Semtech Corporation (NASDAQ:SMTC) Q2 2024 Earnings Call Transcript

Semtech Corporation (NASDAQ:SMTC) Q2 2024 Earnings Call Transcript September 13, 2023

Operator: Greetings and welcome to the Semtech Corporation Conference Call to discuss the Second Quarter Fiscal Year 2024 Financial Results. Speakers for today’s call will be Paul Pickle, Semtech’s President and Chief Executive Officer; and Emeka Chukwu, Semtech’s Executive Vice President and Chief Financial Officer. Please note that this conference is being recorded. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I would now like to turn the call over to Semtech’s Executive Vice President and Chief Financial Officer, Emeka Chukwu.

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Emeka Chukwu: Thank you, operator. A press release announcing our unaudited results was issued after the market close today and is available on our website at semtech.com. Today’s call will include forward-looking statements that include risks and uncertainties that could cause actual results to differ materially from the results anticipated in these statements. For a more detailed discussion of these risks and uncertainties, please review the Safe Harbor statement included in today’s press release and in the Other Risk Factors section of our most recent periodic reports filed with the Securities and Exchange Commission. As a reminder, comments made on today’s call are current as of today only and Semtech undertakes no obligation to update the information from this call should facts or circumstances change.

During this call, all references made to financial results other than net sales will refer to non-GAAP financial measures unless otherwise noted. A discussion of why the management team considers such non-GAAP financial measures useful along with detailed reconciliations of such non-GAAP measures to the most comparable GAAP financial measures are included in today’s press release. Turning to Q2 fiscal 2024. The company delivered net sales of $238.4 million in line with the midpoint of our guidance and an increase of 1% sequentially and 14% year-over-year. Gross margin of 49.6% and earnings per share of $0.11 was above the high end of our guidance range. In Q2 shipments into North America, China, Europe and the Rest of the World represented 24%, 29%, 14%, and 33% respectively.

The additional Sierra Wireless has increased our geographic mix towards North America and Europe. Total direct sales represented approximately 36% of net revenue and distribution represented the remaining 64%. In Q2, gross margin was 49.6% above the guidance range driven by some one-time benefits. For Q3, we expect gross margin to decrease approximately 160 basis points sequentially at the midpoint of our guidance as the favorable impact of a higher mix of IC components revenue is offset by the one-time benefits in Q2 and lower absorption. Due to the softer demand environment and subsequent lower absorption, we expect our gross margins for the rest of the year to remain around current levels. In Q2, operating expenses was $86 million, 6% below the midpoint of guidance due to full cost reduction actions in addition to synergies.

We expect these cost reduction actions and incremental synergies to drive Q3 operating expenses lower to between $81 million and $85 million. In Q2 cash flow from operations was at $12 million use of cash impacted by demand softness and interest expense on our debt. Our cash flow from operations will remain a challenge in Q3 due to a softer demand environment. Our gross debt at the end of Q2 was $1.4 billion or approximately 5.3 times leverage on a net basis. We expect our leverage levels to increase for the remainder of the year as we navigate this softer demand environment. We expect to be in compliance with the financial covenants included in our debt agreements. The Q2 weighted average cash interest rate was approximately 6.37%. In summary, our financial performance continues to be impacted by macroeconomic headwinds.

Meanwhile, we are taking focused actions to realign our operations to enable us not only to manage the current headwinds, but also to position us for strong earnings growth when the demand environment improves. I will now hand the call over to Paul.

Paul Pickle: Thank you, Emeka. While our net sales for the second quarter met expectations. I’m proud to note that our cost saving measures enabled us to surpass estimates on both gross margin and EPS fronts. Yet as we navigate today’s economic climate our Q3 outlook remains cautiously reserved reflecting elevated channel and customer inventories stemming from previously optimistic projections. We are intensifying our focus on cost control and operational enhancements in response. IC component sales after an initial dip this fiscal year is now showing stability with a 16% sequential growth in net sales. Further improvement is anticipated for the rest of the year and into the next due to customer design engagements being prime to boost consumption in the upcoming quarters, particularly in the infrastructure and consumer end markets.

