that migration..

Great. Thank you..

Your next question comes from the line of Blayne Curtis from Barclays. Please go ahead..

Hey, thanks for taking my questions this is (22:34). Just curious what the drivers were for gross margin outperformance in June. I mean, when you look in September it comes down. Obviously mix has something to do with it, but it seems like even if you filter through the mix of IoT it seems like there are some other drivers.

Maybe you could just talk me through that..

Sure, Blayne (22:52). Yeah, we were pleased with the gross margin performance in the second quarter. That really is related to mix. We saw strong results from our mesh networking ICs. We also saw strength in automotive and industrial applications, a good quarter in isolation. So we just, overall, had favorable trends in Q2.

Looking ahead to Q3, we see high consumer mix in Q3 that's mostly in broadcast due to the typical seasonality of that business. As you know, that comes at a somewhat lower gross margin. We also have some consumer content within the IoT category as well which has a bit of seasonality.

And furthermore, we continue to see less results from the optical networking space than we had envisioned at the beginning of this year which is impacting gross margins a bit. And finally, I would point to within IoT, we're starting to see some additional larger deployments with larger customers which come at a bit lower gross margin as well.

So it's kind of a combination of factors, but primarily around those topics..

Got you. And then just back on the infrastructure bucket. I just want to understand the moving pieces there. It was up $2 million. I think you mentioned that timing was flat, but also that comm was down.

So just to kind of try and understand what the offsetting factor there was in timing, and then that would mean that isolation was up quite a good amount. Just if you could just talk about what drove that..

Yeah, you got it. Really, the bulk of the growth in infrastructure was from the isolation products. And the end market difference that you pointed to, there's an industrial component of timing that performs better in the second quarter than the communications portion of timing, but your read of it is right..

Okay. Thank you..

Your next question comes from the line Tore Svanberg from Stifel. Your line is open. Tore Svanberg, if you queued up for a question, your line is open. Please go ahead. Your next question comes from the line of Cody Acree from Drexel Hamilton. Please go ahead..

Thanks for taking my questions and congratulations with the progress. Tyson, with the strong performance and guide, I'm not willing to guide too much for Q4. But it's looking increasingly likely that you might be able to make your double-digit growth target for the year.

I guess just any color on what kind of level of visibility do you have for the next quarters..

Yeah. Cody, we've got quite strong traction in the IoT market. We saw a very good year-on-year performance there and strong, and we're guiding that up here in Q3 with strong design win activity and a lot of customer activity going there.

We also are seeing strong broadcast consumer coming into Q4, with the typical consumer seasonality of that being the seasonal peak. Looking out into Q4, we don't have perfect visibility into that.

Currently, our view is that on the infrastructure side we'll continue to see modest growth out of the isolation products, but the timing products in terms of the macro softness that we've seen in the optical market really driven by China, that's partially offset by some of these other factors.

But depending on how that plays out in the fourth quarter, we could see some strength coming into the fourth quarter both from IoT and infrastructure, but we'll have to see how that plays out. But if you look at the guide and the performance in the first half, it looks like we could very well be on track for a 10% growth this year..

That's great.

And then just being fabless and seeing pretty good strength across the industry, starting to see some indications of constraints, I mean spot constraints here and there, and some lead times starting to extend, I guess are you having any supply constraints with your foundries or any kind of adjacent parts that are starting to cause any concerns in how are your delivery lead times?.

Yeah. Cody, this is John. So short answer is no. We have ample capacity at the fabs where we operate and we represent a very small portion of their total capacity even today, so we feel good about that. That said, we are continuing to operate with a reasonable amount of inventory, and did accumulate a little bit of inventory toward the end of Q2.

So we're positioned for growth and think we have plenty of inventory and available capacity at the fab partners..

Great. Thanks and congrats..

Your next question comes from the line of Anil Doradla from William Blair. Please go ahead..

Hey, guys. Congrats from my end too. So Tyson, one question.

If I look at the composition of the $98 million from IoT, can you give us a sense of how much of it is driven by standalones, the MCUs, versus integrated wireless (28:30)?.

So we don't specifically break out the microcontroller versus wireless components. We did talk last quarter and actually have for some time where the wireless piece of the revenue is now substantially larger than the microcontroller. We're seeing growth year-over-year in microcontrollers.

