# SILICON LABORATORIES INC. (SLAB) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from SILICON LABORATORIES INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1038074/000110465924025535/slab-20231230x10k.htm
Accession: 0001104659-24-025535
Filing date: 2024-02-20
Report date: 2023-12-30
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SLAB/
All MD&A years: /company/SLAB/mda/
Previous year: /company/SLAB/mda/fy2022/ (FY 2022)
Next year: /company/SLAB/mda/fy2024/ (FY 2024)

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see the “Cautionary Statement” and “Risk Factors” above for discussions of the uncertainties, risks and assumptions associated with these statements. Our fiscal year-end financial reporting periods are a 52- or 53-week fiscal year that ends on the Saturday closest to December 31. Fiscal 2023, 2022, and 2021 had 52 weeks. Fiscal 2023, 2022 and 2021 ended on December 30, 2023, December 31, 2022 and January 1, 2022, respectively.

Impact of Macroeconomic Conditions

The current global economic environment is experiencing inflationary pressure, relatively high interest rates, and geopolitical tension. We have experienced a decline in revenues, as our customers have slowed purchases to reduce existing inventories in a softening market. The extent of the impact of these macroeconomic conditions on our operational and financial performance will depend on future developments, including the duration and severity of any economic downturn, the impact to the business of our suppliers and/or customers, and other items identified under “Risk Factors” above, all of which are uncertain and cannot be predicted. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition.

Overview

We are a leader in secure, intelligent wireless technology for a more connected world. Our integrated hardware and software platform, intuitive development tools, industry leading ecosystem and robust support enable customers in building advanced industrial, commercial, home and life applications. We make it easy for developers to solve complex wireless challenges throughout the product lifecycle and get to market quickly with innovative solutions that transform industries, grow economies and improve lives. We provide analog-intensive, mixed-signal solutions for use in a variety of electronic products in a broad range of applications for the Internet of Things (“IoT”) including connected home and security, industrial automation and control, smart metering, smart lighting, commercial building automation, consumer electronics, asset tracking and medical instrumentation. We group our products as Industrial & Commercial or Home & Life based on the target markets they address.

As a fabless semiconductor company, we rely on third-party semiconductor fabricators in Asia, and to a lesser extent the United States and Europe, to manufacture the silicon wafers that reflect our integrated chip (“IC”) designs. Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC. We rely on third parties in Asia to assemble, package, and, in most cases, test these devices and ship these units to our customers. Testing performed by such third parties facilitates faster delivery of products to our customers (particularly those located in Asia), shorter production cycle times, lower inventory requirements, lower costs and increased flexibility of test capacity.

The sales cycle for our ICs can be as long as 12 months or more. An additional three to six months or more are usually required before a customer ships a significant volume of devices that incorporate our ICs. Due to this lengthy sales cycle, we typically experience a significant delay between incurring research and development and selling, general and administrative expenses, and the corresponding sales. Consequently, if sales in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters would be adversely affected. Moreover, the amount of time between initial research and development and commercialization of a product, if ever, can be substantially longer than the sales cycle for the product. Accordingly, if we incur substantial research and development costs without developing a commercially successful product, our operating results, as well as our growth prospects, could be adversely affected.

Because some of our ICs are designed for use in consumer products, we expect that the demand for our products will be typically subject to some degree of seasonal demand. However, rapid changes in our markets and across our product areas make it difficult for us to accurately estimate the impact of seasonal factors on our business.

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Current Period Highlights of Continuing Operations

Revenues decreased $241.8 million in fiscal 2023 compared to fiscal 2022 due to decreased revenues from both our Industrial & Commercial products and Home & Life products. Gross margin decreased to 58.9% in fiscal 2023 compared to 62.7% in fiscal 2022 primarily due to variations in the price and costs of our products and variations in product mix. Operating expenses decreased $38.6 million in fiscal 2023 compared to fiscal 2022 due primarily to temporary cost containment measures taken in the third and fourth quarters of fiscal 2023, including the elimination of certain bonuses and certain other variable compensation, a reduction in the use of contract employees, and the suspension of all non-essential travel. Operating expenses also decreased due to reduced stock-based compensation from the expense reversal to adjust the estimated levels of achievement related to unvested performance stock units. In the fourth quarter of fiscal 2023, we implemented a workforce reduction of approximately 10% of our employees. We incurred total employee separation costs of $9.1 million. Operating loss in fiscal 2023 was $24.2 million compared to operating income of $119.3 million in fiscal 2022. Refer to “Results of Operations” below for further discussion.

