Semtech Corporation (SMTC) Earnings Call Transcript & Summary

Welcome back, everybody. I'm Joe Moore, Morgan Stanley Semiconductor Research. Very happy to have the executive team of Semtech, Hong Hou and Mark Lin with apparently some breaking news I'm told around a facility acquisition. Maybe you could give us an overview of what you just announced in the last few minutes.

Sure. Thank you, Joe. Good afternoon, everyone. You probably haven't get a chance to read the news yet. It's just crossed the wire. So we acquired a semiconductor laser company, indium phosphide-based lasers designed for high efficiency for optical transceivers and more ideally in the CPO, MPO modules and also for the tunable lasers for metro and DCI applications. So this leverage more than four decades of the innovation from the good old for us being around for a long time. Ortel was founded in 1980. It was the first company to commercialize the DFB lasers and Ortel was bought by Lucent. Lucent was bought -- that division was bought by Amkor when I was the CEO there. So now going a full circle, we just acquired that company called [ Hifil ].

Okay. And maybe help us what does that unlock for you guys? Obviously, you have a very strong business in sort of copper capable technologies and this push into optical. What does it help?

Yes. So definitely, we have been focusing on growing our business in the core asset area. Data center is one of them. And for optical transceiver space, Semtech is known to be a provider of the best TIAs for high-bandwidth optical transceivers with the data rate creeping up from 100 gig per lane to 200 gig to 400 gig and also the pursuit for low-power solutions, the LPO and also the DSPs with the manufacturer -- the advanced nodes that require driver solutions as well. So we are expanding our play -- our content in optical transceivers with the drivers. But that's about it for the electrical space. On the optical side, this really set a strong pillar for us to build a platform to provide comprehensive component solutions with the lasers and then we can get into the modulators and in the future, even photo detectors. But the lasers technology we bought in the fab we have indium phosphide-based high efficiency and provide wall plug efficiency well over 40%. So that's about the best, most efficient lasers in the industry. So certainly, that gives us an anchor to really build this comprehensive portfolio for 3.2T optical transceivers and CPO and NPO where they also need high-power lasers.

That's great. Thank you. So I always appreciate breaking news at our conference. Maybe we could wrap that into a discussion about your data center business. Can you talk about your overall positioning within data center and give us an overview of some of the products? And then feel free to wrap in anything that you just acquired into that.

Yes. So our data center -- we have a pretty diverse portfolio and our TIA and Tri-Edge business and TIA in the FiberEdge category. As we are reading the same report, there's going to be a very strong increasing demand for 800-gig optical transceivers. For single mode, we have a pretty good market share, about 50%. So that demand is growing, and that's the baseline. LPO introduction, we announced in the last earnings call that is going to be a milestone for the industry to move to high power efficiency, low-power consumption solutions like LPO and that start ramping. So adding a growth driver on it. The importance of LPO also that's a prelude in my view, is MPO or CPO because it's all going to be DSP less solution. And then we have the copper product, as you alluded early on, the copper edge to provide redrive solutions to extend the reach in the cable or in the copper trace on the PCBs. So the ramp for hyperscalers is going to start midyear this year. That's adding another step function. Then 1.6T, the early deployment, we were -- we had a very minimal play in there. but the industry is moving from 5-nanometer DSP to 3 to 2-nanometer DSPs in the second design cycle, we are front and center in there. So that's representing a step function on top of this baseline and a couple of incremental growth drivers. Now with the high-power lasers, we'll be able to provide optical solution co-optimized with our drivers and TIAs. So it's going to be good for the industry.

Okay. Very helpful. Looking at the TIA market, we've seen really strong market for optical transceivers -- there was other breaking news at this conference about prepurchases of optical components. Where do you stand within that supply chain? Are you tight? Is there other components that are tight around that? And that shortage of optical transceiver seems to be not quite at DRAM HDD levels of seriousness, but approaching that?

