Semtech Corporation (NASDAQ:SMTC) Q3 2024 Earnings Call Transcript
Semtech Corporation (NASDAQ:SMTC) Q3 2024 Earnings Call Transcript December 6, 2023
Semtech Corporation beats earnings expectations. Reported EPS is $0.02, expectations were $-0.15.
Operator: Good day and thank you for standing by. Welcome to Semtech Corporation's Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management remarks, there will be a question-and-answer session. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to Mark Lin, Executive Vice President and Chief Financial Officer. Thank you, sir. Please go ahead.
Mark Lin: Thank you, operator. Good day everyone and welcome to all those joining today's call, including analysts, investors, and my fellow employees. I'm Mark Lin, Executive Vice President and Chief Financial Officer, and I'm joined today by Mr. Paul Pickle, President and Chief Executive Officer. Today, after market close, we released our unaudited results for the third quarter of the fiscal year 2024 which are posted to our Investor website at investors.semtech.com. Supplemental earnings materials including net sales data by end market, reportable segment, and geography, as well as the share count table reflecting potential share issuances from our convertible notes at various stock prices are also posted to our Investor website.
Unless otherwise noted, all income statement-related financial measures will be non-GAAP other than net sales. A discussion of why the company considers such non-GAAP financial measures useful along with reconciliations of such non-GAAP measures to the most comparable GAAP financial measures are included in today's press release. 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 Risk Factors section of our most recent periodic report filed with the Securities and Exchange Commission.
As a reminder, comments made on today's call are current only as of today and Semtech undertakes no obligation to update the information from this call should facts or circumstances change. With that I will turn the call over to Paul to discuss our business and end markets.
Paul Pickle: Thank you Mark. Semtech's Q3 financial performance generally met my expectations with net sales slightly above the midpoint of guidance. I'll provide a bit more color on end-market performance, which we believe improves understanding and comparability of our business before turning the call back to Mark. Infrastructure net sales were $43.2 million, a sequential increase of 2%. Hyperscale data center applications benefited from continued momentum of AI-driven applications and grew both sequentially and year-over-year. We recorded growth in general compute data center applications as well. We had record shipments in 200-gig, 400-gig, and 800-gig applications with our Tri-Edge and FiberEdgeproducts having been well received in data centers around the world.
Net sales for other products in the infrastructure end market including passive optical network, wireless, and infrastructure-focused transient voltage suppression faced a headwind from elevated channel inventories, though POS for each of these products grew sequentially. As stated previously, PON tenders are expected in our fiscal fourth quarter and we have seen some early channel pause in anticipation of this timing. We believe we continue to lead the PON space. Last March, we announced the world's first 50-gig PON chipset which enables multi-gigabit broadband services for multi-tenant locations and will drive new use cases for the PON market including enterprise applications for small business needs. This chipset is currently sampling with module vendors and system integrators with positive feedback.
We have also started sampling 1.6 terabits in linear pluggable optics applications at optical module vendors and system integrators with early success. We believe our technology solutions have meaningful advantage in AI applications offering lower cost, lower power, and lower latency. Net sales from these leading-edge applications are expected to begin in the second half of calendar year 2024. On the automotive front, while net sales are currently small, we believe we are making inroads with the next-generation Ethernet protection devices. Adoption of automotive Ethernet continues to accelerate and our leading products in this space are positioning us for future growth. For the fourth quarter, we expect net sales from the infrastructure end-market to be flat to slightly down as the market further digests channel inventory.
High-end consumer, net sales were $37.6 million, a sequential increase of 10% benefiting from seasonality in TVS products primarily directed at smartphone applications. Sales from these TVS products increased both sequentially and year-over-year with corresponding increases in POS. Strength in the quarter was driven by a measurably greater protection content in current generation products at a leading North American smartphone manufacturer compared to prior generations. Design wins also grew 10% sequentially for handheld devices and wearables further validating our recent innovations in this space. Sales from proximity sensing products declined slightly on a sequential basis, but grew year-over-year, while encouragingly POS grew on both a sequential and year-over-year basis.
Our PerSe Sensing solution provides capacitive touch end-user sensing capabilities. For wearables, PerSe sensors improve the user experience by providing automated functionality and rapid response interactions such as smart assistant activation, noise cancellation control, and media player management. Our PerSe sensors also provide the industry's best performance of minimizing end-user's exposure to RF energy. This allows equipment manufacturers to achieve compliance with specific absorption rate or SAR regulations while maintaining optimal signal connectivity. While PerSe is well known in the smartphone space, efforts to reduce SAR have opened opportunities and design-ins for applications including notebook computers, tablets, and wearables.
For the fourth quarter, we expect net sales from the high-end consumer market to be down due to the aforementioned seasonality and channel inventory digestion. Industrial, net sales were $120.2 million down 26% sequentially, but within expectations with the bulk of the decrease in the ISP modules business. Semtech delivers product leadership in low power wide area and broadband applications and will continue to leverage these areas to return the business to grow. IoT Connectivity Services reported net sales of $24.2 million up 1.4% sequentially highlighting the stickiness and relative stability of this recurring revenue stream. Within AirVantage Smart Connectivity, we continue to see growth in our advanced service line, which offers global access through a multi-EMC multi-profile single SIM solution.
Our carrier plus offering which simplifies regional deployments with multiple Tier 1 carriers is showing growth, particularly in Australia and New Zealand. These growth areas are partially offset by the sunsetting of legacy technologies, but net to stable sales. Net sales of LoRa-enabled industrial products declined sequentially but POS and bookings increased, providing some indication of market recovery. Connected gateways increased 3% sequentially and we are encouraged by substitutes, increases in POS for in-node products. Adoption of LoRa-based solutions in the utility space gained further traction in Q3 with multiple European-based utilities announcing RFPs with a requirement for a LoRa solution. We are also integrating LoRa into custom SoCs for our customer, which has expanded opportunities in hearing aid applications.
