Semtech Corporation (NASDAQ:SMTC) Q4 2023 Earnings Call Transcript

Semtech Corporation (NASDAQ:SMTC) Q4 2023 Earnings Call Transcript March 29, 2023

Operator: Greetings. Welcome to Semtech Corporation’s Conference Call to discuss the Fourth Quarter and 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, this conference call 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 will now turn the call over to Semtech’s Vice President of Investor Relations, Anojja Shah. Please begin.

Anojja Shah: Thank you, Sherry. 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 and that could cause actual results to differ materially from the results anticipated in these statements. For a more detailed discussion of these uncertainties, please review the safe harbor statement included in today’s press release and in the other risk factor section of our most recent periodic reports, filed with the SEC. 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 prepared 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 the detailed reconciliations of such non-GAAP measures to the most comparable GAAP financial measures, is included in today’s press release. Finally, for our prepared remarks today, we will use the phrase Semtech Organic to refer to Semtech’s stand-alone results before the inclusion of Sierra Wireless. And with that, I’ll turn it over to our Chief Financial Officer, Emeka Chukwu. Emeka?

Emeka Chukwu: Thank you, Anojja. Good afternoon, everyone. In Q4 of fiscal ’23, the company delivered net sales of $167.5 million, down 6% sequentially and 12% year-over-year. These results included $15 million of revenue from the Sierra Wireless acquisition we completed on January 12. Fiscal year ’23 revenue was a record $741.5 million for Organic Semtech and $756.5 million including Sierra Wireless. For Semtech Organic, Q4 shipments into Asia, North America and Europe represented 68%, 13% and 19% of revenue, respectively. While this represents a shift to addresses for our distributors and customers, we estimate that in fiscal year ’23, approximately 33% of our shipments were consumed in China, 27% in the Americas, 22% in Europe and the balance over the rest of the world.

Our efforts to diversify our revenue geographically are showing signs of success. We see especially in North America and Europe for Tri-Edge, PON-X and LoRa. On a go-forward basis, we expect the inclusion of Sierra to reduce our exposure to China. In Q4, net sales through distribution represented approximately 78% of revenue for the combined company, while direct represented 22% of net sales. Going forward, we expect to have a more balanced mix due to the addition of Sierra. Looking at our end markets for the Semtech Organic business. Our infrastructure end market fell 18% over the prior year and 20% sequentially and represented 37% of total net revenues. Net revenue from the industrial end market declined 18% year-over-year and 15% sequentially and represented 40% of total net revenues.

Revenues for high-end consumer decreased 26% over the prior year, but we are up approximately 1% sequentially and represented 23% of total net revenues. Approximately 9% of high-end consumer net revenues was attributable to mobile devices, and approximately 14% was attributable to other consumer systems. Our Semtech Organic POS remains balanced with approximately 49%, 29% and 22% of the total POS coming from infrastructure, industrial and high-end consumer end markets, respectively. With the addition of the Sierra Wireless portfolio, we will see a greater mix of IoT revenue, a new segment for us that will include LoRa and less revenue in the consumer end market. Q4 gross margin was 62.3% for the combined company. Q4 gross margin for organic Semtech declined 80 basis points sequentially to 64.7%, driven primarily by a return mix of the high-end consumer end market revenue.

In fiscal ’23 for Organic Semtech, our growth drivers of data center, LoRa-enabled, PON, broad protection industrial and automotive platforms drove record non-GAAP gross margin of 65.1%, up 180 basis points. With the full quarter of Sierra, we expect our Q1 gross margin to average 48.5% at the midpoint of guidance. For the remainder of the year, we expect to see 100 to 150 basis point improvement in gross margin driven by a higher mix of Semtech Organic revenue and achievement of material cost synergies. We expect to achieve our long-term gross margin target of 58% to 63% through: one, sustained growth of data center, 5G wireless base stations, passive optical networks, broad protection industrial and automotive product platforms. Two, accelerated deployment of LoRa endpoint from improved cellular connectivity.

