Semtech Corporation (NASDAQ:SMTC) Q3 2023 Earnings Call Transcript

Semtech Corporation (NASDAQ:SMTC) Q3 2023 Earnings Call Transcript November 30, 2022

Semtech Corporation beats earnings expectations. Reported EPS is $0.65, expectations were $0.63.

Operator: Greetings and welcome to the Semtech Corporation Conference Call to discuss the Third Quarter Fiscal Year 2023 Financial Results. Speakers for today’s call will be Mohan Maheswaran, 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 made. A question-and-answer session will follow the formal presentation. I will now turn the call over to Semtech’s Vice President of Investor Relations, Anojja Shah. Thank you. You may begin.

Anojja Shah: Thank you, John. A press release announcing our unaudited results was issued after the market closed 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 in our remarks 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. And with that, I’ll turn it over to our Chief Financial Officer, Emeka Chukwu. Emeka?

Photo by Scott Graham on Unsplash

Emeka Chukwu: Thank you, Anojja. Good afternoon, everyone. In Q3 fiscal 2023, in-line with our guidance, Semtech delivered Q3 net revenue of $177.6 million, a sequential decrease of 15% and a year-over-year decrease of 9%. We face a challenging macroeconomic environment and see sustained softness in the consumer market and overall weakness in China, but we are beginning to see signs of stability on several bright spots. Our focus on regional revenue diversification is showing signs of success. We see accelerating adoption in North America and Europe for TriEdge for LoRa and our broad-based industrial and business due to our targeted growth efforts with end customers. Overall, Q3 shipments into Asia, North America, and Europe represented 71%, 15%, and 14% respectively.

While this represented a for our distributors and customers, we estimate that approximately 35% of our shipments are consumed in China, 28% in the Americas, so 21% in Europe, and the balance over the rest of the world. Looking at our end markets, our infrastructure end market grew 5% over the prior year, but declined 17% sequentially and represented 39% of total net revenues. Net revenue from the industrial end markets also grew 7% year-over-year, but declined 13% sequentially and represented 41% of total net revenues. As I previously mentioned, we continue to see softness in consumer end markets, where net revenues for high-end consumer decreased 43% over the prior year and 15% sequentially and represented 20% of total net revenues. Approximately 10% of high-end consumer net revenues was attributable to mobile devices and approximately 10% was attributable to other consumer systems.

Our sales channel remains consistent with distribution representing approximately 83% of shipments and direct 17% of shipments. Our distributor POS declined during the quarter, but remained balanced with approximately 38% of POS coming from infrastructure, 33% from the industrial segment and 29% coming from high-end consumer end market. So far in Q4, we see signs that our POS is stabilizing and no longer declining. The Q3 bookings decreased sequentially and represented book-to-bill of less than one. Bookings were generally weaker across all regions and end markets. And just as in POS, we are beginning to see stability in bookings over the past month. Our gross margin remains resilient. In Q3, gross margin increased 30 basis points sequentially to 65.5%.

This is a new quarterly record, driven mostly by a lower mix of consumer revenue. For Q4, we are projecting a small decline of gross margin to 64.5% at the midpoint, driven by lower absorption due to the softer overall demand environment. We expect gross margins to hover at current levels plus or minus 100 basis points until demand recovers. Q3 operating expenses decreased approximately 5% sequentially to $68 million as we took steps to respond to softening demand. For Q4, while maintaining our investments in new products, we will take additional measures to reduce operating expenses by approximately 10% sequentially in response to the weaker demand environment. Managing our cash flow is a focus in these challenging times. In Q3, cash flow from operations was unusually low at $18 million or 10% of revenue, reflecting elevated use of working capital as accounts receivable increased due to timing of shipments and as we continue to pay for prior period long lead time materials.

