Semtech Corporation (SMTC) Earnings Call Transcript & Summary

Okay. We're going to get started. I think this might be the last session of the day, but we're into late afternoon. So very pleased to have Semtech. I'm Tim Arcuri. I'm the semi and semi equipment analyst. Pleased to have Semtech. We have Hong Hou, who is the CEO, and we have Mark Lin, who's the CFO. So thanks, Hong and Mark.

Thank you.

Thank you.

So let's just -- I just wanted to go back, and I thought your quarter was sort of a watershed quarter in a way because now you've got a large customer ramping ACC and really proving out the design. So can you just talk about that? Can you talk about sort of review some of the highlights of the quarter and maybe talk about the data center opportunity, really?

Yes. Thank you. So we just announced our Q3 results last week, early last week, and we achieved the sequential revenue growth. And in our core assets, I want to highlight in the data center area, we had the revenue growth sequentially 8% and we project the revenue to continue to grow in an accelerated pace in Q4 for 10%. We also announced -- gave a detailed schedule for ACC ramp. Our hyperscaler customer gave us the time line to start ramping incorporate ACC in their rack by mid-2026. And then we supply our linear equalizer IC to the cable manufacturers, they need 3, 4 months to get our IC integrated into the cables. So we will start seeing the ramp in April quarter for ACC.

And what is this -- I mean this customer tends to set the tone, I would say, we'll say, for other hyperscalers. So what does it mean? I mean, sort of what does this confirmation mean for how quickly ACC can penetrate other customers?

Yes. So this hyperscaler has a tradition to lead the industry with the disruptive solutions. When they started using 200 gigabit per lane service, so they certainly look at a different connectivity solutions than we have been engaging with them maybe 10 months ago. They started looking at a deck, ACC, then AEC, their primary use cases is interconnect, the different XPUs within the rack and then between racks. So they feel that for the data rate, they wanted to transport -- transmit 1.6 gigabit per second over 6 lanes -- 8 lanes, they can achieve everything they need with a 3-meter reach with the ACC. Below 1 meter, from 0 to 1 meter, they can use 30-gauge deck cable. So now they down selected this between DAC and ACC. And the clear partition below 1 meter is DAC and above 1 meter to 3 meters is ACC.

And yes, I guess, just thinking about how this could catalyze other hyperscalers.

That's right. So they have been the leader in the market in the hyperscaler -- among the hyperscalers. They always pioneered the new technology. I am sure there's going to be a catalyst for other hyperscalers to use ACC in their fabric for direct design and also even the scale-out.

And can you just talk about what your, sort of, I don't like to use the word right to win, but what's your edge with copper edge? Is there room for you to expand content beyond ACC, like maybe sockets in the backplane, for example.

Yes. So first of all, for ACC, the reason they chose ACC versus AEC, clearly, it's a power consideration and the latency is another consideration. When you have ACC can do what AEC can do as well within 3 meters, but with a 90% power saving, they will jump on it and also the latency is almost negligible with ACC. Beyond the cable, you asked about the linear equalizer can be integrated on the board to extend to reach of high-speed links as well. So we have several use cases in the evaluation and qualification stage with other customers.

And does it matter -- I mean is it agnostic for ASIC versus GPU?

It doesn't matter. It depends on the quality of the SerDes and for now, the 200 gig per lane, there's really 2 -- only 2 primary suppliers for 200 gig SerDes. So we work with both of them pretty closely, and we know the characteristics and our product has been tuned to compensate their SerDes characteristic to extend the reach.

But there's no pricing difference. There's no content difference.

Oh, I see. I see. So then our linear equalizers can be integrated in a paddle board of the cable -- ACC cables. The same design, same content can be surface mounted onto the PCB trees then to extend the reach. So the content is about the same. And the technology is identical. It's just the form factor making a little change in order to accommodate easy integration on the board.

Great. Let's talk about -- we talked about ACC, let's talk about LPO. LPO is a little more plug-and-play than ACC has been. I mean, now you've sort of crossed the chasm, I would say, in ACC, but LPO is more plug-and-play. So can you talk about what the opportunity is there and how to size the LPO opportunity relative to the ACC opportunity?

Yes. So you're right. The LPO is more plug-and-play because it's the same form factor with a DSP-based retime solution, optical transceivers, same electrical plug-in interface, same optical plug-in interface, same mechanical form factor. As long as the customers do the test and to see the signal integrity is maintained between their links. For example, the first layer of the switch fabric from server to top of the rack, they can optimistically use low power consumption of the LPO and it's also low latency, a little lower price than the DSP-based solutions as well. So we see more broad acceptance of the LPO with reference to 3, 4 years ago, the industry starts talking about that, there has been some resentment, but now I see that the entire industry really getting a broad acceptance of this technology. So we see some acceptance, and we see some adoption in some first stage of the switch fabric. So you will see the gradual ramp. And in Q4, we're going to be having the first quarter milestone to see the primarily TIA for the LPO at this point reached a mid-single-digit revenue level.