It's pretty tight. So we anticipated this because we have been engaging with our customers' customers very closely, like cloud service providers and GPU and CPU companies and ASIC designers as well. We know this is coming. And in my last earnings call three months ago, I was one of the priorities is to make capacity available. The current manufacturing partners, they are in allocation mode for the capacity. The good thing is we build ahead a little bit, and we -- that created a little briefing room and buffer that give us time to qualify additional foundry capabilities and capacity. So we'll be out right for the next 12, 18 months as we see the trajectory in our forecast.

Okay. And I guess, you're getting visibility into the next 18 months given the repurchasing activity and things like that.

That's right. So we have this long called a co-planning process with the lead customers. Their supply chain has the keen interest to make sure that their suppliers -- their supply chain is robust. So they give us forecast, we're able to get the wafers started way before their demand, but we have certain level of commitment, mutual commitment. And that model has worked out very well. We have expanded the co-planning process from a year ago, one customer to currently seven customers, so.

Okay. And is that growth also strong in 800 and 1.6, both .

Yes. So 800, we had visibility early on. So we were more prepared. 1.6T is coming, coming very strong, and that's a part we have additional capacity in the fab partner foundry qualified.

Okay. But that growth comes on top of what's still growing 800.

Exactly. Yes.

Okay. Helpful. Some of the new opportunities you talked about, copper edge and ACCs. Can you talk about the advantages of ACCs and where you're seeing initial traction there?

Yes. The ACC compared to the counterpart, the DAC, the direct touch copper, it can only go up to about 1 meter long. That's amazing. Actually, if you think about it. There is a 200-gig per lane, but cannot go longer than that. So the alternative is ACC or AEC. We know AEC has been very successful, demonstrated, but ACC consume 90% less power. And that is really very compelling to this hyperscaler, we worked with them a few months ago. It takes a lot of effort for them to qualify for platforms. So now we are finally about ready to ramp on supporting their multiple applications primarily used in the backplane. The copper edge, in the meantime, it doesn't have to be integrated in the ACC cables. It can be integrated on the board to redrive to stretch the rich of the high-speed signal across the board and between boards. So that's -- I'm just so excited with every time when I talk to my product marketing guys. About a year ago, when we were start doing evangelical work and people were very skeptical and we turned them to somewhat curious. Now it's fully engaged. I will say by this time next year, when we talk again, I would definitely project the linear equalizer copper edge onboard is going to be a pretty substantial part of the revenue contribution.

Okay. So you have one kind of initial customer, but you think -- by this time next year, we'll be talking about more than one.

One initial customer on the cable for high volume. We got 3, 4 smaller volume customers -- but the linear equalizer onboard, we got multiple major customers ongoing right now.

Okay. And did that business participate in the NVIDIA ecosystem? Or is it mostly an ASIC.

It can be. It can be. Yes, the ASICs and GPUs and even the switches, wherever it is fundamentally, when you have a link budget issue challenges, say, from bump to bump, either 35 dB or [ 30 dB ] and every twist and turns, you have losses. So how are you going to be bridge the link budget? Well, you can use redriver or retimer. It's obvious redriver is just a very seamless and consume a lot less power than redriver. So I think that's based on that fundamental is going to be used in many different platforms by many customers and the industry is getting more educated. They feel more increasingly comfortable with the redriver solution by closely working with us starting from modeling to test to qualification corner test and to eventually volume deployment.

Okay. And how durable is that opportunity? I mean, it seems like -- some of that may migrate to optical over time as well.

Yes. So recently, I heard something like you say, "Oh, we need to put a terminal value on copper because this is going to be all optics. I can assure you that was my thinking about 20 years ago. Try to kill copper but the copper is getting stronger and stronger. So for scale up, it's always going to be -- copper is the predominant media. You have a printed circuit board. I don't know printed fiber optics board. So in the shorter distance, you are going to be using copper. This transition from copper to optics you pay overhead. So I would say probably up to 800 gig, you don't need optics to scale up. But the co-packaged optics CPO is totally legit. They co-package with a switch die. So now the industry has a comprehensive ecosystem that can support liquid cooling and with one rack can consume 600 kilowatt or higher. And they can put the switch, the first level switch in the fabric in the rack, and that's co-packaged optics is first scale out, right? So scale up in special use cases, it may be happening in 2, 3 years. But right now, I think...