We ended fiscal 2023 with $439.2 million in cash, cash equivalents and short-term investments. Net cash used in operating activities was $30.3 million during fiscal 2023. Accounts receivable were $29.3 million at December 30, 2023, representing 30 days sales outstanding (“DSO”). Inventory was $194.3 million at December 30, 2023, representing 407 days of inventory (“DOI”). During the second quarter of 2023, we paid $535.0 million in cash and issued 0.9 million shares of common stock in connection with the extinguishment of the remaining principal of our 2025 convertible senior notes. In the third quarter of 2023, we repaid $35.0 million in borrowings under our revolving credit facility. In fiscal 2023, we acquired 1.5 million shares of our common stock for $212.9 million.

We have continued to diversify our product portfolio and introduce new products and solutions with added functionality and integration. In fiscal 2023, we introduced a new BB5 family of 8-bit microcontroller units optimized for price and performance, a dual-band SoC designed for long-range networks and protocols like Amazon Sidewalk, Wi-SUN®, and other proprietary protocols, and new integrated Bluetooth® SoC and MCU families that offer IoT device designers energy efficiency, high performance and trusted security for the smallest form factor IoT devices. We plan to continue introducing products that expand the capabilities we offer in order to serve both current and emerging applications, enabling us to address new markets and expand our total available market opportunity.

During fiscal 2023, 2022 and 2021, we had no customer that represented more than 10% of our revenues. In addition to direct sales to customers, some of our end customers purchase products indirectly from us through distributors and contract manufacturers. An end customer purchasing through a contract manufacturer typically instructs such contract manufacturer to obtain our products and incorporate such products with other components for sale by such contract manufacturer to the end customer. Although we actually sell the products to, and are paid by, the distributors and contract manufacturers, we refer to such end customer as our customer. Two of our distributors who sell to our customers, Arrow Electronics and Edom Technology, represented 34% and 15% of our revenues during fiscal 2023 and 33% and 17% during fiscal 2022, respectively. Three of our distributors, Arrow Electronics, Edom Technology and Sekorm, represented 28%, 18% and 12% of our revenues during fiscal 2021, respectively.

The percentage of our revenues derived from outside of the United States was 88% in fiscal 2023, 83% in fiscal 2022 and 86% in fiscal 2021. All of our revenues to date have been denominated in U.S. dollars. We believe that a majority of our revenues will continue to be derived from customers outside of the United States.

Results of Operations

The following describes the line items set forth in our Consolidated Statements of Operations:

Revenues. Revenues are generated predominately by sales of our products. Our revenues are subject to variation from period to period due to the volume of shipments made within a period, the mix of products we sell and the prices we charge for our products.

Cost of Revenues. Cost of revenues includes the cost of purchasing finished silicon wafers processed by independent foundries; costs associated with assembly, test and shipping of those products; costs of personnel and equipment associated with manufacturing support, logistics and quality assurance; costs of software royalties, other intellectual property license costs and certain acquired intangible assets; and an allocated portion of our occupancy costs. Our gross margin fluctuates depending on product mix, manufacturing yields, inventory valuation adjustments, average selling prices and other factors.

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Research and Development. Research and development expense consists primarily of personnel-related expenses, including stock-based compensation, as well as new product masks, external consulting and services costs, equipment tooling, equipment depreciation, amortization of intangible assets and an allocated portion of our occupancy costs. Research and development activities include the design of new products, refinement of existing products and design of test methodologies to ensure compliance with required specifications.

Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel-related expenses, including stock-based compensation, as well as an allocated portion of our occupancy costs, sales commissions to independent sales representatives, amortization of intangible assets, professional fees, legal fees, and promotional and marketing expenses.

Interest Income and Other, Net. Interest income and other, net reflects interest earned on our cash, cash equivalents and investment balances, foreign currency remeasurement adjustments, and other non-operating income and expenses.

Interest Expense. Interest expense consists of interest on our short and long-term obligations, including our convertible senior notes and credit facility. Interest expense on our convertible senior notes included contractual interest, amortization of debt issuance costs, and for periods prior to fiscal 2022, amortization of the debt discount.