And have the interoperability concerns for LPO largely been resolved? I mean. I think -- and part of that is LPO broader than just Broadcom-based systems?

Yes. So I think the LPO, one thing -- one key enabler is a clean signal noise ratio from the SerDes. The Broadcom system is really -- is excellent. Tomahawk 6 ports, the signal integrity is great that enable the adoption of LPO.

So can you size for us maybe just go through some of the relative sizing of the ACC opportunity versus the LPO opportunity?

So the LPO is going to be ramping gradually. So it's going to be, in a way, cannibalizing the DSP-based retime solutions. It's ramping gradually. So I would say probably if you say 2, 3 years later, reach a steady state, maybe overall 800-gig transceivers, pluggable transceivers, you can expect 25%, 30% of the mix is going to be LPO based. Transition to LPO is beneficial to Semtech because we're going to be able to expand our SAM, not only providing TIAs but has the opportunity to provide the drivers. But size-wise, I think ACC from now, we look at it, it's a much bigger opportunity than LPO for us.

ACC is bigger. Yes. And can you just -- just to wrap up on LPO, can you talk about your opportunity and how it changes between 800G and 1.6T?

Yes. The LPO for 800 gig, it's, I would say, pretty mature. For 1.6T on the other hand, the industry is still working on the signal integrity or reflection issue from the transmitting path. Receiving path is good. So some customers wanted to capture the low power benefits of that by rolling out LRO for 1.6T first. So we see the near-term 800 gig, no one cares about LRO and it goes directly to LPO. But for 1.6T, it's going to be going through LRO step, but I do believe eventually the industry will figure out a way to get LPO available for 1.6T.

So you -- but your opportunity is probably bigger in 800G, is that fair?

So the opportunity for 800 gig, we definitely -- our TIA has been broadly widely regarded as the best solution by the industry. We have the lion's share for the TIA side. But driver was a little late, we're playing catch-up and we have some customers designing in use our 800-gig LPO drivers, which we do believe the only driver have to comply with MSA, multisource agreement and provide, say, for example, automated gain control and digital diagnosis capabilities. For 1.6T, we do not want it to be late. That's why we're accelerating our road map. We'll make the LPO compliant 1.6T LPO driver available before the end of the year, so we can sample to our customer base to have them play around, give us feedback. In case if we need a respin, we'll have the base for it.

And is there anything -- any loading commentary you could make for 2026. I mean you haven't guided the year, obviously, but can you give us any like puts and takes in terms of loading commentary, how to think about. I mean, you've got the -- you've the consumer business, too. We haven't talked about that. But give us any loading commentary for like how to think about how the year could play out next year?

Yes. So for the data centers, it's just like we talked about the LPO, we talked about ACC. And another thing is 1.6T transceiver ramp. We are capturing that opportunity as well. Even though a lot of volume for 2026 calendar year is going to be 800 gig optical transceivers. For U.S. hyperscalers, the projection is the 50 million units. That's a significant number compared to, say, calendar year '25, probably will be ending up like 30 million units. So we have a solid base and then overlay the 3 growth drivers on top of it. LPO transition bring more content. SAM is 250% of the DSP-based transceivers. ACC is a net revenue adder. And with this hyperscaler, we project a pretty rapid ramp in the second half of the year than the 1.6T. And the other segment, I will hand it over to Mark to talk about it. We got multiple drivers as well.

Yes. So I'm pleased that say Semtech is firing on all cylinders across all of our end markets. So I'm pleased in that area. High-end consumer, we've released our results for Q3. We're clearly outgrowing, let's say, handset volume as a proxy, right? So that is a great indication where we're gaining market share. We're getting content on devices. in handsets and in wearables, right? That's a new growth area for Semtech. In the industrial side of the business, that business is also inflected to growth. LoRa, we posted over a $40 million quarter in Q3. In that area, we have multiple growth drivers as well. This is where we put in some good amount of investment in the past, and that's really resulting in some very nice top line growth for LoRa. LoRa, we can see growth in dual band, so sub-gigahertz, which is what LoRa is known for, plus 2.4 gigahertz that's expanding a lot of market share, being able to transmit a photo, an image, is really increased adoption, let's say, in the drone market. And then another area is LoRa Plus, another area where we can introduce LoRa Plus another protocol like Z-Wave, really expanding the use cases for LoRa. We received some very nice growth. As we said on the last call, we're ranging from $30 million to $40 million as a base per quarter, growing at about 15% to 20% CAGR.