And three, growth in annual recurring revenue from Sierra’s managed connectivity, software services and LoRa cloud services. We are successfully managing our operating expenses in this challenging revenue environment. Q4 combined operating expenses was $67 million. In Q4, operating expenses for Semtech Organic were down 13% sequentially to $59 million, driven by a reduction in headcount and other variable compensation. In Q1 fiscal ’24, we expect operating expenses of approximately $99 million at the midpoint of guidance, reflecting a full quarter of Sierra and the customary increase in compensation expense is typical at the start of the new year. We now expect to achieve about $50 million of annualized operating expense synergies by the end of the fiscal year.

As a result, for the remainder of the year, we expect operating expenses to be flat to slightly down on a sequential basis, reflecting the achievement of the expected synergies. Fiscal year ’23 operating profit was a record $210.7 million for the combined company. Semtech Organic delivered a record operating profit of $212.7 million, up 5% versus the prior year, with minimal revenue growth due to gross margin expansion and controlled expenses. While fiscal year ’24 demand is starting off weak, we still expect that with the anticipated second half recovery, the Sierra acquisition will be accretive to our fiscal year ’24 earnings. In addition, over time, as the current business climate improves and we execute on the vision behind the Sierra acquisition of driving LoRa endpoint proliferation, we expect to achieve our long-term operating margin target of 32% to 36%.

Our fiscal ’23 non-GAAP normalized tax rate is 12%, and we expect it to remain the same in fiscal ’24. In fiscal ’23, cash flow from operations for the combined company was $127 million or 17% of revenue compared to the $203 million in the prior year. The decline was primarily due to the expenses associated with the acquisition of Sierra. For fiscal ’24, we expect cash flow from operations to be pressured by transaction and acquisition-related expenses and lower profits due to the weak demand environment. Our debt at the end of fiscal ’23 was $1.3 billion or 3.4 times leverage on a net basis. We expect to see an increase in net leverage as we navigate through this softer demand environment. We proactively negotiated an amendment to our credit agreement to get some relaxation to our leverage ratio and interest expense coverage ratio covenants.

The weighted average interest rate is currently approximately 5.64%. As we have said before, the main priority for free cash flow will be to pay down debt. In summary, fiscal year ’23 has been a year of significant change for Semtech. We delivered record revenue and operating income and closed on the largest acquisition in our history. While fiscal year ’24, we have these challenges, I’m very excited about the opportunities at Semtech at this moment in our history. Let me summarize what I see now. One — first, we expect to see our growth drivers of data center, PON, 5G wireless regain their growth momentum as the business environment normalizes, but more importantly, become more regionally balanced as we see revenue run for these products in North America later this year.

Second, Sierra’s cellular capabilities, combined with our high-margin LoRa and LoRa cloud technology, we open up new market opportunities for both technologies, driving increased revenues, gross and operating margins for the company. And finally, once we have executed on our synergies and portfolio review, we expect that in fiscal year ’25, we will start seeing much improved margin expansion and EPS growth. I will now hand the call over to Mohan.

Mohan Maheswaran: Thank you, Emeka. Good afternoon, everyone. I’d like to briefly comment on my intention to retire from Semtech. The last 17 years have been an incredible journey for me, and I’m very proud of the growth and transformation of Semtech and our many accomplishments during this time. As we approach the next phase of growth, this is the right time to appoint the next leader of this highly innovative technology company. To ensure a smooth transition, I am committed to staying involved until a new CEO is appointed and will continue to be an adviser for a period of time as needed. On January 12, we closed the acquisition of Sierra Wireless. This was the largest and most strategic acquisition in Semtech’s history. Our Q4 FY ’23 and FY ’23 numbers include 18 days of Sierra Wireless.