Provision (Benefit) for Income Taxes. Provision (benefit) for income taxes includes both domestic and foreign income taxes at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits, global intangible low-taxed income, Subpart F income inclusions, and other permanent differences.

Equity-method Earnings (Loss). Equity-method earnings (loss) represents income or loss on our equity-method investment.

Income from discontinued operations, net of income taxes. Income from discontinued operations, net of income taxes includes the results of operations of our former infrastructure and automotive business.

The following table sets forth our Consolidated Statements of Operations data as a percentage of revenues for the periods indicated:

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Comparison of Fiscal 2023 to Fiscal 2022

Revenues

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The decrease in revenues in fiscal 2023 was due to decreased revenues of $77.1 million from our Industrial & Commercial products and $164.7 million from our Home & Life products. Unit volumes of our products decreased while average selling prices increased compared to fiscal 2022. The average selling prices of our products may fluctuate significantly from period to period due to changes in product mix, pricing decisions and other factors. In general, as our products become more mature, we expect to experience decreases in average selling prices.

The overall demand environment for our customers’ products is generally weak. Customers are also seeking to reduce inventory levels relative to the amounts they held during the recent period of widespread supply chain disruptions. As a result, the current demand environment for our products is experiencing high volatility and general weakness, with customers more frequently requesting cancellations, changes to delivery dates, and price and payment term concessions.

Gross Profit

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Gross profit decreased in fiscal 2023 due primarily to decreased product sales across both of our product groups. Gross margin decreased primarily due to an increase in cost related to product mix.

We may experience variations in the average selling prices of certain of our products. Increases in average selling prices may occur during periods of increased demand, but such demand may be short-lived and could be accompanied by higher product costs. Declines in average selling prices create downward pressure on gross margin and may be offset to the extent we are able to introduce higher margin new products and gain market share with our products; reduce costs of existing products through improved design; achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors; achieve lower production costs per unit as a result of improved yields throughout the manufacturing process; or reduce logistics costs.

Research and Development

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The increase in research and development expense in fiscal 2023 was primarily due to an increase of $6.3 million for personnel-related expenses and an increase of $5.9 million for IT-related costs. Within personnel-related expenses, increases of $15.0 million in salary expense, $2.4 million in stock compensation, and $7.2 million in termination benefits primarily from the workforce reduction in the fourth quarter were partially offset by a $21.8 million decrease in bonus and variable compensation from lower attainment and the cost containment efforts in the third and fourth quarters. Other decreases to research and development expense in fiscal 2023 were $4.5 million for new product introduction costs and $3.7 million for the amortization of intangible assets. The increase in research and development expense as a percent of revenues in fiscal 2023 was due to our decreased revenues. We expect that research and development expense will remain relatively stable in absolute dollars in the first quarter of 2024 compared to the fourth quarter of 2023.

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Selling, General and Administrative

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The decrease in selling, general and administrative expense in fiscal 2023 was primarily due to a $35.4 million decrease to personnel-related costs, which included a $20.7 million decrease in certain bonus and variable compensation as a result of the cost containment efforts in the third and fourth quarters and a $14.7 million reduction in stock compensation driven by a decline in expected achievement for certain performance-based awards. Additionally, amortization of intangible assets decreased by $5.0 million and outside services decreased by $5.1 million, partially offset by an increase in IT-related costs of $1.3 million. The increase in selling, general and administrative expense as a percent of revenues in fiscal 2023 was due to our decreased revenues. We expect that selling, general and administrative expense will increase in absolute dollars in the first quarter of 2024 compared to the fourth quarter of 2023.

Interest Income and Other, Net

Interest income and other, net in fiscal 2023 was $19.2 million compared to $13.9 million in fiscal 2022. The increase in interest income and other, net in fiscal 2023 was primarily due to increased interest income earned as a result of higher market interest rates.

Interest Expense

Interest expense in fiscal 2023 was $5.6 million compared to $6.7 million in fiscal 2022.

Provision for Income Taxes

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The decrease in the provision for income taxes for fiscal 2023 was primarily due to decreases in pre-tax book income and global intangible low-taxed income inclusions as compared to fiscal 2022.