We saw growth in Q2 in microcontrollers, but that is a lower level of growth than the wireless. So wireless this year is driving growth on the order of 40% year-on-year. So the growth in the IoT area is really being driven by wireless.

Within wireless, you have a combination of transceivers which essentially do not contain a microcontroller, SoCs which contain a microcontroller, and then modules which contain an SoC, and so there's a mix of those.

We've been seeing the strongest growth in the SoCs as well as good performance out of our 15.4 modules and Bluetooth modules in particular.

And so the integrated portion of the wireless continues to grow, but we still have a healthy business in the proprietary area where we're selling transceivers but the predominance of the wireless revenue now is based on our SoC platform..

Very good. And if I dig a little bit deeper on the wireless, clearly mesh is turning out to be a huge success.

Now, is there a way for to you qualitatively give us a sense of the breakdown between mesh applications and non-mesh applications?.

The proprietary area is one that we've been in for over a decade, and we've built a substantial business there. The 15.4 mesh is now of a comparable size, actually somewhat larger than the proprietary area, and we also are seeing good traction in the Bluetooth area.

So if you rank them, the 15.4 mesh is top, then proprietary, and then Bluetooth with substantial growth across all three of those areas..

Good. And if you don't mind me sneaking one final thing, Tyson.

The success of the mesh application, did that surprise you or was that something that you guys expected all along?.

Well we're pleased to see the adoption of mesh technology in the Wi-Fi-enabled routers and gateways, and see the deployment of those even within set-top boxes. So the mesh networking technologies based on 15.4 are starting it to see widespread deployment now.

This is something that we, when we acquired Ember back in 2012, we believed that there was a need for a separate network away from Bluetooth and Wi-Fi that would enable low-power devices which are lower duty cycle, smaller data rate, but that's really what you need to connect a wide range of these IoT devices.

We saw a need for that, and now we're seeing the market respond to that need as these networks and end devices get deployed.

And so I would say that we anticipated this and we've been working diligently to get that capability integrated with Bluetooth and other wireless technologies in a way that is highly flexible, and we think that mesh is an important part of the rollout of IoT as we're moving forward..

Great. Thanks a lot, guys..

Your next question comes from the line of Tore Svanberg from Stifel. Please go ahead..

Yes, thank you.

Can you hear me now?.

Yes..

All right. So congratulations on the record revenue. First question for you, Tyson.

With the Bluetooth SIG announcing the mesh networking capability last week, does that mean you'll start to see a meaningful amount of designs now or is there still going to be a process for ratification before customers actually move ahead?.

The Bluetooth mesh standard has now been released, and we also simultaneously released our Bluetooth mesh protocol stack as well as network analysis tools and an application which supports that capability on smartphones.

So you can actually design a product and an application today using our stack and the new Bluetooth mesh protocols, and that is supported on our multi-protocol SoCs as they exist, so this is a firmware upgrade based on existing products. You can also run a 15.4 ZigBee or Thread protocol stack on that same device.

So it's our view that people that have our SoCs designed into end node devices can very rapidly enable those with Bluetooth functionality and get those out into the market fairly quickly..

Very good. And as my follow-up, could you just elaborate a little bit more on what you said about your bridge product? I mean, I do assume that these are bridge products for IoT.

They're probably more interface-related, but I'm just trying to understand if you're being selective in that market or you're actually going after a whole host of different applications..

So we have quite an extensive portfolio of what are essentially fixed-function microcontroller products, and so the one that we announced recently is targeted at audio applications and it connects from USB to a digital audio format.

That is one of a suite of products that we've had a long-term strategy around USB and have a substantial business in USB both in terms of adding USB function to microcontrollers, so we offer a number of microcontrollers with USB but also those fixed-function devices.

So that's part of an overall strategy within our microcontroller group to address wired connectivity with USB, and there's a lot of different applications that USB is used for. So this was an example of one of those..

Very good. Thanks and congratulations again..

Thank you..

Your next question comes from the line of Craig Ellis from B. Riley..

Yeah. Thanks for taking the question and, Tyson and John, congratulations on hitting not only IoT at 50% of sales but in the same quarter hitting the target operating margin model. So great execution there. Tyson, I wanted to follow-up on that comment regarding participation in gateway products within IoT.

Can you help us understand a little bit more the breadth of your customer penetration and the degree to which gateway as an application group can be material to segment sales either this year or as you look out over the next 12 to 24 months?.

