Semtech Corporation (SMTC) Earnings Call Transcript & Summary

All right. Thank you, and good afternoon, everybody. Welcome to the end of day 1 here for our TMT Conference from Morgan Stanley. Great to have you all here. And I'm Mark Edelstone from Morgan Stanley. Really happy to have Hong Hou, the CEO of Semtech and Mark Lin, the CFO of the company. And we'll definitely have time for Q&A from the audience but I want to just spend the time trying to help everybody kind of understand the key issues facing the company, the drivers and all those things.

So maybe Hong, you could just sort of start out. The company has been through a lot in the last few years. You've been the CEO for 9 months. All the things that would have transpired up before that point, you had no involvement with. So maybe to start at a high level, kind of give your perspective of how you see the company positioned today, where you see the key challenges, opportunities and so on, just to kind of level set everybody.

Thank you, Mark. Yes. No, the company has gone through a lot. I'm the third CEO in 2 years, and I'm 9 months on the job but I do feel that one side, I can say the Board is not afraid of making changes. If it's not on the right track. I do feel we are on the right track right now. And we have a very clear strategy, how do we go forward and capture the emerging opportunities and accelerate the growth. And there's a lot of opportunities ahead of us. We -- that's why we are trying to do some portfolio optimization. In the last few months I have really tried to instill a strong culture to change the way of customer engagement. So I do feel like we're on the right track. Like any CEO will say, right? But I do think our Board is very involved in the governance of the company and to do right things in strategy and capture the opportunities.

Yes. Maybe just focus on culture for a moment. I've been -- I have the good fortune of being here for a long time, and I'm here at Morgan Stanley because our culture is amazing. So your perception as you came into Semtech, what would you how -- what would you define as the culture before? And what [indiscernible] forward?

So I benefited from being a Board member for a year prior as an outsider looking inside, found that the company has a very strong technology base, very well respected by the industry. We got a very talented and dedicated employee base but we're just somehow kind of like not engaging with the customers, with the market front footed. For example, the commercial side, we would wait for the industry to define a standard, then we do launch the R&D effort and then we go after that. In these days, a very fast-moving world, that's just not enough. So that's the one thing to change the customer engagement, the way to engage with the customers and to really identify opportunities and provide solutions and not be afraid of doing custom design and purpose built. And that's tremendously enhanced the customer intimacy, and we were able to get our road map aligned with the customers' need from multiple generations. And that way, we can really invest our R&D dollars more efficiently.

Yes. Great. So maybe then just talk a little bit about strategy, high level. What do you see as kind of the key strategic objectives for you and your team?

Yes. So as for the strategy side, Semtech has been traditionally a pure-play semiconductor company. With the Sierra Wireless acquisition, we get a broader portfolio but we also get a mixed bag. So in some areas, we continue to be the leading -- in the leading position in the industry. And for example, the data center, AI connectivity, we can leverage our analog and mixed signal design expertise and then established leading position in the industry to further enhance our portfolio and really provide low power, low latency and cost-effective solutions to the AI connectivities. But there's other end of the spectrum. For example, some modules, we probably competing with ODMs. So you will never get the gross margin and profit margin profile in the IC areas. So that is a strategy we try to transform into a pure-play semiconductor company and specializing in analog and mixed signal serving the AI connectivity, IoT and high-end consumer electronics applications.

Okay. Great. And we'll dig into all those things. But let's just go back. I thought you did something that was really quite important. You obviously came in at a really difficult time for the company and I personally think with your background, you're kind of the perfect person to lead Semtech out of the issues that we have. But you -- I think your first 100 days on the job or something like that, you set up your 3 near-term priorities that you had. Can you maybe just give an update to those? How you think they've played out so far? Do you need to make adjustments at all to what those near-term priorities are?

Yes. Thank you. So yes, I did set the 3 near-term priorities when I started with the company as the CEO. The first is to strengthen the balance sheet, rationalize our product portfolio. And the second is to discipline the innovation. As a technology company, new product and new technology development is a lifeline for the future business growth. Then the third area is enhance the engagement of the employee and engagement with the customers. We were somewhat kind of like -- we're not very clear in the future direction and partly because of the challenges in the balance sheet. So I will say now 9 months later, the product rationalization is very clear, what's core and noncore and the balance sheet has improved tremendously. We reduced the leverage ratio from 11.2x to now 2.2x, and that allow us to focus on accelerating the growth through some disciplined investment in the second area of the priority of the R&D. Then the third area, I couldn't be happier that the engagement score with the employees based on the recent survey has demonstrated tremendous improvement. So we are reestablishing the trust with the leadership team, with the management, and then the employees are leaning forward, engaging. We launched some type of rising initiative. So the employees really feel that they are getting the true information. They are inspired to really take the empowerment and accountability, and the -- do whatever they do the best to build up this winning culture. So I'm really happy about the progress over the last few months.