I will now discuss our Q4 fiscal year ’23 performance by product group, our fiscal year ’23 performance and then provide our outlook for Q1 of fiscal year ’24. In Q4 of fiscal year ’23, net revenues were $167.5 million, Organic Semtech contributed $152.5 million, slightly above the midpoint of our guidance. In Q4, Organic Semtech posted non-GAAP gross margin of 64.7% and non-GAAP earnings per diluted share of $0.50. For the combined company, non-GAAP EPS was $0.47 per share. In Q4 of FY ’23, our Signal Integrity Product Group revenue was down 21% sequentially and represented 36% of total revenues. The decline was driven mostly by the economic slowdown in China and excess inventory as customer consumption declined. We saw reduced demand from all our infrastructure segments across all geographies with China data center and China wireless base station being particularly weak.

Despite the softer demand, we continue to see new design in activity for our Tri-Edge and Copper-Edge platforms in both optical modules and active copper cables. As we mentioned last quarter, Tri-Edge has been selected by a major North American hyperscaler in a new high-volume multiyear program to enable lower power, lower latency and lower cost interconnects within their data centers. This is our first major North American hyperscaler Tri-Edge win, and qualifications are progressing well. And we expect production ramps to begin in the second half of FY ’24. The benefits of Tri-Edge align well with the long-term goals of hyperscalers, focused on lowering the power and cost of interconnects within their data centers. At the Optical Fiber Conference earlier this month, we demonstrated a 200-gig Palan optical transmission link, enabled by Semtech’s latest Fiber-Edge 200-gig PAM4 platform and Broadcom’s latest DSP platform.

We remain confident that our full portfolio of data center platforms, including Clear-Edge and Tri-Edge CDRs, Fiber-Edge PMDs and Copper-Edge re-drivers will enable us to rapidly grow our hyperscale data center business nicely over the next several years. While we saw a sequential decline in our overall PON business in Q4, our 10-gig PON business reached a new quarterly revenue record. Our PON business continues to grow outside of China, and we remain confident our PON business will grow over the next several years as global demand for higher access bandwidth drives an increase in global PON deployments. At OFC, we demonstrated both a 25-gig and 50-gig PON system and our sampling products for both systems now. Revenue from our wireless base station business was down in Q4, both on a sequential and year-over-year basis.

Again, despite the current softness, we have numerous 5G base station design-ins with both our Clear-Edge and Tri-Edge platforms, and we expect continued adoption of both platforms in front haul optical modules throughout FY ’24 and beyond as 5G deployments accelerate. We’ve recently announced several new innovative products that extend our leadership position in PMD and CDR platforms targeted at the data center, wireless base station and PON segments. These new products provide our customers with a lower power, low cost and low latency needed for advanced infrastructure applications. While our Signal Integrity Product bookings improved sequentially, the weak macro environment, particularly in China, is resulting in lower infrastructure demand in Q1 across all sub-segments.

As a result, we expect our Signal Integrity Product Group revenues to be down significantly in Q1 of fiscal year ’24. Moving on to our advanced protection and sensing product group. In Q4, we merged our proximity sensing product group into our Protection Product Group and created a new Advanced Protection and Sensing Product Group. We made this shift to align our system protection and sensing road maps for our high-end consumer customers. Q4 net revenue from our Advanced Protection and Sensing Product Group decreased 6% sequentially and 32% annually and represented 29% of total revenues. The decline was due to ongoing weakness from the consumer segment, including from smartphones, wearables and PCs. Consumer demand for both China and Korea remains extremely soft.

We continue to diversify our Advanced Protection and Sensing business into the broader industrial telecommunications and automotive sectors, which we call ITA, where we see relative stability with modest growth from the automotive market. In addition, our increasing design wins for USB-C protection across all end markets, position our protection business for growth as USB-C becomes the high-speed interface of choice across the high-end consumer and ITA segments. In Q4, new SAR regulations were finally passed in China, increasing the market opportunity for our proximity sensing portfolio as smartphone customers will now need to integrate proximity sensing functions into their phones being sold into China. We expect both our protection and sensing businesses to rebound as the overall consumer market improves in the second half of fiscal year ’24.