So the trend of integrating 15.4 mesh networking capability in gateways, routers, and in other Wi-Fi-connected devices is a significant trend.

From our view, while it's an interesting revenue opportunity to both get our software and our mesh networking ICs into these devices, the more significant aspect of this is all of the devices that are going to connect to those devices.

And so we are working with the gateway providers across a fairly large number of folks who are working with the Wi-Fi gateway chipset providers to look at interoperability and make sure that the performance of both the Wi-Fi and the 15.4 is adequate and performs correctly in terms of being able to back off so that you can talk to both networks seamlessly.

But, again, the significant thing is that this really expands the number of end node devices that can connect to these gateways supporting both Wi-Fi-connected devices as well as the 15.4 Thread and ZigBee and even Bluetooth devices into those networks, and then all of the interoperability and the way all of those devices talk to one another.

So I think it's a significant trend beyond just the near-term revenue opportunity for us in the gateway, but really driving the multiple tens or greater number of end node devices that will connect to those gateways over time..

That's very helpful. Thank you. And then I'll follow it up with a longer-term question. At Analyst Day, the company outlined a goal of $1 billion in sales in 2020, and certainly we've seen a strong quarter, and at mid-year we're tracking well towards 10% growth this year.

The question is with the timing business seeing softness in one key end market, are you still confident that $1 billion in sales is possible or any discomfort given some of the intermediate-term end market weakness in one of the strategic product groups? Thank you..

Yeah. So, I mean, if you take our growth model and apply that to the profile of our business today, our fastest growing business is IoT, and now it's over 50%; in the last quarter, grew 27%. So I think that if you apply that model to the revenue profile that we have today, the result will get you over $1 billion in 2020.

I want to take this opportunity to really talk about where we've been putting our R&D, and have put a large fraction of our R&D into IoT where we're able to provide the silicon, the software, and really provide the SoC into these devices, and we view that as a long-term growth path.

It's a very, very large market and it provides a long runway for us to be able to grow. That $1 billion mark is just a milestone in what I think can be a large business.

I think combined with that, we have also been investing in our power products, in the isolation products, and we see a lot of trends in terms of the electrification of vehicles, of motor controls, of high-efficiency power supplies, of green energy applications, and that again is a trend that has been driving our isolation products and I think is a long-term trend that we can capitalize on in our isolation products within our infrastructure group.

And if you look at that 10% growth target that we have there, I think that that is sustainable especially if you look at – we have a short-term softness in the optical market, but the trends of driving data growth across wireless, across data centers, and the connection of all of those together, that trend is not going to stop and our timing products fit into these.

And while we may have a little bit of softness right now in terms of the CapEx and the rollout, the rollout of 5G is going to provide a great opportunity for us. So I feel confident in our strategy across the bandwidth applications, the green energy applications in IoT.

And with those now over two-thirds, over 70% of our revenue coming from those areas, I think it positions us well to continue to grow into the future..

That's helpful color. Thanks, Tyson, and good luck.

Your next question comes from the line of Harsh Kumar from Stephens. Your line is open..

Yeah. Hey, guys. Congratulations on my part as well. One quick question. Tyson, as you look out longer-term, now you're doing more than 50% from IoT, but let's just assume that that continues to grow and gets bigger and bigger.

What is the margin profile that is possible? Let's just say a few years down, you're doing 70%, 80%, 90% in IoT and some other from infrastructure.

What can we look at from a margin angle?.

I think if you look overall at the company, we are comfortable with our operating model. The board, the management team, are all looking at that and saying that that is the right operating model for the company and are committed to maintaining that going forward.

So the goal within that model is to grow as fast as possible, and certainly we've got a great opportunity within IoT and continue to be aggressive about gaining share. Our goal is to be the number one provider of silicon software and solutions for the IoT market focused on end node devices.

And so it's really a matter of optimizing growth and optimizing the margin within that target operating model. There's a mix. We have certain aspects of the IoT that are above that range. We've talked about modules being below the range.

Some of the high-volume applications that are starting to emerge are coming at a little bit below that target operating margin. But, again, you have a mix of timing, you have a mix of isolation, and higher-value IoT devices that mix within there.

So while we will have seasonal variations, and we'll try to keep those within that range, we believe that that target operating model for the overall company is something that is sustainable going forward..

Understood. And for my follow-up, I was wondering. You talked about long-term growth, so maybe from that angle. In the past, Silicon Labs has done tuck-in technology acquisitions.

