Semtech Corporation

Greetings, and welcome to the CEMTEC Corporation conference call to discuss the second quarter fiscal year 2023 financial results. Speakers for today's call will be Bohan Maharswamy, CEMTEC's President and Chief Executive Officer, and Emeka Chukwu, CEMTEC's Executive Vice President and Chief Financial Officer. Please note 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 will now turn the call over to CENTEC's Executive Vice President and Chief Financial Officer, Emeka Chukwu.

Thank you, Operator. A press release announcing our unaudited results was issued after the market closed today, and it's available on our website at CENTEC.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 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 the Exchange Commission. As a reminder, comments made on today's call are current as of today only, and CEMTEC 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 my prepared remarks and Mohan's 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 detailed reconciliations of such non-GAAP measures to the most comparable GAAP financial measures are included in today's press release. In Q2 fiscal 23, the company delivered record net revenue of $209.3 million, a sequential increase of 3.5% and an increase of 13.1% year-over-year. While in a challenging business environment, we focused on operational execution and were able to grow our earnings at approximately twice the rate of revenue growth and delivered non-GAAP earnings per share growth of 9% sequentially and 34% year-over-year. Our business is seeing a continued relative strength in North America and Europe, and a bigger shift to the industrial and data center segment. This shift is aligned with our strategy to diversify our geographic and end markets. We saw significant growth in the infrastructure end market, growing 11% sequentially and 25% over the prior year, and represented 40% of net revenues. Net revenue from the industrial end market also grew nicely, up 7% sequentially and 44% over the prior year and represented 40% of total net revenues. Like many, we are seeing softness in consumer end markets where net revenues for high-end consumer decreased 14% sequentially and 31% over the prior year, and represented 20% of total net revenues. Approximately 9% of high-end consumer net revenues was attributable to mobile devices, and approximately 11% was attributable to other consumer systems. Overall, Q2 shipments into Asia North America and Europe represented 72%, 16% and 12% respectively. While this represented the shift to addresses for our distributors and customers, we estimate that approximately 35% of our shipments are consumed in China, 28% in the Americas, 21% in Europe, and the balance over the rest of the world. Total direct sales are stable at approximately 12% of net revenue, and distribution represented approximately 88%. Our distributor POS declined during the quarter, but remained balanced, with approximately 45% of POS coming from infrastructure, 31% from the industrial segment, and 24% of the total POS coming from high-end consumer end market. Q2 bookings decreased sequentially and represented book-to-bill of less than one. In addition to inflation, recession fears, and continued supply chain challenges, the effects of COVID are still driving some of the downturn we see in China. Q2 growth margin increased 40 basis points sequentially to 65.2%, a new quarterly record, driven by a higher mix of our growth engines. For Q3, we expect gross margin to expand to another record, reflecting the benefit of lower mix of consumer revenue. We expect this trend to continue, and in fiscal 23, we expect our gross margins to trend higher, 100 to 20 basis points, from favorable richer mix of our growth platforms. Q2 operating expense increased slightly to $71.9 million, driven by new product introduction expenses. For Q3, we expect our operating expenses to decrease approximately 7% sequentially as we manage through and respond to a weaker demand environment. We will, however, continue to invest in a new product innovation to sustain our market positions and our long-term growth. In Q2 fiscal 23, operating profit grew 7% sequentially, approximately two times the rate of net revenue growth. reflecting the higher gross margin and modest increase in operating expense. These strong operating leverage drove an expansion of operating margin to approximately 30.8 percent. This represents a sequential expansion of 100 basis points and 370 basis points from the same quarter last year. In Q2, cash flow from operations was a record $77 million, up 46% from the same quarter last year. Free cash flow increased 52% year over year. Cash flow generation has benefited from record operating profit and our focus on exceptional management of working capital. In Q2, 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 acquisition. Q2 accounts receivable increased 7% sequentially due to higher sales, and the days of sales declined slightly to 30 days. In Q2, net inventory in absolute dollar terms was up slightly sequentially, and days of inventory decreased seven days to 133 days. We expect net inventory to increase in Q3, reflecting the weaker demand environment. In summary, we are very pleased to deliver another record financial performance in Q2. As we look ahead to a much softer second half of the year driven by micro issues, we expect to see stable gross margins. and the reduction of operating expenses to help mitigate the impact of weaker demand on operating profit. We will continue to invest in product innovation to take advantage of our strong market positions and sustain our long-term growth. Before I hand over to Mohan, I want to provide an update on the status of the proposed acquisition of Sierra Wireless. We are still on track to close the acquisition in the second half of this year. As previously announced, We have fully committed debt financing for the transaction and are currently in a syndication process to achieve an optimal debt structure and cost of capital. We are excited about the strategic opportunities that this proposed acquisition brings to us. We look forward to closing the transaction as soon as possible and getting to work delivering on our vision. I will now hand the call over to Mohan.