Yes. Is it time to start adding some additional near-term priorities?

Yes. So yes, I think that, for example, the balance sheet is improved. That's no longer the priority. The rationalization, the portfolio is rationalized but we need to focus on the transformation. Some noncore assets, we are in the process of running divestiture. Some of the core assets, we're going to be adding more R&D. We may identify some gaps. We may do some small tuck-in to make the portfolio aligned with the market needs. And as for the culture, really, right now, I think this year, if it's a first year, the focus on Semtech rising, this year, we're focusing on Semtech transforming so that we will get a good portfolio, good product lifeline to in the future years, Semtech accelerating.

Yes. You've got a broad portfolio for sure. So maybe you can just help everybody understand what you see as the most strategic parts of the portfolio that you want to continue to basically foster and invest behind.

Sure. So in general, the IC focus, we are a high-performance analog and mixed signal company. We have been in the space of connectivity for high speed for the AI connectivity, the low latency, high-speed, lower power are very, very critical. So we will continue to focus in that area. And we do see some gaps on our portfolio, and we can [ use ] some R&D to fill the gap. And the gaps were identified through the alignment with the customers through frequent meetings at the technical level. And really, it's great. I feel like the investment on those products will be low risk. Basically, we build that they will come. LoRa, long-range IoT that technology was created by Semtech and the industry was created by Semtech. In over the last 15 years, we really have worked with our ecosystem, demonstrated a lot of successful use cases. Now is the time for us to provide more enablement, provide broadening of the portfolio to accelerate the growth. That's core. In high-end consumer electronics, we're in a great position. We can leverage the same core competency in analog and mixed signal design to getting stronger portfolio in there and proliferating in major electronics companies. And for some -- one of the rationales at the time of the acquisition for Sierra Wireless is to use a service platform and offer LoRa services. And recently, I have done some deep dives with my management team, we see that, that synergy can play out. So that's -- those are the core areas. What can be noncore is, for example, the cellular modules, taking the chipset from Qualcomm and making modules to be integrated in the different routers and gateways and some other devices for different cellular operator applications. That may not be core for us because we don't have a low-cost manufacturer base but it can be core to some company they have that infrastructure. The great thing is the business has inflected to growth. We have demonstrated that quarter-over-quarter growth over the last 3 quarters in a row, and there are also tremendous tailwinds that play into the strength. So this will be the good time to find a great buyer to get that portfolio divested.

Yes. Fantastic. And to the extent you could do that, maybe, Mark, give your sort of priorities, if you're able to divest noncore assets and monetize that accordingly, what would you use the cash for?

Yes. Currently, we're still looking at debt repayment as the #1 area of -- we're still -- we still have a credit facility outstanding that has a fairly high interest rate. So that would be the #1 use there but continuing to strengthen the balance sheet. I think that strategy has served us well, and we'll continue with that path.

Yes. You've obviously done a good job of delevering here pretty meaningfully in the last 9 months. So do you have a target of where you'd actually like to see sort of long-term leverage for the company?

Yes. So we've given a long-term leverage target of less than 2.5x net. We're below that now, right? So there is some optionality. But in cases where we want to delever a little bit more to have some dry powder maybe for a potential tuck-in that Hong mentioned. But really, it's focused on reducing our leverage.

Yes. Maybe go back, Hong, to your comment on just customer engagement and really making sure that you're delivering what customers want. I would argue -- and I've basically followed Semtech for decades. I would argue that under Mohan's leadership, he did that with LoRa, it seemed to me. LoRa was clearly something he was significantly passionate about and probably over-indexed on it actually, quite frankly. But when you look at things in Signal Integrity and the broader sort of port protection and the broader portfolio of core Semtech, is this sort of customer alignment, is that a new thing? Or you just enhanced what was being done before? Just give us a sense for how much was really deep in the weeds with your customers to make sure that you're designing products for what they really want.