However, our consumer demand currently remains very weak and inventory levels remain high. As a result, we expect our Advanced Protection and Sensing business to be down significantly in Q1. Turning to our IoT product group. Our newly formed IoT product group has two sub business groups. The first business is the IoT system product group, which is made up of Semtech’s LoRa-enabled business, Sierra’s IoT module business and Sierra’s IoT router business. This business also includes the Sierra broadband module business. The second business is our new IoT connected services business, which includes Sierra’s managed connectivity services business and Semtech’s LoRa Cloud Services business. This services business is a recurring revenue business. In Q4, total IoT revenues were $58.8 million, 18% higher sequentially and 34% higher on an annual basis and represented 35% of total Semtech revenues.

Our IoT revenues included approximately $15 million of Sierra Wireless revenue. In Q4, our LoRa-enabled revenues were down 12% sequentially and flat over the previous year due to softer demand from China and a significant drop in Helium revenues. We do not expect any more material revenues from Helium. The adoption of LoRa continues to grow across many IoT use cases globally, especially in North America and Europe where we are starting to see larger LPWAN deployments. Some of the most recent more exciting announcements include Ital Gas in Italy issued an RFP for 7.6 million LoRa WAN gas meters, and we’re seeing similar requests for LoRa WAN-based systems in utility tenders all over the world. The Things Network Industries announced it has achieved 1 million connected LoRa WAN devices.

The LoRa Alliance announced it has now certified 620 LoRaWAN devices. Yesterday, Amazon announced that they are expanding their commitment to LoRa with the opening of the Amazon Sidewalk network to device makers and developers with new tools and new AWS services for both LoRa and LoRaWAN developers to make it easier to deploy. LoRa technology plays a critical role in enabling long-range community coverage with Amazon Sidewalk, which now covers approximately 90% of the U.S. population. We announced the first third-party products based on Amazon Sidewalk from Browan, Device Roy, Meshify and New Cosmos are now available. Additionally, we have partnered with other industry leaders on development kits and modules based on Semtech’s LoRa technology that will enable device makers and developers to rapidly create new Amazon Sidewalk devices.

And finally, Frost & Sullivan recognized Semtech as the 2022 Global Company of the Year for innovative IoT hardware based on the progress of LoRa. We are now in the process of integrating Sierra Wireless into Semtech so we can execute on our vision of transforming the entire low-power IoT industry by bringing together the ultra-low power and long-range connectivity benefits of LoRa technology, together with the low latency high-bandwidth network connectivity benefits of cellular technology. The combination of LoRa and cellular technology is a highly strategic opportunity that positions Semtech as the clear leader in the fast-growing ultra-low power IoT market. Our goal is to enable IoT deployment simplification through end-to-end connectivity, deliver disruptive edge AI networks and deliver a unique cloud-based sensing as a service capability that helps customers accelerate their digital transition to the Internet of Everything.

Our teams are unified under our new IoT leadership, and we are currently reviewing our product portfolio to prioritize investments and identify non-strategic assets. Now let me comment on our fiscal year 2023 performance. In fiscal year ’23, Organic Semtech net revenues achieved a record $742 million. Including Sierra Wireless, revenues were $757 million. We achieved this record revenue amidst significant macroeconomic headwinds, ongoing geopolitical challenges in China, COVID lockdowns in China, the war in Ukraine and softness in the global consumer market. In FY ’23, Organic Semtech also achieved record gross margins of 65.1%, record operating income of $213 million and record EPS of $2.80. In FY ’23, our SIP product group grew 4% annually and achieved record revenues of $304 million, driven by record PON revenues of $142 million, which grew 58% annually and record 5G revenues of $11 million, which grew 18% annually.

In FY ’23, our Protection Products business declined 8% over the prior year. However, the broader ITA protection business achieved record revenues of $80 million and grew approximately 9% year-over-year. In FY ’23, our organic Wireless and Sensing business grew 40% to achieve a record $200 million. Our LoRa-enabled revenues also grew 40% for the year to achieve a record $187 million. In FY ’23, our LoRa business continued to make solid progress on the growth metrics we have established. These metrics included the number of LoRaWAN network operators, which grew to 181 at the end of FY ’23 from 166 in FY ’22. LoRa endpoints reached approximately 300 million connected devices in FY ’23, up from 240 million in FY ’22. The number of LoRa gateways deployed increased 84% from 3.2 million at the end of FY ’22 to 5.9 million at the end of FY ’23.