We expect our cash flow from operations to rebound in Q4 to normal seasonal levels. Cash, cash equivalents, and marketable securities increased approximately $256 million to $618 million. The increase is primarily due to the $319.5 million in convertible notes, we issued to help fund the proposed Sierra Wireless acquisition, slightly offset by a $23 million payment on our existing line of credit. The convertible notes resulted in net cash proceeds of approximately $280 million after expenses, sale of warrants, and the cost of convertible note hedge transactions we entered into in conjunction with the issuance of the notes. These convertible notes carry an interest rate of 1.65% and will mature on November 1, 2027. The conversion price of the notes, including the hedge transactions is $51.15.

And on a non-GAAP basis, there will be no dilution below this price. In Q3, we did not repurchase any stock because of our pending acquisition of Sierra Wireless. We have approximately $209 million remaining in our share repurchase authorization. Going forward, we expect to primarily use our cash to pay down the expected debt from completing the Sierra Wireless acquisition. In Q3, accounts receivable increased 13% sequentially due to the timing of shipments and days of sales increased 9 days to 39 days. In Q3, net inventory in absolute dollar terms was up slightly sequentially and days of inventory increased 27 days sequentially to 150 days as we continue to receive previously committed long lead time materials, by the decline in demand. We expect net inventory to be flat to slightly down in Q4, reflecting the weaker demand environment.

As we look forward to the pending acquisition of Sierra Wireless, we remain excited about the growth potential of the two companies when combined. Sierra’s reported revenue is consistent with our expectation. When it completes, the transaction is expected to be immediately accretive to Semtech’s non-GAAP EPS. In summary, our business continues to be adversely impacted by the broad slowdown in China and a sustained weakness in the consumer market. Maintaining our financial health is paramount during these uncertain times. We have a management team that has experience managing through industry downturns, and I’m confident that the proactive actions taken are focused on new products, design wins, working capital management, and geographic diversification of strength in Semtech and prepare us well for the recovery.

I will now hand the call over to Mohan to share more details on the business.

Mohan Maheswaran: Thank you, Emeka. Good afternoon, everyone. Let me begin by providing a brief update on our proposed acquisition of Sierra Wireless. I will then share details of our Q3 fiscal year 2023 performance by product group, and then provide details on our outlook for Q4. Regard to our acquisition of Sierra Wireless, as previously announced, we received a second request from the U.S. Department of Justice. We are cooperating fully with the DOJ and providing them with their requested documents. In parallel, together with Sierra, we have made significant headway through integration planning and are prepared to close immediately when approval is accomplished. We continue to be extremely excited by the transformation we can drive in the entire IoT industry by bringing together the ultra-low power long range sensor benefits of LoRa technology together with the low latency, high bandwidth network benefits of cellular technology.

Our goal is to enable IoT deployment simplification through end-to-end connectivity and deliver a cloud to chip IoT services platform that will accelerate our customers’ digital transition to the Internet of everything. We continue to receive very positive feedback from our customers as they start to recognize the disruptive potential of the combination of the two companies. Combination of optimizing LoRa and cellular technology is a highly strategic opportunity that will position Semtech as the clear leader in the fast growing ultra-low power IoT market. Now, turning to our Q3 performance. Our Q3 net revenue was $177.6 million, slightly above the midpoint of our guidance range. We posted record non-GAAP gross margins of 65.5% and non-GAAP earnings per diluted share of $0.65.

Despite the challenging macro environment, we continue to execute well, have solid new product releases, and new design in momentum and are very excited by our future growth prospects across all our target market segments. Let me begin with our Signal Integrity Product Group. Revenue was up 2% from Q3 of fiscal year 2022, and represented 44% of total revenues. As expected, the weak economic environment in China is impacting infrastructure demand negatively. Our hyperscale data center business slowed in Q3 following a strong first half performance. Despite the softer demand, our FiberEdge revenues doubled over the previous quarter as we increased our PMD penetration in the 400 gig active optical cable segment. In addition to solid FiberEdge momentum, our tri edge platform continues to make excellent design and progress in global data centers, predominantly in North America.