Yes. So Mark, in that area, I will say, even up to today, we have made tremendous progress. There's still more to go. I think company probably, I don't know exactly the reason, I feel like a very passive used to be, I mean, maybe because about more than 70% of our revenue were through channels. So the commercial team is very used to just push the channels, have them to drive the design wins, drive the engagement with the customers. I was overstating. I we were hiding behind pushing them. I want everyone to jump to the front to pull to generate the demand and not only engaging with the customer but also engaging with the customer's customer. I know ACC, it's kind of like generated a little bit of pocket but that was a result of engaging with the customer's customer. We see that is very effective. At this point, right now, the innovation cycle is so short, so accelerated. You just don't have the luxury to wait for the smart guys in the room to debate and formulate the standards, then you launch your R&D to do it. And another thing is really benefited, especially in the AI and high-end consumer electronics area, you have the leading customer, they are hyperscale. Even you may come up with a solution, it may not be universal, it may not be ubiquitous to address the entire industry's need as long as you lined up with 1 or 2 hyperscalers, you're going to be having a very sizable demand. So we're changing the way and really getting people to go out and talk to the customers so frequently. I would say they increase the frequency of touch point with the customers maybe by 2 orders of magnitude. Because I was the customer of Semtech at Intel days, I know how frequent they can bother us but now I want them to engage with our customers almost like several times a week.

Right. Yes. As I said earlier, your background is so perfect for Semtech laid out against the core competencies of the company. So maybe in that, I think one of the more exciting areas is signal integrity. So maybe talk about that. You talked a little bit about the kind of core analog mixed signal, the ability to basically drive performance at low power. But just contextualize that business within infrastructure, we could start with data center to begin with, maybe seize the opportunity and then give a sense for where you think the real opportunities would exist in data center for you going forward?

Great. Yes, sure. So the data center area, right now, the demand is increasing, driven by the CapEx spending of all the CSPs and service providers and the enterprise and then the sovereign, they're building the data center everywhere. So we provide the key electronics IC components to the optical module suppliers. So Semtech has been recognized as a leader in the TIA or transimpedance amplifier industry for a couple of decades. Arguably, we provide the best components in the industry. So that buys us a ticket into the game. And what right now, the strategy is how do we increase the share of the wallet? How do we bring in the TIAs and bring in the drivers. And then bring the CDRs and certainly, the DSP has been in a very high demand but DSP is also a very high barrier. For us, it's too little too late. We had several unsuccessful attempts over the last 20 years at Semtech alone. I will leave that business to the capable industry participants for them to continue the innovation but we can have the analog version of CDR, cloud data recovery to cater for the specific needs of low power, low latency and lower cost. So that's on the electronics part. Of course, if I have some compelling optical components I can bring along, then I'm changing my position from just being a commodity component supplier to possibly a solution provider. So this is really -- think about this is very exciting. The ACC is part of that solution. What's ACC, behind ACC is a linear equalizer. That is basically provide a very low-cost, low-power, low latency solution for signal integrity and high speed. LPO can drive that transformation for the share of wallet from a few dollars to tens of dollars to several tens of dollars, that level of the growth. So enriched the portfolio, transforming the business strategy, and that's basically what I'm trying to do to drill the signal integrity product business.

Right. Okay. So a lot of drivers, which I think is good, and it seems to me that in this data-centric era of AI, it just increases the opportunities that you should have. The rate of change should be high. Obviously, there should be a pretty big TAM for you to go after. You had to put out an 8-K on the copper edge with ACC. Maybe just give a little bit of details on that just to be able to fully understand it. And then also kind of how we see that basically sort of going forward? Because it's -- I would argue it's a relatively small part of your business, and it seemed to have a pretty adverse reaction in people's minds.

Yes. No, I know that's a short subject. You're absolutely right. It's a small incremental business. So the ACC is, again, the leading equalizer we developed -- co-developed with a leading GPU manufacturer to solve the interconnect between racks and for the GPU compute cluster. So we were -- we guided a number right before I joined the company. I feel like we feel the management feel like that's a material information out there. A couple of days before the 8-K event, we were giving the new forecast and also informed on the platform change, which will create air pocket for demand by 2 to 4 quarters depending on their next-generation platform. We were told basically they wanted to ensure the generation -- after the 2 generations after the current one, it will be on time. So that will -- clearly will reduce our ramp of the linear equalizer for this specific customer below $50 million. But we have been using the same engagement technology methodology with a broader customer base from CSPs in the U.S., CSPs in China, switch vendor in U.S., switch vendor in China, ODMs in Taiwan, cable companies around the world. So we'll probably engage with 2025 possible customers using ACC. So the response has been super positive, and they are at the different stages of the verification and qualification. I will not be surprised one of the major ones can start buying in volume towards the end of this year. But it does have this temporary air pocket. It definitely was not handled as well kind of like we issued the release Friday afternoon, they thought there's -- we bury something, but it is a small impact to the overall business from the long run. And -- but we just wanted to get in front of the investors and analysts to explain the situation. And other part of the business fundamentals has not changed. So we'll have our earnings call next Thursday. And so certainly, you'll hear what our results for the Q4 and FY '25 prior to this 8-K came about.

