Semtech Corporation

Thank you, operator. A press release announcing an audited resource was issued after the market closed today, and it's available on our website at CEMTECH.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 Semtec 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 were referred to non-GAAP financial measures or less 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 11 cents. 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 addition of Sierra Wireless has increased our geographic mix towards North America and Europe. Total direct sales represented approximately 36 percent of net revenue, and distribution represented the remaining 64 percent. In Q2, gross margin was 49.6 percent 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 the 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 focused cost reduction actions in addition to synergies. We expect these cost reduction actions and incremental synergies to drive Q3 operating expense lower to between $81 million and $85 million. In Q2, cash flow from operations was a $12 million use of cash impacted by demand softness and interest expense on our debt. Our cash flow from operations will remain challenging Q3 due to a softer demand environment. Our growth 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 governance included in our debt agreement. 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. 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're intensifying our focus on cost control and operational enhancements in response. I see 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 primed 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're 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 undebated. We're 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 and 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. Tri-edge and fiber-edge applications all improved sequentially, with a large U.S. 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, in-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 and secured in smartphone applications. We are especially well positioned with new protection circuitry for North American smartphone vendors. Proximity sensing or our per se product was also up in the quarter ahead of anticipated regulations in China for specific absorption ratio limits starting in fiscal year 25. Per se 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 9 cents and plus 22 cents per diluted share. We're 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 the last year's combined entity, Proforma. Further refinements are on the horizon. During my short tenure at Simtech, 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 is seeing fluctuations due to pandemic-driven demand, but the need for electronic advancements remains robust. At Simtech, 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. Thank you.

We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question comes from Craig Ellis with B Reilly Securities. Please proceed with your question.

Hello, Craig.

Oh, I'm sorry.

I think we have to take everybody off mute.

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

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 Emeka, can you give us some sense, you know, for the October guide at $200 million, you know, is the semiconductor business flat down or up? And, you know, where do you see this year wireless contribution coming in 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.

Yeah, thank you for the question, Quinn. I think, you know, for the most part, we've definitely seen a bottoming out of semiconductors. It happened fairly early in the cycle. And of late, I think we've seen a little bit of pullback in hardware. You know, routers is off in terms of in-market demand. And when I say in-market demand, I'm really looking at POS numbers. So it's off slightly. But modules has substantially pulled back. You know, the mix between those routers has a tendency 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. I've seen the hardware business pull back. Semiconductors, conversely, is doing fairly well, skipping along the bottom. Perhaps we're beyond the dead cat bounce that one looks for 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.

Great. Thanks for that, Keller. 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 to 85 million. Is that the right baseline to think and model going forward? Do you think you can bring non-GAAP OPEX even lower? And how long will you hold OPEX at kind of that baseline level? you know, before you start to increase OPEX?

So the way it's a good question, you know, I wouldn't necessarily look at the current quarter as a baseline. We're going to have some ebbs and flows in that number in terms of R&D projects. There was pullback 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're 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 it 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 Um, the first tranche is, um, I don't want to say easy because you know, it's, it's, uh, it's always difficult to make those, uh, those changes. Uh, the decision-making is perhaps a little bit easier. The second tranche, uh, needs to be a bit more thoughtful, um, going forward. And so we need, I need to spend some more time discovering, um, you know, the ends, the workings of the organization and how it can be optimized and expect that to be, you know, continual improvement. on a go-forward basis. But I do believe that there's more efficiency for this company to garner.

Great. Thank you. I'll get back in queue.

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

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 six 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 of optimizations you can make with the Semtech business?

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 the current state of the economy, the current state of the company has necessitated a, hey, we're going to have to walk and chew gum at the same time, coming in and enacting some cuts. I will say, Um, you know, my priorities are, are a little bit split and I believe, um, that that's not a, it's, 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, uh, profitability model, given the current, uh, you know, making projects, products, uh, and, and then, um, and then the various go to markets along with. Assessing what we're really good at, the beachheads and technology that we have, and putting together a good strategic plan for a long-term vision and long-term operating model. I think we're 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 and on the intermediate constructive plan for long-term operating model and vision that works and will drive shareholder value.

That's real helpful. Thank you. And then I'll follow up with Emeka on a couple of clarifications. So, Emeka, can you just help us understand how we compare the prior 50 million Sierra-related synergies target with the 100 million in expense reduction that Paul just mentioned? And then with respect to the gross margin color, what are the biggest changes that have occurred from where we were expecting 100 to 150 basis points? of expansion through the year to flattish from here. Thank you.

Hi, Craig. So with regards to the synergies, I think the last time I gave a number for the synergies, I said it was about $50 million that we were expecting. I think we're doing a little bit better than that now. I don't have an exact number, but we're doing a little bit better than that. And then in addition to some of the other actions that Paul has already taken with the company, we're getting to $100 million reduction from a pro forma number. With regards to gross margin, it's actually very simple. We are seeing the benefit of the mix, of a higher mix of the IC component revenues. That is good for gross margin. However, when the guidance was initially discussed, Craig, the expectations was that the revenue levels would be much higher and we'll be able to improve the utilization of our manufacturing businesses and stuff like that. So right now we have a lot of fixed manufacturing overhead that we're not able to absorb and that is the primary reason for coming off of the previously expectation that was set for about 100 to 150 basis points in gross margin improvement.