Equity-method Earnings (Loss)

Equity-method loss in fiscal 2023 was $16.0 million compared to earnings of $3.4 million in fiscal 2022. The decrease in equity-method earnings in fiscal 2023 was due primarily to the loss recognized on the sale of an equity-method investment.

Business Outlook

The following represents our business outlook for the first quarter of fiscal 2024.

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Liquidity and Capital Resources

Our principal sources of liquidity as of December 30, 2023 consisted of $439.2 million in cash, cash equivalents and short-term investments, of which $226.9 million was held by our U.S. entities. The remaining balance was held by our foreign subsidiaries. Our cash equivalents and short-term investments consisted of government debt securities, which include agency bonds, municipal bonds, and U.S. government securities; corporate debt securities, which include asset-backed securities, corporate bonds, and Yankee bonds; and money market funds.

Operating Activities

Net cash used in operating activities was $30.3 million during fiscal 2023, compared to net cash provided by operating activities of $141.3 million during fiscal 2022. Operating cash flows during fiscal 2023 reflect our net loss of $34.5 million, adjustments of $104.4 million for depreciation, amortization, stock-based compensation, equity-method losses and deferred income taxes, and a net cash outflow of $100.3 million due to changes in our operating assets and liabilities.

Accounts receivable decreased to $29.3 million at December 30, 2023 from $71.4 million at December 31, 2022. The decrease in accounts receivable resulted primarily from a decrease in shipments during the last quarter of fiscal 2023 compared to the last quarter of fiscal 2022. Our DSO was 30 days at December 30, 2023 and 25 days at December 31, 2022.

Inventory increased to $194.3 million at December 30, 2023 from $100.4 million at December 31, 2022. Our inventory levels will vary based on the availability of supply and the impact of variations between forecasted demand used for purchasing inventory and actual demand. Inventory has increased in part due to us investing in building inventory to minimize potential supply disruptions and meet forecasted future demand. Our DOI was 407 days at December 30, 2023 and 90 days at December 31, 2022; the increase is in part due to the lower cost of sales combined with higher inventory levels during the last quarter of fiscal 2023 compared to the last quarter of fiscal 2022.

Investing Activities

Net cash provided by investing activities was $469.8 million during fiscal 2023, compared to $240.5 million during fiscal 2022. The increase in cash inflows was principally due to cash provided by net purchases, sales, and maturities of marketable securities of $492.6 million in fiscal 2023.

Financing Activities

Net cash used in financing activities was $711.9 million during fiscal 2023, compared to $887.1 million during fiscal 2022. The decrease in cash outflows was principally due to a decrease of $666.3 million for repurchases of our common stock, partially offset by an increase of $571.1 million in payments on debt in fiscal 2023.

Discontinued Operations

Net cash used in discontinued operations was zero during fiscal 2023, compared to net cash used of $69.5 million during fiscal 2022 related to income tax payments.

Debt

As of December 30, 2023, we had a $400 million revolving credit facility. We have an option to increase the size of the borrowing capacity of the revolving credit facility by up to the greater of an aggregate of $250 million and 100% of EBITDA, plus an amount that would not cause a secured net leverage ratio to exceed 3.50 to 1.00, subject to certain conditions. In June 2023, we borrowed $80 million under the revolving credit facility. In the third quarter, we repaid $35.0 million in borrowings under our revolving credit facility. As of December 30, 2023, the outstanding balance in the revolving credit facility is $45.0 million. In June 2023, we paid $535.0 million in cash and issued 0.9 million shares of common stock in connection with the settlement of our 2025 convertible senior notes.

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Capital Requirements

Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential acquisitions of companies or technologies and the expansion of our sales and marketing activities. We believe our existing cash, cash equivalents, investments, credit under our credit facility, and cash generated from operations are sufficient to meet our short-term (i.e., over at least the next twelve months) and long-term capital requirements, although we could be required, or could elect, to seek additional funding prior to that time. We may enter into acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.

Contractual Obligations

Our purchase obligations primarily include contractual arrangements in the form of purchase orders and purchase commitments with suppliers. As of December 30, 2023, such purchase obligations were $37.0 million. For a description of other contractual obligations, see Note 10, Debt, and Note 11, Leases, to the Consolidated Financial Statements.

Comparison of Fiscal 2022 to Fiscal 2021

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A discussion of changes in our results of operations and liquidity and capital resources from fiscal 2021 to fiscal 2022 has been omitted from this Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K filed with the Securities and Exchange Commission on February 1, 2023.