We are pleased to report tri edge has been selected by a major North American hyperscale data center provider in a new high volume multi-year program to enable low power up, low latency, and low cost interconnects within their data centers. We expect to be in production on this project in the second half of fiscal year 2024. The benefits of tri edge align well with the long-term goals of hyperscalers, focused on lowering the power and cost of their interconnects within their data centers. TriEdge and CopperEdge are starting to gain traction in advanced data centers in North America that are focused on leading edge, artificial intelligence, or high speed computing applications with both low cost and low latency critical requirements. In addition to our current FiberEdge and TriEdge momentum, we continue to invest in new higher performance solutions that will enable further system level innovation within the hyperscale data center market.

We recently demonstrated our first 200 gig per channel PAM4 FiberEdge platform. This innovative PMD platform will be used in 800 gigabit and 1.6 terabyte optical modules deployed by hyperscalers. We also recently introduced our ultra-low power, 50 gig per channel TriEdge solution for both ultra-low power 200 gig and 400 gig optical modules. In addition, we are starting to see great interest in our new CopperEdge re-driver platform. Targeted at 100 gig per channel copper interconnects. We expect to announce more significant CopperEdge, TriEdge and FiberEdge design wins throughout FY 2024. We remain confident that our full portfolio of data center platforms, including ClearEdge and TriEdge CDRs, FiberEdge PMDs, and CopperEdge re-drivers will enable us to continue to rapidly grow up our hyperscale data center business nicely over the next several years.

In Q3, our PON business also declined sequentially due to weakening demand in China. What was up approximately 36% on an annual basis and is on-track to deliver another record year. We continue to see relative strength in 10 PON, OLTs and ONUs while gigabit PON demand is weakening. While most of our PON revenues today are from China, we are starting to see increasing deployments of 10 gig PON outside China. In addition, we are actively engaged with leading PON system providers globally to our focus on higher bandwidth PON deployments. We expect global PON deployments to continue to accelerate as demand for higher access bandwidth is expected to increase in the future. While weakness in China is a major headwind at this time, we remain confident this business will grow nicely over the next several years as other regions deploy PON solutions and as our China business recovers.

Revenue from our wireless space station business was down in Q3, both on a sequential and year-over-year basis. This was mostly driven by economic weakness in China, which negatively impacted 4G and 5G deployments. However, our 5G revenues grew 75% on an annual basis as European customers start to expand their 5G footprint. In Q3, we announced the production release of our TriEdge 5G base station platform targeted at 50 gigabit per second PAM4 front haul links. This TriEdge platform is a bi-directional analog PAM4 CDR with an integrated differential driver, offering ultra-low latency and low power and enables the use of low cost 25 gigabits per optics. to operate at 50 gigabit per second. We already have numerous 5G base station designs with both our ClearEdge and TriEdge platforms and expect continued adoption throughout FY 2024 and initial production revenues in the second half of FY 2024.

While overall macroeconomic conditions continue delay the rollout of 5G infrastructure, we are seeing more global deployments driven by European 5G vendors, which will provide more geographical balance in this business. As a result of demand weakness and excess inventory in China, we expect the infrastructure market to remain weak and expect our Signal Integrity Product Group revenues to decline in Q4. However, we still anticipate that our Signal Integrity Product Group would deliver record annual revenues for FY 2023. Moving on to our Protection Product group. In Q3, our Protection revenues were down 27% sequentially and represented 22% of total revenues. Extreme softness from the high-end consumer market negatively impacted our business. Lower revenues from our Asian smartphone customers and broad consumer weakness offset record revenues from our North American smartphone customers.

We believe we are very well-positioned in the consumer protection market with a strong USB-C protection portfolio, which is expected to be the high speed interface of choice across most future consumer segments. Our broader industrial protection business, which represents a wide range of end markets across all regions showed resilience in the Americas and Europe markets. We are seeing continued positive traction in the automotive segment as our Ethernet shield, display shield, and antenna shield products are all gaining momentum as our customers integrate more advanced lithography technologies with higher speed interfaces into their vehicles. Our Protection Shield solutions also have solid design win momentum at several of the top global EV makers, which is the fastest growing sub segment of the automotive market.