We are delighted with the large increase in gateways deployed globally as this LoRa infrastructure is critical to enable the broad range of industry use cases that are emerging. With continued network expansion globally, we expect end node deployments to accelerate rapidly over the next three to five years, growing from the 300 million end devices deployed with LoRa today. Once we have completed the integration of Sierra, we will be establishing a new set of IoT metrics that represent the new IoT vision and strategy that is now in place. Now let me discuss our outlook for the first quarter of fiscal year ’24. The Organic Semtech demand remains very weak due mostly to a weak China and consumer demand. In addition, the Sierra Wireless demand, which is typically seasonally weaker in Q1 is also being negatively impacted by the overall macro weakness in North America and Europe, resulting in both pushouts and some cancellations.

As a result, we are currently estimating Q1 net revenues to be between $230 million and $240 million. The midpoint of $235 million includes projected revenues of approximately $135 million from Sierra Wireless and approximately $100 million from organic Semtech. To attain the midpoint of our guidance range, or approximately $235 million, we needed 16% turns orders at the beginning of Q1. We expect our Q1 non-GAAP earnings to be between negative $0.11 and negative $0.04 per diluted share. I will now hand the call back to the operator, and Emeka I will be happy to answer any questions. Operator?

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Q&A Session

Operator: . Our first question is from Scott Searle with Roth MKM. Please proceed.

Scott Searle: Good afternoon. Thanks for taking the questions. Mohan, congratulations and best of luck is — I know you’re not going off to retirement tomorrow, but best of luck as you start to look down that road. Maybe just to dive in quickly on the last comment of Semtech Organic being about $100 million in the April quarter. I was wondering if you could dig into that a little bit more deeply. I know you went into the specific product categories, but how much is inventory related? What sort of a recovery should we be expecting as we go into the July and beyond quarters? And also as well, if I could, for Emeka, on the OpEx front, it sounds like you’ve talked about deal synergies now moving from $40 million to $50 million. I wanted to clarify in terms of the OpEx of around $99 million to $100 million in the April quarter, if that’s where we should be modeling taking out that $10 million to $12 million as we get through those integrations? Thanks.

Mohan Maheswaran: Yes. So let me start with the Q1 guidance comment question, Scott. So across our different product areas, we are seeing weakness. Obviously, I mentioned China and consumer are probably the two greatest areas. And all of our businesses are going to be down on an annual basis, something between 40% and 50%, I would say. And so it’s pretty broad. It’s not one specific area, but I would say consumer in China are definitely impacting us in a big way. We have, LoRa, a specific issue also with Helium, which has also come down. So there’s some specific things there. But largely, I would say, it’s on the whole, it’s pretty broad. We do think we’re near the bottom. I think that’s important to understand is that what we are seeing now is bookings starting to get a little bit better.

The customer’s consuming — indicating that consumption is going to start to increase that. We haven’t really seen that yet. But I think that that’s our expectation as we get into the second half. And that is really going to be the key. Obviously, as demand comes down, inventory is the issue. And I think we’re seeing inventory across the consumer markets and the infrastructure markets now. So until that inventory is absorbed, the market will be solved. So we’re expecting the first half to be fairly weak.

Emeka Chukwu: Yes. And Scott, on the OpEx, the $99 million that we guided toward the midpoint already factors in the synergies that we have achieved. The team has actually done a very good job of the integration so far. We’ve been able to drive a lot of the identified synergies. At this point, I’ll probably estimate that about 80% of the identified synergies have already been achieved and baked into the numbers. And the expectation is that by Q3 that we probably would achieve 100% of the $50 million target that we have provided.

Scott Searle: Got you. And one last one, if I could, Mohan, on Sierra Wireless, it seems like they’re actually performing pretty well if you’re guiding to $135 million in the current quarter. There had been some channel inventory out there, I think, on the module front. But it doesn’t seem like it’s that onerous at this point. So I’m wondering, as you start to look into the back half, where Sierra Wireless was peaking at $160 million to $180 million a quarter, is that something that’s achievable as we look out to the end of this calendar year or early next year? Thanks.