Maybe longer than that even. I mean, it seems like it a lot of the decisions around that have not been finalized yet, who's using what scale up?

Right. So the good news is we have solutions for copper, we have solutions for fiber as well. If they move from copper scale up to fiber scale up, fine. We have TIAs, we have drivers. Now we have lasers as well. With lasers, we can build silicon photonics modulator because our laser has the best far field pattern. That -- what does that mean is our laser light can couple into silicon photonics waveguide with very minimal loss.

Okay. Great. And then LPO, you've talked about in your initial comments, where are we with regards to potential adoption?

So the LPO adoption is a little different compared to ACC. ACC is more tied to a new platform design. So if they decide to use ACC and combine with the deck, and that's how all the backplane is going to be constructed that way. The LPO is more like the customers has been used it opportunistically. For example, in their system design, they all of a sudden found "Oh, there 2, 3 kilowatts shy in power budget." And they can say, "Hey, look, this is the same form factor, totally interchangeable." And for shorter reach, they can replace retimed transceivers with LPO transceivers. So we're seeing the ramps from the quarter we just finished, and we see this is going to be continued, but it's a gradual ramp. The significance of LPO is really building the confidence in the industry is evolving into this MPO near package optics solution. You don't have to commit pin out and other perimeters for XPU for co-package, but leave the socket open and bring all the optics near the XPU. Then when your XPU ready, it just drop in, of course, you need to clear definitions through multisource agreement, whether is the geometry, pin out, keep out zone, shoreline density, all of that. We're very active in participating in that MSA, but NPO is stemmed from the good success of LPO in terms of signal integrity.

Okay. Great. So you have a lot of growth drivers in data center.

TIAs, I'm very excited about...

Like 6 months ago, we were talking more about new products, but the TIA market also looks very exciting, exactly, at this point.

And then after 200 gig, we have 400 gig, right? So the industry is continuing to push for the innovation in the upcoming OFC in the next 2, 3 weeks. We're going to showcase multiple chips from TIAs to drivers, to linear equalizers operating at 200 gig per second.

Okay. Great. Turning to industrial. LoRa was pretty strong in Q3. Can you talk about the outlook for that business and help us sort of size the exposure?

Yes. So LoRa continue to be very strong. Traditionally, the LoRa has been used widely used in three vertical markets. Smart metering for water meter gas meter is really long range, low power and very robust connectivity serves very well. That continues to be strong, but you only have so many meters and then the battery works for 15 years. We'll continue to have a good business on that asset tracking and connected spaces. The most recent application drone has been really fantastic. The commercial drone and our product manager show the display, the Chinese New Year, they don't light up the fireworks anymore. They launched drone show each fleet, they get 20,000 drone that can change the pattern and other different colors, it's a fantastic -- and of course, the slow attitude economy in China, that's a very fertile ground for a lot of innovations. So drone is fourth vertical -- and because of the bandwidth increase using dual band, we're not only using LoRa to send control signals, but they can transport with a very respectable bandwidth right now is at a 1.6 megabit per second. That's increased from 10, 15 kilobit per second. So combined with some compression technology, people are developing use cases for edge AI. So they can take a snapshot, steel picture, send it back for archiving -- and for shorter distance like within a couple of hundred meters, you can even have the live video we demonstrated at -- at CES a month ago. So that's high bandwidth, we benefited from that in unlock other vertical with edge AI. Then this Gen 4, LoRa plus, its LoRa plus another protocol, unlocked some other applications like security in smart homes. So we'll continue to expand the application use cases in different market verticals. We can easily see that business continue to grow at 15% to 20% year-over-year growth rate.

Okay. And can you give us a little bit more color on the Gen 4 multiprotocol, what that does?