Thank you, Emeka. Good afternoon, everyone. I will now discuss our Q2 fiscal year 23 performance by product group and provide our outlook for Q3 of fiscal year 23. Our Q2 fiscal year 23 net revenue was a record $209.3 million, representing a 3.5% sequential increase and a 13% year-on-year growth. We posted record non-GAAP gross margins of 65.2% and record non-GAAP earnings for diluted share of 87 cents. Our signal integrity product group grew 19.5% annually and achieved a fifth consecutive quarterly revenue record and represented 42% of our total revenues. Growth was driven by strength from the PON and data center markets. In Q2, our hyperscale data center business was strong led by growth from 100 gig optical modules. Design ends of our tri-edge short reach platform for 200 gig and 400 gig PAM-4 optical modules continue to gain momentum globally. Our customers are also giving us positive feedback on our long reach tri-edge samples targeted at 200 gig FR-4 optical modules. This will be another growth driver for us over the next few years. as this new longer reach platform increases our data center SAM by over 50%. We expect strong growth from tri-edge over the next few years. We recently announced our new highly innovative copper edge platform targeted at short reach copper interconnects and active copper cables used in data centers. This is a new product portfolio targeted at 400 gig and 800 gig data center applications and represents a completely new sound for Semtech. The first product in this new portfolio is a quad 112 gig PAM-4 linear equalizer offering lower power and lower latency. We are sampling this new product now and will be showcasing its performance at the European Conference on Optical Communications next month. We remain confident that our full portfolio of data center products, including ClearEdge and TriEdge CDRs, FiberEdge PMDs, and CopperEdge equalizers, will enable us to continue to grow our hyperscale data center business over the next several years. In Q2, our PON business achieved a seventh consecutive record revenue quarter, driven by notable strength from our PONx 10 gig PON platform. As global demand for higher access bandwidth grows and new global pond deployments and use cases emerge, our comprehensive pond portfolio, together with our innovative roadmap, positions us extremely well in the global pond market. The pond market is growing rapidly, and we expect new pond tenders in the second half of FY23 to stimulate further market growth. Our PON business continues to show strength, and we remain confident this business will grow nicely over the next several years as PON deployments and PON bandwidths increase worldwide. In Q2 of FY23, revenue from our wireless base station business showed solid annual growth on the strength of 5G base station deployments. We continue to win new designs for both ClearEdge and TriEdge in 5G base station front-haul optical modules. We expect our 5G wireless base station business to continue to grow in the second half of FY23 and accelerate over the next few years as global 5G system deployments increase, driven by new 5G tenders in the first half of FY24. We also expect to see our first TriEdge revenues from the 5G base station market in the first half of FY24. Despite the secular demand strength and strong design wind momentum associated with our infrastructure platforms, the macro environment is showing signs of slowing, and we continue to experience COVID-related issues in China. As a result, we expect infrastructure demand to decline in the second half relative to the first half of FY23. We expect the single integrity product group revenues to decrease slightly in Q3. Moving on to our protection product group. In Q2 of fiscal year 23, net revenue from our protection product group increased 10% over the same period last year, representing 26% of total revenues. Our consumer protection business remained soft during the quarter. as strength from our North American smartphone customers was offset by smartphone weakness from both China and Korea. North America now represents the largest region for our smartphone protection business, surpassing both Korea and China for the first time in Q2. Our efforts to diversify our protection business continue to be successful, and our growing revenues from the automotive, communications, and industrial segments now represent approximately 42% of our total protection business. Our high performance protection products continue to see greater market acceptance across all industry market segments as system designers increasingly utilize advanced process geometries and higher speed interfaces. In Q3 of fiscal year 23, we expect our protection revenues to decrease due to a weaker consumer market driven by ongoing weakness from our Asian smartphone customers. Turning to our wireless and sensing product group. In Q2 of fiscal year 23, revenues from our wireless and sensing product group increased 8.1% over the prior year and represented 32% of our total revenues and delivered another record revenue. Our LoRa-enabled revenues achieved another record in Q2 and remain on track to grow approximately 40% this year. We continue to expect our LoRa-enabled revenues to grow at a 40% CAGR over the next five years. Strong gateway deployment set a solid infrastructure foundation, which should enable the proliferation of ultra-low power sensor networks across numerous use cases. Global customers are recognizing the importance of deploying ultra-low power IoT sensor networks to accelerate the digitization of their industrial assets or to mitigate against climate change impacts. Here are some recent examples of RORA use cases. City Light launched a new smart city lighting platform using RORA WAN. City Light noted that they have saved 1.29 billion kilowatt hours of energy through the implementation of smart street lighting in more than 100 cities. And this new platform will help them further accelerate their global expansion plans. Cranberry Analytics announced new LoRa-based smart water