And can you talk about the force sensing business, the new force sensing business?

Yes. So we identify the 3 key areas, the core asset, data center, LoRa for IoT and then sensing. So we have our portfolio of the technology in a product, the person sensing for a specific absorption read and also [ gesture control ]. That's based on capacitive sensing capabilities. And when we did the road map exercise with our technologies, we always feel that adding force sensing onto our existing capacitive sensing and [indiscernible] sensing technology will broaden our capability, will allow us to penetrate in a broader customer base. It just so happened this technology, this asset available we grabbed it and this is a really pretty exciting opportunity for us. We've got this -- acquired this asset from Qorvo. They acquired a company called NextInput 4 years ago. They have about 175 issued and pending patents. We -- together with the deal transaction, about 50 key employees came with it. So we are already addressing some common customers with the combined solutions. We do expect this combination by leveraging our global sales and supporting staff will help us to accelerate the force sensing business, but also pull through our capacitive sensing business. So this is very synergistic.

So is there any way to size like how much the synergies could be the force sensing business combined with pulling through your other businesses? Like is it crazy to think that next year, I would think it's probably not going to be that much. But in 2027, is it -- I mean could it be a $40 million or $50 million type of an outcome having acquired that.

That's consistent with our model and thinking and projection.

Okay. And then can you talk a little bit about just about the asset divestitures that's something that you've been fairly consistent that you want to clean up the product portfolio more. So can you just talk about that?

Yes. We've been pretty consistent among the portfolio. When we had a balance sheet limitation, I will say that way, but we still identify some growth opportunities. We delineated the core assets. For those assets, we increased R&D investment over the past 18 months. But for some noncore assets like the cellular module, specifically, to us, it's a challenging. We got a great team and it has been integrating well and has inflected growth, but the margin profile is very different from the semiconductor from even the other part of the Sierra Wireless acquired asset. So it's low margin to us, but to the right acquirer, it's the great margin to them. So this time around, we hired different adviser for [ disclosures ]. So UBS is a transaction adviser for this time, we map out the target space and think about the synergy and did very targeted marketing. And we received multiple indications. We're in the process of due diligence. So that's -- with that part carved out, we'll be able to clear up a lot of noise and solve this margin disparity issue. And then for the employees, the business going with the transaction, they will have a good home, and they will be viewed as a core asset in the new home. So I think it will be good for that business to continue to drill and serve the broader customer base.

And following the divestiture, we're looking at gross margins approaching 60% starting with the 6%. That in and of itself is a really compelling reason for the divestiture. And it's really going on top of our Signal Integrity Products business, which in Q3, we reported a 65.1% gross margin. That segment includes all of our data center business, right? So if you're looking for where we consider growth areas, data center plus ACC plus LPO plus the transition 1.6T. This is a very clear path to 60% plus gross margins for Semtech on a consolidated basis.

And Mark, do you think -- on kind of a pro forma basis, do you think that you'd be able to make it earnings accretive?

Yes, we do.

You do, okay. And just in terms of sort of other optimizations of the portfolio and like how you can -- how synergistic are the -- if we pro forma the business, how synergistic from a development perspective are the remaining businesses going to be?

Yes. Let me just say, at this point, we're really focused on this first transaction, right, the cellular module transaction. We believe that's going to be transformational on gross margin on a consolidated basis. And then after we get that project completed, we'll be looking to maybe provide some other insight into further thinking.

Can we talk about LoRa? So you did say that LoRa is between $30 million and $40 million is your thinking in sort of the near term. I think you guided it back to the middle of the range for December quarter. So can you just talk about the drivers there? I know Gen 4 is gaining a lot of momentum. But just can you walk through that business a little bit for us?

Yes. So LoRa has been traditionally used in 3 vertical -- market verticals, smart metering for the water meter and gas meter, connected spaces for the industrial automation and asset tracking because of the broad coverage and low power. So that's a good sweet spot. And because of the dual band increased the bandwidth from 15 kilobit per second to 2.5 megabits per second, that's significantly increased, that's unlocked some opportunities in the commercial space. For example, commercial drone using aerial survey, you'll be able to snap pictures and transmit back the [ steel ] pictures then giving some -- adding some functionality. And then this LoRa Plus with other RF protocols unlock opportunities like security, smart building. So we are adding more application verticals, and that's the basic driver for growth of the business.