Okay. Great. Maybe just -- you obviously have other things that you do in infrastructure. Maybe talk about that part of the business as well.

The other part of the infrastructure we have in there. So Mark, maybe we can -- I can hand it over to you.

So in other parts of the infrastructure business, we have a telecommunications piece of the business. That area, there's one section that's passive optical network or PON, and then we have what we call wireless backhaul, so supporting cellular infrastructure. Those areas, especially with cellular infrastructure, I'd say it's been fairly muted for quite some time. So in that area, we're seeing in the industry, there are some tailwinds, right? But in that area, we'll probably count it as a growth area when we see some carrier CapEx come through, right? And then in PON, passive optical network, by the way, this is the same design team that works on the rest of our infrastructure business, right? So there's a lot of synergies in terms of R&D and capability there. With PON, it's largely aligned to a tender process. So that tender process is a little bit cyclical. But I think that PON has recovered definitely off the lows from last year.

Yes. So maybe just if you kind of wrap that all together and looked at what you think maybe like a 5-year growth rate of data center and maybe overall infrastructure could be given the portfolio that you have and the dynamics in the end markets, what does that look like?

Yes. So Mark, what we were trying to do through rising now they're transforming, I wanted to transform to a compelling portfolio that can achieve faster than the peers, faster than the market growth rate. So we set a target of 50% higher than the market. For example, if the market grow 10%, we wanted to be in a position to grow 15%. What gave us the reason for that, basically, we wanted to really anticipate what the market needs, and we have done 4 months long strategic planning process. I think we mapped out the industry, we really had a lot of debate and the plan we put in place, I do believe will give us a comprehensive and compelling portfolio to enable us to accelerate the growth in the industry.

Yes. Is that just within data center and infrastructure? Is that like the whole...

In every -- in our core areas. But of course, I have a couple of moves I need to do in order to get the portfolio optimized.

Right. Okay. Very good. And then maybe on that point, when you think about -- and then we'll take questions in the audience in one second. Maybe, Mark, for you, you have this range of products today post Sierra Wireless, and we know the module business is not a high-margin business as an example. But if you envision a world where you're back to what core Semtech would have looked like before plus maybe the connected services business, which is high margin, what is the kind of end state look like for gross and operating margins when you have the portfolio more aligned to get?

Yes. Definitely, I think you can get there pretty quickly, right, when you look at the portfolio and just maybe looking at some of our disclosures. I think in the 60% gross margin is a very kind of achievable area. That's the place that we want to be. And then a little bit of a drive would be gross -- to move operating margins in starting with the 3, so in the 30s, right? There's a little bit more work to do on operating margin, a little bit of scale but definitely on the gross margin side, that's a more near-term achievable target.

Right. Okay. So very much top tier. Okay. We have a question in the audience. Just wait for the mic.

Yes. Two questions. The first one is kind of on your CDR business. I think that's a business that should do very well, both the ClearEdge and Tri-Edge for NRZ and PAM4. What -- how much of that -- what can you share in terms of like how much is that in your business and what the growth rate is for that? My second question, kind of longer term is kind of co-packaged copper. Right now, that back plane on NVL72 is big ugly and hard to do anything with if something goes wrong. But co-packaged copper looks like a great way to scale up and wanted to understand how do you guys play in co-packaged copper. So really CDR question and co-packaged copper.