Our IoT systems product group witnessed an 11% sequential decline, bringing the total to $119 million on a pro forma basis, while we have experienced a decline in demand for both module and router products. Modules revenue is presenting a particular challenge in the current quarter. However, we are seeing silver linings in the broadband module business horizon with legislative discussions putting our low-cost APAC competitors under the spotlight. This presents us with an unexpected opportunity to expand our market share. In quarter, pipeline engagements have significantly increased as a result and we are gearing up to seize this window to our advantage. Despite a minor drop in wireless radio-enabled component sales LoRa end-node sales increased slightly.

LoRa’s potential for private networks especially where power reach and mobility are crucial remains significant. While LoRa may not be a cellular infrastructure substitute, its unmatched value proposition for specialized private networks remains unabated. We are envisioning a more inclusive strategy to harness this vast potential, especially at the outer fringes of the IoT realm. Q2 IoT Connected Services remained relatively consistent at $24 million, a 20% year-over-year growth was achieved from smart and enhanced carrier connectivity. Given the relatively low attachment rates for our cloud services platform, we will be focusing on enhancing hardware revenue with a high margin software sales and a renewed focus for our IoT-managed connectivity in cloud platforms.

The Signal Integrity Products group grew 12% sequentially in Q2 quarter to $46 million. Cloud Hyperscale Data Center revenue was significantly up sequentially in the quarter benefiting from the momentum in AI-driven applications. Product sales were driven by strong 100 gig, 200 gig, 400 gig data center and broadcast revenue. TriEdge and FiberEdge applications all improved sequentially with the large US hyperscaler placing initial orders for a 400 gig active optical cable application. These gains were offset by weaker 10 gig China PON and wireless infrastructure revenue. Channel inventories remain high amidst improving although cyclically weak end market demand. China infrastructure demand although stable remains muted. Our product portfolio in PON is well-positioned and is poised to benefit when this market rebounds in the upcoming quarters.

The advanced sensing and protection products grew 35% sequentially, primarily driven by anticipated production of new design in secured and smartphone applications. We are especially well-positioned with new protection circuitry for North American smartphone vendor. Proximity sensing or our PerSe product was also up in the quarter ahead of anticipated regulations in China for specific absorption ratio limits starting in fiscal year ’25. PerSe is still in the early innings of the design cycle. But the penetration and early ramp is encouraging. We continue to make progress in diversifying our end markets for the advanced sensing and protection products group, with approximately half of product revenue coming from industrial, telecom and automotive applications.

For Q3 2024, we project net sales between $190 million and $210 million. Non-GAAP earnings for Q2 are expected to range between minus $0.09 and plus $0.22 per diluted share. We are steadfast in our commitment to the synergy plan presented to investors earlier this year and aim to fulfill it ahead of schedule. Post my induction I launched a robust cost reduction initiative, which along with other measures has decreased our OpEx run rate by about $100 million compared to last year’s combined entity pro forma. Further refinements are on the horizon. During my short tenure at Semtech, I’ve been immensely impressed by our team’s dedication and talent. Our unique state-of-the-art products create a competitive barrier setting us apart. After extensive discussions with team members, I’m optimistic about navigating current market challenges.

The tech industry has seen fluctuations due to pandemic-driven demand, but the need for electronic advancements remains robust. At Semtech, our vision is clear. Enable a smarter, more connected planet. Our focus for the upcoming months will be to execute this vision. I’ll now turn it over to the operator for Q&A.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from Craig Ellis with B. Riley Securities. Please proceed with your question.

Paul Pickle: Hello, Craig?

Operator: Oh, I’m sorry.

Paul Pickle: I think we have to take everybody off mute.

Operator: One moment. Thank you. Our first question is from Quinn Bolton with Needham & Company. Please proceed with your question.

Quinn Bolton: Hey guys, thanks for taking my question. Paul, welcome to Semtech. I guess first question, obviously guidance coming in, I think, much below expectations on a revenue basis. The semiconductor business has already been hit pretty hard by the combination of weak demand and market inventory. Paul and Emeka can you give us some sense for the October guide at $200 million? Is the semiconductor business flat down or up? And where do you see this Sierra Wireless contribution coming in the October quarter? It looks like it’s got to be well below $100 million if the semiconductor business, as I think you indicated in the script might be flat trending higher in the back half of the fiscal year.