And Mark, can you talk about -- so as you look into the April quarter, what sort of -- I'm not asking you to guide April, but what's the sort of normal seasonality? I know that the IoT business has a lot of seasonality in April. But how to think about the puts and takes seasonally?

Yes. Really, in the April quarter, the only seasonality we somewhat see is in that industrial business, but it's really related to one portion of the business, kind of the routers and gateways business. Other than that, seasonality is typically in the fourth quarter, right? So when we're in high-end consumer, right? Typically, it's down 15% to 20% historically, just based on let's say, smartphone builds. We guided our Q4 down in the low single digits, though. So that's another, call it, proof point of market share gain.

And then this is just more of a -- just how to think about the dilution. There's been a lot of volatility from the converts. So can you just talk about that and just how many shares do we have?

It's absolutely something that we want to address in terms of dilution. So without getting to the math, if you look at our earnings presentation that we issued along with the last call, we have a dilution table. But needless to say, that's something that we want to address. We had 2 converts outstanding. Just last quarter, we took out one of them completely. The other one we reduced by 1/3. So on the 2027 converts, it was about $320 million outstanding. We took that down to about $101 million. Then we issued $402 million in new convertible notes, 0% coupon, and we have a cap call up to 100%. So really, it becomes dilutive at north of around, let's say, about $142. So we've taken care of dilution, we believe, and there's just going to be a lot less volatility due to converts. I think those are both beneficial.

Got it. And then can you walk through just -- this is -- I mean, let's assume pro forma of the business. Can you walk us through some of the puts and takes as you think about gross margin as we go through '26. Can you walk through some of the relative margins of those remaining businesses?

Sure. I'd say it's mostly to the positive. I think there's, in my view, a little bit more upside opportunity than downside risk. So like we said, Q3 gross margin for Signal Integrity, a reported quarter. We had 65.1% gross margin. ACC is additive to that. LPO is additive to that. Other areas, just total portion -- total part of the business, LoRa being an asset that can grow pretty nicely as gross margin starting in the 70s, right? So north of 70% gross margin, that's pretty healthy. So in terms of overall, like I said, if we were to divest the lowest margin portion of our business, again, low margin for us, great margins for somebody else. We quickly approach 60% gross margins. In the growing areas of business, we can surpass 60% in the near term just based on our expectations of growth over the next fiscal year.

And Hong, let me ask you about China. So what are your opportunities in China with the Chinese CSPs, as they start to build out racks?

Yes. So China is an important market for us. We ship our ICs going through distributors in Hong Kong. Some are for the China domestic use, and a lot of them are integrated in China or Southeast Asia, then imported back into the U.S. So in the U.S., we got all the hyperscalers accelerate the data center build-out for AI applications. For China CSPs because of the availability limitation to -- of the GPU, the most advanced GPUs, so their acceleration rate is not as high. And also, most of the optical transceivers, for example, is 100 gig per lane, 800 gig level, but it's still pretty healthy in growth. So we have a very broad penetration. We probably, as of September -- well, a couple of months ago, we were able to address the last customer that we had no component in it. So we supply to everyone, every optical module suppliers. Some of them are more focused on China market, and some of them are mostly focused on the U.S. market. So they are not growing as fast as the U.S. market, but still demonstrated sequential growth.

Great. And then last thing, Hong, I wanted to ask you, you mentioned on the call, you said your 2 priorities. One is to your growth opportunities in -- with your core assets; two is to divest the noncore assets. But then you said to fill capability gaps. So where do you see your capability gaps?

Yes. So we wanted to clearly -- the data center is a key area we wanted to grow today in our transceiver content. In the transceiver content, our contribution is still limited. It's just still limited at the physical media device level, drivers and TIAs. It will be great to have the optics. But we're looking at differentiating capabilities, not just for the sake of it. We can have the operational leverage, but we are looking for differentiated capabilities that we can co-sell with devices. So -- and we are looking at other areas as well. But for now, we wanted to focus on making the capacity available to capture the growth opportunity and never wanted to miss the opportunity because of the capacity because the lead time limitations. So we're addressing that proactively.

And these are things you have to acquire? Or do you think that you could...

This thing is more the operational focus, but then some gaps are internally developed because we have multiple generation road map alignment with some key customers. We know where the gaps are. So going forward, now our balance sheet is much stronger than before. We'll be more heavily indexed in R&D growth in the data center area, R&D investment in data center area to accelerate the growth in the future years.

Perfect. Well, we're out of time. Thank you, Hong and Mark.

Thank you so much, Tim.