Do you feel at this point in time based on what you see today, of course things change, but based on what you see today did you have all the parts and pieces to be able to sustain kind of high growth for some time?.

We believe that we have all of the pieces necessary today to continue to thrive within the IoT market. We have the SoC technology, we are developing our own protocol stacks, we have our own development tools, and we continue to expand that portfolio and evolve it over time.

That being said, we did raise $400 million back in March in a convertible bond offering and have a cash balance of $667 million at the end of Q2, and continue to be active in looking for attractive businesses to bolt-on to both our IoT products.

So that's been the main focus of our M&A activity here over the last five years, but also looking within the infrastructure area as well. And we see that there are opportunities to deploy that capital. Nothing to report at this time, but I think that that is an important part of our growth strategy going forward..

Thanks, Tyson..

Your next question comes from the line of Matt Ramsey from Canaccord Genuity. Please go ahead..

Thank you very much. Good morning. Tyson, it's hard to ignore the strength in isolation over the last few quarters, and it's a pretty broad space you supply into. But I wonder if you might expand a little bit on the opportunity in the electrical vehicle market.

I know there's one customer that's pretty prominent that you guys have talked a little bit about publicly, but from some work that we've done I think the engagements in that market are a bit broader across the industry than some might realize, and I just wonder what the potential for that business is over time and the competitive landscape in the EV space.

Thanks..

Specifically around the EV opportunity, we have a large number of engagements in that. We've logged in a number of design wins across battery management systems, motor controls, and chargers for electric vehicles, and our isolation products are uniquely appropriate for these types of applications.

The robustness that you're able to achieve, the integration levels you're able to achieve make them ideal for electric vehicle applications. And as we see the ramp of electric vehicles across the world, as we transition from carbon-based fuels into hybrid electric and electric vehicles, I think that that is a good growth driver for isolation.

I would kind of reiterate, our isolation products, it's one of our broadest product lines.

It spans across – electric vehicles is one area, but the efficiency of power supplies especially in applications like data centers, of motor controls for a lot of industrial applications where you're trying to improve efficiency and flexibility of the motors, and in the green energy applications like solar inverters and other ways of converting from AC to DC and various types of energy, these types of products are very attractive.

And if you look at the robustness of our solutions and the integration that we're able to achieve with our architecture, it's a very promising area for us. We've just logged our tenth consecutive revenue growth quarter and we don't really see any end in sight in terms of the opportunity for isolation products.

Thank you very much for that. And then as a follow-up, I don't know if it's for Tyson or for you, John. You talked about, and I think Tyson expanded on it a little bit in a previous answer, the comfort around the operating margin range that you gave at the Analyst Day, and I think that gets up into the mid-20s as the company grows here.

But if you I guess juxtapose the revenue growth and the potential for that to accelerate a bit with mix again, 3% OpEx growth or thereabouts this year, you can get operating margins above that range.

So maybe you could talk us through the balance there of what would the incremental investments be to keep us within the range and why not confidence that the margins could move a bit above that over time. Thanks..

Sure thing, Matt. Yeah, we're pleased with the operating performance thus far this year, and we are committed to operating within the target operating margin range.

Within that, we have to balance the opportunity to grow this business with delivering profitability, and we see really an enormous opportunity in IoT in particular, with an opportunity pipeline that continues to grow and expand, and we need to continue to feed that success and allow that to come fully to fruition.

So we'll be looking at this carefully this fall as we work through the annual operating plan cycle. I think that most likely in January we'll have better visibility to provide some better indications on the 2018 operating expense growth rate.

But we are committed to operating in the model, but at the same time we do need to continue to grow this business, and there are some areas of additional investment that we see that could accelerate our growth. So those are all things we'll be looking at more closely this fall..

Thank you very much..

We can take a couple more questions. Your next question comes from the line of Rajvindra Gill from Needham and Company. Please go ahead..

Yes. Thanks for taking my questions and congrats as well. The RF integration in the IoT market has been a material competitive advantage, and I don't think it should be overlooked.

I was wondering if you could maybe highlight that competitive advantage in your ability to gain share against microcontroller suppliers, the traditional microcontroller suppliers on one hand and then the RF suppliers on the other hand, your ability to develop an RF SoC being multi-protocol. Maybe you could talk a little bit about that..