We recently announced our new hot switch platform for industrial and communications applications. This truly innovative system protection platform provides new protection features that will safeguard systems, prolonging the lifespan of electronic devices, and reducing electronic waste. As the overall macro environment improves, we remain well-positioned to grow in the broader protection market with a well-rounded protection portfolio for high speed interfaces such as 10 gig Ethernet, USB Type C, touch displays, and antennas and expect our broader industrial protection business to deliver record revenues in FY 2023. While we are starting to see demand levels stabilize, due to high consumer inventory levels, we expect the protection business to further decline in the fourth quarter.

Turning to our Wireless and Sensing Product group. In Q3, revenues from our Wireless and Sensing Product group declined 3% from the same quarter a year ago and represented 34% of our total revenues. Our LoRa enabled revenues grew 36% annually, driven by growth from the smart building, industrial IoT, and smart city segments. LoRa revenues increased nicely in North America and Europe, but remained weak in China due to ongoing COVID lockdowns and general economic softness in the region. LoRa continues to be utilized across a broad range of exciting used cases and we are seeing increasing global adoption of LoRa, due to its ultra-low power, long range, and low cost connectivity. Here are a few exciting announcements from this past quarter. Exeger is integrating lower edge with their unique solar cell technology for indoor and outdoor asset tracking and global supply chain logistics.

Combining Semtech’s lower edge asset management platform with Exeger’s significantly extends the battery life of asset tracking and environmental sensing devices. CWD introduced a new module combining LoRa and Bluetooth to bring the LoRaWAN capabilities to hazardous work environments such as oil rigs, mines, and construction sites. However, employee safety is the first priority. These easy to deploy IoT modules enable the tracking and monitoring of employees safety. Intent Technologies announced its LoRa enabled smart property solution, which enables improvements in the operating performance of a building is being adopted by Nexity, a leading real estate service provider to optimize performance, improved quality of service, and reduce the carbon footprint in residential and commercial properties.

Their platform has already achieved a 10% savings in overall building operational costs. Kiwi Technology introduced a new fully autonomous LoRaWAN-enabled network control unit for gas metering. This new comprehensive MCU will enable multiple remote meter reads per day and allows customers access to their real time and historical gas consumption trends to identify cost savings, and discover waste reduction opportunities. The MCU also anticipates and remotely shuts off gas in potentially dangerous situations. Kiwi Technology expects these meters to remain fully autonomous for 10 years. This week at Amazon’s re:Invent Conference, we announced that Amazon Web Services is integrating our LoRa-cloud geolocation capabilities into their AWS IoT core platform, and launching a new service to simplify asset tracking solutions using AWS.

Customer adoption is already beginning and we expect this will enable the broad expansion of our LoRa-cloud geolocation services and our LoRa Edge silicon platform in the future. LoRa’s global adoption continues to make very positive progress. And our metrics dashboard indicates solid momentum. These metrics include a number of public LoRaWAN network operators, grew to 178, up from 173 at the end of Q2. In addition to public networks, private networks are also experiencing significant growth as evidenced by many new used cases and applications. We expect approximately 180 public LoRaWAN network operators by the end of FY 2023. There were 5.6 million LoRa Gateways deployed at the end of Q3, ahead of our FY 2023 target of 5.5 million. This was driven by growth in Amazon’s Sidewalk Gateway deployments, which were up 14% sequentially and up 120% annually.

And private network gateway deployments, which increased 13% sequentially and 45% on an annual basis. Macro Gateway deployments also increased 10% sequentially and 33% on an annual basis. We expect these global gateway deployments to drive an acceleration in end device attach rates over the next several years as numerous new used cases increasingly adopt low power sensor works. The cumulative number of LoRa end nodes deployed increased 15% sequentially to 280 million at the end of Q3. We expect this number to exceed 300 million cumulative end nodes by the end of FY 2023 with the increased interest in adopting digital technologies to monitor and preserve our natural resources and to help mitigate climate related issues. We expect end node deployments to accelerate rapidly over the next three to five years.