So Gen 4, basically, people like the LoRa and -- but they wanted to have some other like a BLE protocol to say, the building managers, they wanted to send out kind of like a command to lock out all the doors in the building, and that works really well. But it has a little bit latency. And -- but you combine with another protocol like a BLE in there, near term is short is BLE and -- but not losing the LoRa feature. You basically have 2 IoT protocols in 1 -- and we have LoRa plus BLE, ZigBee, Thread, Matter and Z-Wave. And of course, each protocol, you need a software development kit to activate it, and we are doing one after another.

Like many silicon labs in a way.

Yes.

Okay. Great. And then maybe just to round out the markets, high-end consumer a lot of anxiety about memory constraints and what that might mean for the -- for some of the consumer businesses. Can you talk about that?

Sure. Mark you want to...

We're still pleased with our high-end consumer end market. In this area, we've been outpacing, let's say, just handset unit growth, and this is really due to Semtech's ability to capture market share and increase our content within the device. The last quarter, we talked about various TVS Transient Voltage Suppression devices. These aren't commodity devices. We're really protecting high-speed ports and to be able to clamp down the voltage and meet our customers' requirements on a high-speed data line. It's not something easy to do. So in that case, we still feel very strongly about that market. We also have within that high-end consumer market is our per se sensing portfolio. Within that portfolio, we have what we believe is a leading-edge product there for sensing. Traditionally, it's been used in handsets to detect how close the handset is to a person's body, kind of lower the power, be form a way, meet specific absorption rate requirements. This is also an area where we had a nice small tuck-in acquisition at the beginning of the quarter. We're adding not only our per se product, we're adding a force sensing product, a force touch product. It's a really nice combination of 2 areas. And this force sensing product that was really on our product road map. This was a clear way of maybe expanding on the make -- buy versus make thesis rather than wait 3 years, we had a portfolio that was available to us at quite a reasonable price. I think last quarter, we said it's well under 1 quarter of operating cash flow.

Okay. That was from Qorvo.

Correct.

Any other acquisition targets that you guys think about or any capabilities that you might need within really any of the businesses, which you know...

Yes. So we're constantly looking at our road map and most of the ideas and projects and desire stem from the interaction with the customers. when we provide a solution, they ask, do you have that? What about this? Okay. That's defined our road map. So Mark mentioned about this force sensor. It was on our road map and you come to make or buy opportunistically when that asset became available, we just snapped it. Here, this acquisition we just did the HFO in that category as well, there has been a little bit longer pursuit. We know that for the data center growth in order to grow the content, for example, we have the aspiration for 800-gig optical transceivers. We provide TIAs. Our content is only high single digit. I wanted to be growing into high double digits by 3.2T. So we got to grow, but you can't really do the me-too to chase the market, especially when the market grows so rapidly, and we have to be able to think ahead and build some differentiations. So that's on our road map, and we pursued others and didn't come through, but this one, we drop to the finish line. This is a very exciting opportunity for us to put another anchor to build a platform. I use that analogy. As for other targets, certainly, we are having strong aspiration. We got more ideas to drill, but nothing at this point. It's close to...

Sure. I think we've been pretty prudent and selective in targeting on acquisitions. And we're bringing that same muscle memory from how we invest in our organic R&D. R&D is -- we increased R&D, but the return on this investment for our R&D, it's been proving out LoRa data center per se. And this acquisition that we just announced today, consideration is about $34 million. So very, very prudent use of capital to really expand Semtech's market share, markets.

Yes. That's great. Maybe we could talk about the Sierra Wireless situation. How do you think about the outlook for IoT Cellular? And is the divestiture of noncore assets still something that you?

Yes. Maybe I'll address the divestiture. So this is of the cellular module business, which we've spoken about and we discussed on our last call. This business is still performing quite well. Backlog and order rates are still quite strong. This business though has about a 20% gross margin. So it just doesn't fit in Semtech's portfolio. It's a great business that fits in someone else's portfolio. The process for divestiture is ongoing. It's an active process, and we have multiple touch points a week and diligence calls and whatnot. So it's difficult for me to peg a time in terms -- because it moves the deal speed, but I'm very -- I believe that the deal is pending, optimistic that we can get this to a close.