Silicon Labs has a long history of RF integration in standard CMOS process technology. The founding of the company over 20 years ago, our first product was to integrate the RF front end for a mobile phone, and we were one of the pioneers in that area.

But then moved after we sold our cellular business in 2007, really redeployed that into multiple areas which include our timing products, our broadcast products, and now the IoT SoCs – the integration essentially of microcontrollers and RF capability into a single chip. And so I think that our capabilities in that area are leading the industry.

If you look across our product portfolio, over two-thirds of our products contain some form of RF in CMOS.

That is a different history than a lot of the microcontroller vendors where the integration of this RF circuitry with the microcontroller and digital functionality is difficult to achieve at the right level of performance, and so we think that that is a competitive advantage. But as we've gotten into the RF SoCs, it's also the protocol stacks.

It's the understanding of networking technology, of mesh networking, and of how devices talk to one another. It's the development tools. And then when you're really talking about IoT, it's how to spread that across a large number of customers and applications, and that is the microcontroller model.

So you really have to put all of those pieces together. So the RF vendors, I think, don't have the digital integration, they don't necessarily have strong software capabilities. The microcontroller vendors don't necessarily have the RF capability or the communications expertise to put that together.

And then when you start talking about multi-protocol and the expertise required to get that out into those different applications, we think that we have a unique position.

I mean, we don't have any illusion that we're the only ones in the industry that are capable of this, but I think that we've been looking at this over an extended period of time, have built the platform, built the infrastructure to really leverage this opportunity and have a chance to lead the industry in the deployment of this technology going forward.

So I think competitively, we're well-positioned versus both the MCU and the RF providers, but nobody is standing still and we're pushing forward as hard as we can..

No, that's great. And last question. So you're seeing a lot of growth within IoT from wireless, your wireless portfolio of mesh networking, BLE, and sub-gigahertz products, proprietary products.

What is your plans then to integrate low-powered Wi-Fi to round out the portfolio?.

Yeah. We've been talking about Wi-Fi as an important technology for a number of years. We've actually been working on our own internal development for Wi-Fi over that period of time, doing a number of software developments.

We did an acquisition of Zentri back in January which brought in the software capabilities as well as cloud and device management capabilities. So we have developed that. Actually, earlier this quarter we ticked out our first Wi-Fi low-power device and we'll be rolling that out into the market.

We also sell Wi-Fi-enabled modules today with third party silicon. But we look at as we evolve our IoT SoCs into the next-generation platform that we are essentially organically adding Wi-Fi capability to that platform.

And if we look back a couple of years, this was really a make versus buy solution, and we really felt like to be able to offer a true low-power, high-performance solution that is really meeting the requirements of the IoT end nodes, that we really had to do this the right way.

And so we're well on our way towards building Wi-Fi capability optimized for end nodes into our next-generation platform..

Thank you..

Our last question will be from Suji Desilva from ROTH Capital. Please go ahead..

Hi, Tyson. Hi, John. Congratulations on the IoT progress here. So a question on the infrastructure side. The telco I understand has macro weakness in the next quarter.

But can you talk about what the non-telco data center is in the mix and the design win mix and whether that non-telco portion of timing can be material and help the business in 2018 or whether it's still going to be telco-dominated?.

Yeah. Suji, this is John. So the business does still have the majority of the revenue from the telco part of the market. We do have data center and industrial within that, but those are relatively small portions. It does help to offset the telco concentration a bit, but the predominant factor continues to be telco.

And while we envision continuing progress in data center and industrial next year, we think telco will continue to be the majority of the revenue..

Okay. That clarification helps. And then also just a follow-up on something you said earlier on the gross margin commentary. You said one of the drivers of being slightly lower next quarter is some larger customers ramping in IoT. I was curious what sub-segment those larger customers' ramps are in.

Is it smart home or some other area or a mix of areas? Thanks..

On the IoT side, we've got ramps in multiple application areas. Lighting is an exciting new area for us where there's 2.5 billion light bulbs sold globally per year, and so this is a high-volume application and there's a lot of elasticity in that market and integration required.

We see that there's a favorable integration path there of both the IoT, SoC, and specific functionality for lighting that can be interesting over time, but that is an example of one of the areas. We also have a number of consumer ramps for consumer type IoT applications that are also ramping in Q3 and a factor there as well..

Great. That color helps. Thanks, guys..

Thank you. I would now like to hand the call back over to Jalene Hoover..

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

Thank you for your participation. You may now disconnect..