Critical Accounting Estimates

The preparation of financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported. Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in the financial statements. We believe the following critical accounting policies affect our more complex judgments and estimates.

Inventory valuation – We assess the recoverability of inventories through the application of a set of methods, assumptions and estimates. In determining net realizable value, we write down inventory that may be slow moving or have some form of obsolescence, including inventory that has aged more than 24 months. We also adjust the valuation of inventory when its manufacturing cost exceeds the estimated selling price less costs of completion, disposal and transportation. We assess the potential for any unusual customer returns based on known quality or business issues and write-off inventory losses for scrap or non-saleable material. Inventory not otherwise identified to be written down is compared to an assessment of our 18-month forecasted demand. The result of this methodology is compared against the product life cycle and competitive situations in the marketplace to determine the appropriateness of the resulting inventory levels. Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those that we project. In the event that actual demand is lower, or market conditions are worse than originally projected, additional inventory write-downs may be required.

Impairment of goodwill and other long-lived assets – We review long-lived assets which are held and used, including fixed assets and purchased intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors which are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique.

We test our goodwill for impairment annually as of the first day of our fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill may be impaired. We assess goodwill for impairment by comparing the fair value of a reporting unit to its carrying amount. In determining fair value, several valuation methodologies are allowed, although quoted market prices are the best evidence of fair value. If the fair value of the reporting unit is less than its carrying amount, we recognize an impairment loss equal to that excess amount.

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Acquired intangible assets – When we acquire a business, a portion of the purchase price is typically allocated to identifiable intangible assets, such as acquired technology and customer relationships. Fair value of these assets is determined primarily using the income approach, which requires us to project future cash flows and apply an appropriate discount rate. We amortize intangible assets with finite lives over their expected useful lives. Our estimates are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Incorrect estimates could result in future impairment charges, and those charges could be material to our results of operations.

Revenue recognition – We recognize revenue when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. In order to achieve this core principle, we apply a five-step process. As part of this process, we analyze the performance obligations in a customer contract and estimate the variable consideration we expect to receive. The evaluation of performance obligations requires that we identify the promised goods and services in the contract. For contracts that contain more than one promised good and service, we then must determine whether the promises are capable of being distinct and if they are separately identifiable from other promises in the contract. Variable consideration primarily includes sales made to distributors under agreements allowing certain rights of return, referred to as stock rotation, and credits issued to the distributor due to price protection. We estimate variable consideration at the most likely amount to which we expect to be entitled. We make these estimates based on available information, including recent sales activity and pricing data. We apply a constraint to our variable consideration estimate which considers both the likelihood of a return and the amount of a potential price concession. If our evaluation of performance obligations is incorrect, we may recognize revenue sooner or later than is appropriate. If our estimates of variable consideration are inaccurate, we may recognize too much or too little revenue in a period. We may adjust assumptions used to estimate consideration periodically based on analysis of prior estimates.

Stock-based compensation – We recognize the fair-value of stock-based compensation transactions in the Consolidated Statements of Operations. The fair value of our full-value stock awards (with the exception of market-based performance awards) equals the fair market value of our stock on the date of grant. The fair value of our market-based performance awards is estimated at the date of grant using a Monte-Carlo simulation. The fair value of our stock option and employee stock purchase plan grants is estimated at the date of grant using the Black-Scholes option pricing model. In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest. If our actual experience differs significantly from the assumptions used to compute our stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost. See Note 15, Stock-Based Compensation, to the Consolidated Financial Statements for additional information.

Income taxes – We are required to calculate income taxes in each of the jurisdictions in which we operate. This process involves calculating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, we are required to estimate the amount of expected future taxable income. Judgment is inherent in this process, and differences between the estimated and actual taxable income could result in a material impact on our Consolidated Financial Statements.

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine whether the weight of available evidence indicates that the tax position has met the threshold for recognition. Therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

Although we believe the measurement of our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit or litigation, they could have a material effect on our income tax provision and net income in the period or periods for which that determination is made. We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax. We believe adequate provisions for income taxes have been made for all periods.

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Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is provided in Note 2, Significant Accounting Policies, to the Consolidated Financial Statements. Such information is incorporated by reference herein.

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