meters, which allows for effective planning of water distribution, as well as real-time monitoring, leakage analysis, and mitigating water waste. WiTrack's new intelligent track and trace platform which uses both LoRaWAN and cellular connectivity, is providing a new cold chain asset tracking and management solution. Skylab and HENET, which leverages Centex 2.4 gigahertz solution, is using LoRa to optimize global maritime logistics and sea condition monitoring for passenger vessels. We recently invested in Dryad and their SilverNet early wildfire detection and forest monitoring system, based on solar-powered LoRa-based mesh networking. Wildfires have become a major driver of climate change, generating up to 20 percent of global CO2 emissions, while costing the global economy approximately 140 billion U.S. dollars to date. The Dryads LoRa-based solution aims to provide an innovative monitoring system to help mitigate against wildfire damage. These are just a few examples of exciting new LoRa use cases being deployed globally today. In Q2, the LoRa Alliance recently held their global expo with excellent attendance and solid media coverage reaching over 3.5 million business leaders with exposure to LoRaWAN. The LoRa ecosystem continues to expand as measured by new service providers, OEMs, and system integrators joining the LoRa Alliance. and we expect the Alliance and ecosystem to continue to grow for many years to come. Our LoRa metrics also continue to make very positive progress. The number of public LoRaWAN network operators grew to 173, up from 170 at the end of Q1. Private networks are also experiencing significant growth, as evidenced by many new use cases and applications. We expect approximately 180 public LoRaWAN operators by the end of FY23 and expect to have near nationwide LoRaWAN coverage in 20 of the top 30 GDP countries by the end of this fiscal year. LoRa gateway deployments continue to grow and achieved a record 5 million gateways deployed at the end of Q2 versus 4.2 million at the end of Q1. PicoCell Gateway deployments continue to increase nicely, driven by smart home and smart campus segments, as Amazon Sidewalk Gateway deployments increased 23%, and Helium Gateway deployments increased 18% sequentially this quarter. Both Sidewalk and Helium networks should drive an acceleration in end-device deployments over the next several years, as the smart home and campus segments increasingly adopt low-power sensor networks. In addition, our macro gateway deployments increased 8% sequentially, demonstrating the continued deployment of LoRa for wide area network use cases. We expect LoRa gateway deployments to achieve approximately five point by the end of FY23. The cumulative number of LoRa end nodes deployed increased to 270 million at the end of Q2, from 256 million at the end of Q1. We expect this number to exceed 300 million cumulative end nodes by the end of FY23. With continued network expansion globally, we expect end node deployments to accelerate rapidly over the next three to five years. Our LoRa pipeline continues to be strong, ending the quarter at 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. We continue to see growth in sustainability and smarter planet initiatives in areas like smart utilities, smart logistics, asset tracking, industrial IoT, smart home and smart cities, where innovative solution providers are using LoRa to monitor, measure and manage resources more efficiently. Opportunities continue to drive geographical diversification in our LoRa revenues as we continue to see our LoRa momentum accelerate in the Americas and Europe. Over 82% of our LoRa opportunity funnel is currently from regions outside of China. In Q2, revenue from our proximity sensing platforms declined due to Asia's smartphone softness and some ongoing pandemic-related challenges in China. While we are seeing proximity sensor design wins in both smartphones and the consumer wearable market, we are expecting a weaker second half demand environment for our consumer-related products, including proximity sensors. For Q3 of fiscal year 23, we expect net revenues from our wireless and sensing product group to be down due to macroeconomic softness and a weaker consumer market. The Semtech innovation engine continues to deliver new and disruptive technologies to our customers across several end markets. And in Q2, we released 14 new products and achieved 3,200 new design wins. This quarter, we entered into a definitive agreement to acquire Sierra Wireless. This transformative acquisition will bring together the ultra-low power long range and network flexibility benefits of LoRa technology, together with the low latency, high bandwidth and global network coverage benefits of cellular technology. The combination of optimizing LoRa and cellular technology is a highly strategic decision to position Semtech as the leader in the fast growing ultra low power IoT market. We aim to bring solution simplification to a disruptive chip to cloud IoT services platform. that helps our customers accelerate their digital transition to the internet of everything. The acquisition will approximately double the scale of Semtech, be non-GAAP earnings accretive immediately, and expand our IoT addressable market to almost $10 billion by 2027. We expect the transaction to close in the second half of FY23. Looking forward to the third quarter of fiscal year 23, we are seeing the effects of a softening macro environment, ongoing COVID-related issues in China, and a very weak consumer market. We also continue to have pockets of supply chain challenges in specific areas. As a result, we are currently estimating our Q3 revenues to be between $170 million and $180 million. To attain the midpoint of our guidance range, or approximately $175 million, we needed terms orders of approximately 6% at the beginning of Q3. We expect our Q3 non-GAAP earnings to be between 60 and 66 cents per diluted share. I will now hand the call back to the operator. Emeko and I are happy to answer any of your questions. Operator?