That's helpful. If I could just sneak one more in for Paul. Paul, you commented in your prepared remarks about the strength in signal integrity, and it looked like it was within data center. Can you just talk about the visibility you have to that strength and what some of the specific program drivers are for that? Thanks, guys.

So we've got quite a bit of visibility there. I will say, though, it's a bit more difficult to plan for those particular customers because when they're ready to go, they turn on a dime. And it's also the kind of thing that we don't have a ton of channel inventory that's out there waiting to be consumed either. So we're cognizant of it. It's very much a hands-on process where We're running proof of concepts, understanding that the programs are coming, and staging them, getting ready for when the orders drop down. In terms of planning that in a particular quarter, it's a bit more difficult. So I think we have a good sense that it's going to be becoming a bit more of a relevant figure for us over the next several quarters, but exactly which quarter is a little bit more difficult for me to determine.

Thanks, guys. Thank you.

Our next question comes from Anthony Stoss with Craig Hallam. Please proceed with your question.

Thanks. Hey, Paul. Just to put a finer point on what Quinn was asking on OpEx. So if there was some, I guess, one-time things that elevated the OpEx, should we think about OpEx coming down a couple million dollars each quarter sequentially? And at what point do you think your goal of getting to $100 million cost taken on in total will be done in which quarter? And I have a couple of follow-ups.

So I don't think I said a couple of hundred million dollars. But, you know, I think on a run rate basis, we're $100 million off. I think we can improve that. I won't put a number on it at this juncture. In terms of the rate of fall off, I think don't expect it to be, you know, significant windfall chunks that happened, but we'll be looking to execute as quickly as possible. And I'll say through Q1 is the current plan to have most of those operational efficiencies in place. After that, it would be continual improvement that we would look to enact. So try to give you a little bit of a timeline. I'll avoid putting an exact number on it until I have a good feel for what that budgeting exercise is.

Got it. And then at what point are you going to reach a determination of what assets you may want to keep, either from Sierra or Semtech? Are you getting closer to that?

I think if I look at, you know, first of all, right now, every asset that's a positive contribution is an asset to keep at this juncture, unless I can hit certain clearance ratios associated with those assets. And that really kind of comes down to the short-term exercise. If you ask me long-term, do I need Certain assets, I've already made a determination what is strategic in my mind and critical for our future. Other than that, we don't need certain assets in order to get that job done for the long-term vision of where we'd like to go. I'd like to spend a little bit more time on that plan, but I have a good sense of which assets I can divest, and it just comes down to whether or not I can reach those clearance ratios. Having said that, I really don't think this is a conducive environment to doing a deal or running a process. So my goal and my determination at this point is to get the company to a point where we are not forced to do a divestiture, but we can do that if it strategically makes sense. And I think of it more as a long-term principal pay down.

Got it. And last question, just your comments related to the FCC coming out last week highlighting the Chinese module makers, and you said your pipeline is increasing. This has been discussed from the Commerce Department and other agencies for almost two years. What's giving you confidence now that they actually might do something?

Yeah, we saw a significant boost in the pipeline, and I think it's to the point where, you know, I'll quote one customer, they don't believe that it's necessarily an issue or risk, but they just don't feel like they can fight the politics anymore. So if we kind of look at it from that standpoint, I think if I can offer better quality, better security, maybe a slight premium to the cost that they're currently paying for a low-cost APEC counterpart, I don't know why somebody wouldn't come my way because, you know, we're certainly going to solve that problem. We also have the ability to put in place TAA-compliant modules if that becomes a requirement as well. So it really kind of comes down to from an infrastructure or critical industrial applications, we will be the guy to beat, and we're going to make sure that we're the guys to beat.

All right. Thanks, Paul.

Thank you. Our next question comes from Harsh Kumar with Piper Sandler. Please proceed with your question.

Hi, thank you, Paul. Congratulations on your first earnings here at Sumtech.

Thank you, Harsh.

Paul, what you've got here is you've got two companies, a couple of different product lines, and as an analyst, I'm trying to understand, you know, what is Sumtech, what is Sierra Wireless, and I was wondering if just from sake of simplicity, if you would be willing to give us you know, how much is core Semtech revenues and how much is core Sierra Wireless revenues. And within Sierra Wireless, if you don't mind breaking out routers versus modules, because you called out, I think you said the routers were off slightly and modules were down quite a bit. So I was wondering if you could help us level set, you know, some parts and pieces so we can be better at modeling.

Yeah, and so if we look, my commentary was on modules versus router was in the current quarter, so I'm kind of projecting a little bit, really kind of talking about the guidance here. You got routers. I'm going to give you some rough percentages, so don't expect us to reconcile to the dollar, but essentially you've got $300 million of module business. You've got $100 million connectivity. and $100 million of routers. I'm really oversimplifying the actual buckets and allocations. But routers pulled back approximately 30% to 35% or so, but modules is substantially off in the going forward quarter. I don't expect that to you know, to sustain at those levels. I expect that inventory to be consumed. It is a business where, you know, you end up placing a purchase order for a chipset manufacturer. So any acquisition of those chipsets really need to make sure that the modules follow through. And so a lot of those orders tend to be in CNR. So you can kind of see how, you know, we had a bit of a pileup even at the end customers, even though modules is largely direct, about 80% direct business. So good visibility into those customers, good visibility into demand. I'd say that their consumption, their in-market demand is off a little bit, but it really does come down to the ordering patterns that kind of made this happen.