Paul Pickle: Yeah, thanks for the question, Quinn. I think for the most part, we definitely see a — seen a bottoming out of semiconductors that happened fairly early in the cycle. And of late, I think we’ve seen a little bit of pullback in hardware. Routers is off in terms of end-market demand, and when I say end-market demand I’m really looking at POS numbers. So it’s off slightly, but modules has substantially pulled back. The mix between those routers has it tends to be heavy channel-dependent. Those inventories are not too terribly out of whack given the POS pullback, but modules is largely a direct business and we’ve seen at least some indicator from our direct customers that they are sitting on some substantial inventories over the next several quarters.

So I’ve seen the hardware business pullback, semiconductors conversely is doing fairly well skipping along the bottom perhaps we are beyond the dead cat bounce that one looks forward to resume a kind of normal rate. And then I’d say for the most part going forward we’d expect continued improvement in the high-margin semiconductor business versus the hardware.

Quinn Bolton: Great. Thanks for that color. And then a follow-up question. Paul, you referenced sort of having already reduced the OpEx run rate with synergies and other actions by $100 million. You guided OpEx in Q3 to a level of $81 million to $85 million. Is that the right baseline to think, when model going forward, do you think you can bring GAAP OpEx even lower? And how long will you hold OpEx at kind of that baseline level, before you start to increase OpEx?

Paul Pickle: So the way — it’s a good question. I wouldn’t necessarily look at the current quarter as a baseline. We are going to have some ebbs and flows in that number in terms of R&D projects that was pulled back on R&D projects in the previous quarters. Those are coming into fruition now which kind of, if you read between the lines there, it says our baseline is perhaps a little bit better than what we are currently showing. In terms of how good can it be? I think the way I kind of look at it and the way the team is looking at is to say, all right, everybody kind of bloated expense during the COVID cycle. So if we go back, imagine a run rate business that was pre-COVID look at those OpEx levels where the company used to be at, we should be able to easily get back there.

So I think that there’s without giving you an absolute number, there’s improvements to be made. The first tranche is, I don’t want to say easy because it’s always difficult to make those changes. The decision-making is perhaps a little bit easier. The second tranche needs to be a bit more thoughtful going forward and so I need to spend some more time discovering the workings of the organization and how it can be optimized and expect that to be a continual improvement on a go-forward basis. But I do believe that there is more efficiency for this company to garner.

Quinn Bolton: Great. Thank you. I’ll get back in queue.

Operator: Thank you. Our next question comes from the line of Craig Ellis with B. Riley Securities. Please proceed with your question.

Craig Ellis: Thanks for taking the question and trying again. Paul, welcome to the call. I wanted to start Paul with an intermediate-term question for you. Since this is your first call, can you just take a step back and look out over the next 6 to 12 months. And just frame up what your priorities are as you come into the role and start to interact with the street and look at the initial phase optimizations you can make with the Semtech business?

Paul Pickle: That is a great question. I think when you come into a company you’d like to be afforded the opportunity to learn and really go through a proper discovery purpose or process. And I think we’ve — the current state of the economy, this current state of the company has necessitated, hey, we are going to have to walk and chew gum at the same time coming in and enacting some cuts. I will say my priorities are a little bit split and I believe that’s not as it’s really kind of a twofold approach needs to be done in parallel where we kind of look at how can we structure the company for its most efficient profitability model given the current makings, projects, products and then the various go to market along with assessing, what we are really good at the beachheads and technology, that we have and putting together good strategic plan for a long-term vision and long-term operating model.

I think we are making nice progress. I’m making nice progress along those fronts. I would say, of late, it seems like I spent a good portion of my day on the tyranny of the urgent, an affectionate term, but still we have a good team here as soon as we identify something I’m able to delegate and continue to kind of think a little bit longer term. So short-term get us back to financial health on the intermediate constructive plan for long-term operating model envision that works and will drive shareholder value.