Great. The CDR, so the Tri-Edge product we have right now is a bit dated. It was developed 4, 5 years ago with PAM4, 50 gig, and it's used in active optical cables. So 200 gig aggregated bandwidth and 400-gig aggregated bandwidth. And the good thing is it has demonstrated really lower power than a DSP-enabled counterpart. And so I know it was not easy at the time, that's why we did not continue for 100 gig and 200 gig. And -- but we had some architecture breakthrough. We also see the industry processing capability improvement enables the new performance of FtF max of the transistors. So we have now adding 100 gigabit CDR and 200-gigabit CDR into our product portfolio. So when we communicated with our customers, is this makes sense? Do you think you may have a usage? Are you kidding me? That's great. So it's very well anticipated and it can be used in immediately in AOC, AEC where they need more knobs than ACC but they don't need the power and complexity of DSP. So I think that's going to be a good product. We are -- that is on our road map, we have a good schedule to sample to the customers on different generation products. As for the copper backplane, the CPC, co-packaged copper looks so slick. It's just beautiful. So TE Connectivity and our partner Internet others, last year, they had a similar thing as well. And they got the interconnect management done so well and so seamlessly. That's going to be improved the airflow because of better layout and improved the signal integrity as well because it's not buckled, bundled, all of this running into each other thing. Our play there is a linear equalizer in the connectors. So there's a lot of innovation. Now we see that when they see the linear equalizer is capable and provide the performance they anticipated.

Yes, over here.

Hong Hou, I think in last November, we have reported last quarter result, you mentioned like you say a lot of CSP and other companies use the linear equalizer, no matter it's like on the board, on the cable, on the connector. So basically, just mentioned about what's the progress in the engagement with the cable customers. So do you have any progress how to engage using the linear equalizer on board? Do you see any like update design, design win for this?

Good question. So we engaged with probably total 20 to 25 potential -- well, customers. They are using in different configurations, the paddle board and then a little dot board and some build into the PCBs. Because they sometimes ask us to do some little bit of modification from pitches of the bonding, the wire bond or the surface mount pitches. The primary application is several. One of them is the backplane and another one is the inter-rack connectivity. Another one is the NIC port to top of the rack and then CPC, co-packaged copper cable applications. There's just 5, 6 different applications. As I said, one of them, they have gone through pretty much the validation of the different corner cases. They're pretty much finalized and ready to go but they're waiting for their deployment volume before the end of the year. But then there are additional applications that is under development.

Do you think the onboard mini equalizer can replace the retimer?

So onboard retimer, so the DSP-based retimer -- if you need a DSP-based retimer, you'll probably be easier to be in the pluggable modules. I haven't seen many use cases that they got a DSP integrated onboard. And plus the DSP consume a lot more power, then it really have a lot more involved in -- you do DSP but you have to analog, digital, digital analog conversion. I don't know the use cases of DSP onboard then that need to be replaced by the linear equalizer. And maybe closest one is LPO. That is a little bit motherboard, DSP-based board being replaced by linear equalizer-based board.

Other questions? Yes, over here. Just wait for the mic, please.

[ Navis Victor. ] I'm not too familiar with this space. Can you educate me a little bit about ACC versus AEC? And to me, it feels like a competing product but there's pros and cons in both ways. You guys are lower power, low latency, lower cost, et cetera. But based on what -- whether it be Credo or SteriLabs, you guys are saying AEC is a pure approach that the CSPs preferred. I'm just wondering what your thought is?

Sure. Yes. So AEC, just for those of you not familiar with the terminology, stands for active electric cable. So this product was designed and introduced about 4, 5 years ago was primarily to address the extension as it reach the typical stack cable or direct attach cable. It goes about a meter or slightly over depend on the host signal noise ratio or host quality. And in many use cases in the data center, that's just not long enough for 100 gigabit traces. So that's why the AEC was developed, and it was very quickly adopted by many CSPs -- well, several CSPs. So today, AEC, as you named a couple of leading suppliers, they have a pretty good volume and the business shipping to 3 out of 4 CSPs. Well, the ACC can do the same thing, basically improve the signal integrity. For the 200 gigabit, we right now can transmit a signal up to 3 meters. For 100 gigabit, in some cases, we have demonstrated it can transmit up to 5 meters. So AEC, the standard specification, I think it's about 7 meters, right? 7 meter at 100 gigabit. So we are getting there but it is AEC still can transmit for longer distance. As for power, ACC is consumed a lot less power than AEC, maybe about 20% of total power consumption in AEC. And then does not introduce any signal delay latency because there are no DSP involved. So you can say pros and cons. Pro certainly low-cost, low latency, low power for ACC. Con is not as far reach marginally. So I do believe the ACC gave some time, with our concerted effort to market this technology, make aware of the advantage of this technology to the marketplace in a couple of years, it can drill into the level of business of AEC.

Okay. Great. I think we will stop there. So thank you all for your questions. Thank you for being with us here at the end of day 1 of our conference. Look forward to seeing you tomorrow. Thanks to Hong and Mark.

Thank you.

Thank you, Mark.