Returning to our hardware business and expanding on the regulatory environment, I discussed in our last quarter's earnings call, as the largest North American module supplier, Semtech is definitely seeing a meaningful share shift in pipeline from our competitors to us and pipeline is translating to design wins. Customers in this market have varying degrees of risk tolerance, most sensitive as critical infrastructure such as industrialized laptops used by first responders in cellular routers used by utilities, we are now benefiting from the next wave of concern with applications that involve payments or personal identifiable information. Point-of-sale devices are a prime example where there was perhaps a hyper-focus on cost for point-of-sale applications, the security of Semtech as a North American supplier has resulted in design wins that translates to revenue in the second half of next year.
Our near-term headwind for our router business is government spending constraints under the current federal budget situation with traditional end-of-year public sector spend lower than trend. For the fourth quarter, we expect industrial net sales to be flat to slightly down with continued inventory digestion and the aforementioned public sector headwinds, but stable net sales from our managed connectivity offerings. Now I'll turn the call back over to Mark.
Mark Lin: Thank you, Paul. Turning to our Q3 results, we recorded net sales of $200.9 million slightly above the midpoint of our guidance. Paul discussed end market net sales performance with infrastructure up 2% sequentially, high-end consumer up 10% sequentially, and industrial down 26% sequentially. I'll refer participants to our investor website for the last five quarters of net sales data by end market, reportable segment, and geography. Gross margin was 51.3%, a sequential increase of 170 basis points and above the high end of our guidance for the quarter. Gross margin reflected well-negotiated supplier concessions to reduce third-quarter manufacturing costs offset by incremental inventory reserves and unfavorable mix.
Supplier agreements particularly benefited IoT systems for the third quarter. Netting these items, consolidated gross margin would have approximated the midpoint of guidance. Operating expenses were $82.5 million favorable to the midpoint of guidance with R&D expense sequentially increasing about $900,000 and SG&A sequentially decreasing by $4.1 million. Net interest expense was $22.3 million with only about one week's benefit from the capital structure change completed at the end of October. We recorded net earnings per share of $0.02 based on a diluted share count of 64.3 million shares. Changing gears to the balance sheet, we ended Q3 with a cash balance of $123.8 million and undrawn revolver capacity of $280 million, working capital moved in a favorable direction with inventories decreasing $19.6 million.
Principal outstanding on our debt was $1.4 billion with a weighted average interest rate of 5.57%. At the end of the third quarter, our consolidated net leverage ratio calculated in accordance with our credit facility was 6.49 and we expect to maintain compliance with our debt covenants for the next 12 months. Including the effects of our convertible notes and interest rate swaps, loan principal was about 83% fixed and 17% floating at the end of Q3 and all of the loan principal was long-term. At the end of Q3, there are no scheduled principal payments on our senior secured credit facility until January 2028 and no scheduled principal payments on our convertible debt until November 2027. I'd like to discuss the five-year $250 million, 4% convertible note we issued this past October.
In addition to the benefits of increasing our mix of fixed to floating rate debt and eliminating scheduled principal payments on our term loan, we placed emphasis on reducing cash interest costs. A Federal Reserve rollback in interest rates may occur when I turn on the high beams, I expect to be in a protracted elevated interest rate environment. As I mentioned, all of our loan principal is long-term. While deleveraging is a key use of excess cash, the convert eliminated $67 million in scheduled principal payments next fiscal year providing optionality. Also addressing dilution, please refer to the convertible notes dilution table posted at the Semtech Investor website. This table provides incremental dilutive shares on both the 2027 and 2028 convertible notes.
On both the notes par value or principal is paid in cash and conversion of par is settled in cash or shares at Semtech's discretion. Assuming the conversion of both notes was settled in shares, dilution of 20% is reached at a stock price a bit above $85 with no effect on diluted shares today. On the date we priced the 2028 notes offering, a $250 million raise would be the equivalent of 15.6 million shares or an immediate 24% dilution, which I do not believe counteracts the benefit of reduced interest expense. I hope this extended explanation provides some insight into management's calculus in issuing the convert. Free cash flow was $12.4 million use of cash, reflecting ongoing restructuring and integration activities, but sequentially improved $6.5 million.
Adjusted EBITDA was $28.1 million compared to $39 million in the second quarter. Now turning to the fourth quarter guidance, we currently expect net sales of $190 million plus or minus $10 million. Our industrial end market is expected to be flat to slightly down. The high-end consumer end market is expected to be seasonally down and the infrastructure end market is expected to be flat to slightly down. While end customer demand consisting of direct shipments plus POS has improved, our net sales guidance reflects a thoughtful reduction in channel inventories. This unexpected product mix, gross margin is expected to be 48% plus or minus 100 basis points. Operating expenses are expected to decrease 10% at the midpoint to $74 million plus or minus $2 million primarily reflective of cost reduction actions we've already implemented in the third quarter.
SG&A is expected to sequentially decline 13% to $33.5 million at the midpoint. Research and development expense is expected to sequentially decline 8% to $14.5 million at the midpoint and we do not believe we have materially impacted projects that result in near-term revenue or materially affect any of our customers' roadmaps. Net interest expense is expected to be $21 million reflective of timing of interest rate reset periods relative to quarter-end. These amounts are expected to result in a diluted loss per share of $0.05 plus or minus $0.06. I'd now like to turn the call back over to the operator for Q&A.
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