Okay. And then what do you think the gross margin profile of the company looks like post divestiture.

Sure. Just historically, if you strip out this business, we're approaching close with striking distance of 60% gross margins. And what Hong was talking about in these growth areas, especially in data center, right, it's accretive to that -- very accretive to that 60% gross margin. Last quarter, we reported that our Signal Integrity Products segment had a 65% gross margin and new product introductions would be accretive to that 65%. So really kind of for a company in our space, having a gross margin starting with a 6% is really where we should be.

Yes. Great. Well, look, you've had a great tenure as CEO. Maybe just I'll open up for questions, but just to close for me. The opportunity that you've delevered the company and now you're able to focus on these growth drivers, it seems apparent that sort of that delevering process was a major focus in the beginning. At this point, you're really focused all forward on growth.

That's right. Yes. So we have come a long way in a short time. So certainly, when I started about 20 months ago, with the CEO. So we kind of map out the 3 stages. It's a little bit tongue and cheek. We say some tech rising. We need to absolutely beef up our balance sheet to fix the balance sheet. We had a leverage ratio of 9.5x, $1.3 billion net debt, and we do not have any operational freedom to do anything aggressive. So Mark has led the effort. We benefited from the good market as well. We did the financing. We now today totally fixed the balance sheet. We have well over $600 million liquidity. We can do things somewhat more aggressive. But even in that time, the second pillar of the Semtech Rising is we are a technology company. We have to delineate what is the core, noncore and invest -- accelerate invest in the core area. So that's why we were able to gain market share in the data center. That's why we were able to expand our portfolio with a limited financial capability. And the third thing is the employee morale. We're not sure what the future of the company is through the Semtech Rising initiative, we built the transparency, build the trust and getting the whole company going into the same direction. So that has been great. Then what? The second step was the Semtech transforming. So it's again, tongue and cheek, but it's really significant. We wanted to optimize our portfolio, some noncore assets we're doing divestiture. I would say we're well within 20-yard line. So -- and I'm optimistic it's going to happen. And then we're adding things in the core asset area and to really evolving ourselves from the commodity component second source supplier to the leading solution provider. We wanted to be in a room when a new standard, new solutions come about. For example, last week, we instigated and founded the MSA for ACC that drive a standard and benchmark how to do test, what kind of performance you should expect. We're going to do the same thing on MTO side. And then we have, again, as I said, have a pretty aggressive plan and very exciting road map. We're going to increase R&D investment. Now we have the capability, we can do that. And we're going to continue to look around some tuck-in opportunities. Then the third step, we wanted to be the industry leader in the area we are in, Semtech excelling, deliver higher growth rate than peers, deliver higher operating margin than peers. So we -- I think we're well underway and we're pretty excited about what's ahead of us.

That's helpful. I actually did have one additional question. Just your relationship with hyperscalers, that seems really important when you're sort of pushing in these data center markets. Are they coming to you with projects, things that they want, sharing their road map with you?

Yes. So it's not easy. Sometimes it just take the persistence, but the overarching principle is the customers, they are so busy. They don't want to meet you if you don't add value. So good thing is in the beginning, I had a good connection and I was able to keep the doors open. And when I got my guys in, they really see the analog design is not easy. We are really known, that gentleman in the back was telling me that I was so happy to hear that. Yes, so we were able to do modeling end-to-end signal integrity in the beginning, you must have a model, we have a model as well. Now they realize Semtech has a really very robust model. So before they define a platform architecture, they wanted to check what are the boundary conditions. Can this be achieved or not? So we're the guy, and that's really a great position to be.

Great. With that, let me see if there's questions from the audience. If not, we'll wrap up there. Thank you so much.

Thank you, Joe.

Thank you Joe.