Excluding China, we expect our FY 2023 LoRa-enabled end nodes to increase on an annual basis by approximately 60% confirming the increasing attach rate of devices to install gateways globally. Our LoRa opportunity pipeline at the end of Q3 was approximately $1.1 billion. We anticipate that on average 40% to 50% of the opportunities currently in the pipeline will convert to real deployments over a 24 month timeline. Over 82% of our LoRa opportunity funnel is currently from regions outside of China. In Q4, we expect our wireless and sensing business to decline as weakness in China and a weak consumer business negatively impact both our LoRa and proximity sensing businesses. However, driven by record LoRa-enabled revenues, which we expect will grow approximately 39% in FY 2023, we anticipate our Wireless and Sensing business to deliver another record revenue year in FY 2023, despite very weak consumer revenues.

In Q3, we released 12 new products and achieved 2,189 new design wins positioning us very well for future growth as macro trends improve. Looking forward to the fourth quarter of fiscal year 2023, we see continued demand challenges in China resulting in weaker than normal seasonality. However, we are starting to see signs of stability in both demand and POS, including from China. As a result, we expect our Q4 net revenues to be between $145 million and $155 million. To attain the midpoint of our guidance range or approximately $150 million we needed turn orders of approximately 27% at the beginning of Q4. We expect our Q4 non-GAAP earnings to be between $0.44 and $0.52 per diluted share. I will now hand the call back to the operator. Emeka and I are happy to answer any of your questions.

Operator?

Q&A Session

Operator: Thank you, sir. Our first question comes from the line of Tore Svanberg with Stifel. Please proceed with your question.

Tore Svanberg: Yes, thank you. The first question is on your current number there for the January quarter. So, I think last quarter, I think you expected 0% churns, obviously now quite a bit higher. Does that mean Mohan that kind of like the supply and demand is back in balance? Because I think historically you turn about 20%, 30% on any given quarter. And as a follow-up to that, what gives you the confidence that you can actually achieve the 27% terms?

Mohan Maheswaran: Yes. I think that is correct, Tore. Its supply lead times are starting to normalize and get back to what they kind of historically have been. There are also €“ there’s also inventory in place. So, meeting short lead time orders is not going to be as difficult as it has been in the past. I think also with the POS stabilizing and the general feeling that consumer, for example, has been extremely weak for a long period of time and starting to see some improvement in bookings there gives us that confidence. And as you point out, yes, historically, we’ve turned 30%, 40% a quarter fairly frequently.

Tore Svanberg: Very good. And as a follow-up to Emeka, Emeka when you talk about OpEx next quarter, you mentioned a 10% number, so is that total OpEx down 10% sequentially? And would this sort of be the new run rate going forward for as we model the rest of the year?

Emeka Chukwu: Yes, it is 10% down sequentially. As you know, Tore, when we start a new fiscal year, there are additional expenses that will come out, right, higher taxes and things like that. So, the operating expenses I would expect going forward, it’s probably going to be a little bit up in the first quarter and the first half of next year, but I think the run rate is going to be significantly down from what it was for fiscal year 2023. As a matter of fact, I will probably expect your quarterly run rate to be about $63, $64 million a quarter.

Tore Svanberg: Very good. Just one last house-keeping one, you mentioned that 82% of the LoRa funnel is outside of China, which means 18% in the funnel is China. Why would that would be currently as far as revenue is concerned?

Mohan Maheswaran: Revenues are closer to 45% to 50% of total revenues up from China, Tore. Obviously, I think in the last quarter, it’s probably a little lower than that, but I think it’s still €“ most of the €“ a lot of the revenue is up from China. The funnel obviously takes time to transition into revenue, but the important point there is that we are seeing a lot of success outside China. Now, China also is still doing very well and LoRa is growing in China and I think it will continue to grow in China. But there are other regions, particularly North America, has taken a while to catch up. But I think now if the funnel €“ if we execute on the funnel transition to revenue, then we’ll start to see a little bit more balanced geographical business for LoRa.

Tore Svanberg: Very good. Helpful. Thank you.