Mohan Maheswaran: Yes. I think so, Scott, it’s difficult. Even the Sierra business is down. Obviously, I mentioned on the — in my commentary that Q1 is seasonally down for them. So — but we are seeing a little bit more weakness than we’d expect. And then some pushouts and some cancellations as I mentioned. So even their business is down on a kind of 20%ish on an annual basis. So not as bad as the Semtech business, but still down. And their business is primarily North America and Europe. But yes, I think we are still expecting the second half to be stronger across all segments. There’s no indication of that in terms of hard bookings yet. But given where some of these markets have been soft for some time now, especially consumer.

And if you look at China, one would expect them to come back for sure. And then I think some of these other regional segments, like North America and Europe infrastructure, I think should at least we should start to see some improvements in the second half.

Scott Searle: Great. Thank you.

Operator: Our next question is from Craig Ellis with B. Riley. Please proceed.

Craig Ellis: Yes, thanks for taking the question. Mohan, I’ll echo the congratulations on your transition into a new phase. It’s been a tremendous pleasure working with you over the years. I wanted to follow up with a point that Scott asked about. Just digging in more to the Semtech side of the revenue guidance. If I look at the $100 million and look back in my model, it seems like we’re at revenue levels that we would not have seen since the fiscal ’11 timeframe when the portfolio was a lot different and really didn’t have the Signal Integrity contribution that it does now. So with that as the context for the question, the question is really this, to what extent do you feel like you’re under shipping normalized demand to work through excess inventory? And how long would you expect that under shipment period to last because it does seem to be quite acute here in the current quarter?

Mohan Maheswaran: Yes, I would say probably two quarters, Craig. As I mentioned, obviously, if you look at FY ’23 and take our Signal Integrity Product business, as an example of that, it was a record $300 million. So when we now look at the current run rate and how fast it’s come down, we’re on a 160 kind of run rate. So it’s definitely come down significantly. And I would suggest most of that is inventory, and some of that is related to China. And as I mentioned, we are expecting in the second half, some ramps and some specific drivers to bring that back. But it’s across the board. Our consumer business is similarly down. Our industrial parts of our industrial business are similarly down. I would say North America and Europe a little bit better. It’s mostly China and consumer are the two major culprits, but across the board, everything is down at least 15% to 20%.

Craig Ellis: Got it. And then the second question is one related to some of your comments near the end of your script. One of the things that you mentioned is you’ve got the teams together. They’re working hard and collaboratively on integration, and you’ll be looking at things that are not strategic as opportunities to really prioritize resources around things that are. So with that said, can you comment any further on the scope of things that may not be strategic? And given where we are with the global macro today versus where we are — where we were when we announced deal, how do you look at the target $40 million in cost savings from the deal? Do you feel like there should be upside to that? Or does that remain a solid number given your sense of where the longer-term opportunity is?

Mohan Maheswaran: Well, I’ll start with the portfolio review, Craig. I mean we do it regularly at Semtech anyway. But I think now with the Sierra acquisition, obviously, a lot of the Sierra businesses are fairly new to us. And so the Board is engaged in kind of looking at what elements of the portfolio are really strategic for us and which are not. And we’ll make decisions based on what we find from that. It’s early days though, we just really started that. I would give it six months here. And then Emeka, do you want to talk about the synergies?

Emeka Chukwu: Yes. With regards to the synergies, Craig, like I mentioned in my prepared remarks, we had estimated about $40 million on an annual basis. Now we’ve increased that number to $50 million, and I just mentioned that. As of now, we have achieved about 80% of that on the run rate basis. And we do expect, by the end of Q3, we would be at 100% of the $50 million.

Craig Ellis: Got it. Thanks for that guys. I’ll hop back in queue.

Operator: Our next question is from Harsh Kumar with Piper Sandler. Please proceed.