Semtech Corp Q1 FY2020 Earnings Call

Good afternoon. My name is Erica, and I will be your conference operator today. I would like to welcome everyone to the Q1 FY '20 Semtech Corporation Earnings Release Conference Call. Thank you. Mr. Sandy Harrison, Director of Business Finance and Investor Relations, you may begin your conference.

Thank you, Erica, and welcome to Semtech's conference call today to discuss our financial results for the first quarter of fiscal year '20. Speakers for today's call will be Mohan Maheswaran, Semtech's President and Chief Executive Officer; and Emeka Chukwu, our Chief Financial Officer. A press release announcing our unaudited results was issued after the market close today and is available on our website at semtech.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 Semtech undertakes no obligation to update the information from this call should facts or circumstances change. During the call, we will refer to non-GAAP financial measures that are not prepared in accordance with generally accepted accounting principles. Discussions 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. All references to financial results in Mohan and Emeka's formal presentations on this call refer to non-GAAP measures unless otherwise noted. With that, I will turn the call over to Semtech's Chief Financial Officer, Emeka Chukwu. Emeka?

Thank you, Sandy. Good afternoon, everyone. For Q1 fiscal 2020, net sales as expected decreased 18% sequentially to $131.4 million. In Q1, shipments into Asia represented 78% of net sales. North America represented 12%, and Europe represented 10%. Total direct sales represented approximately 38%, and sales to distribution represented approximately 62%. Our distribution business remains balanced with 54% of the total POS coming from high-end consumer and enterprise computing end markets and 46% of total POS coming from the industrial and communications end markets. Q1 bookings improved nicely Q-over-Q and resulted in a book-to-bill above 1. Accounts bookings accounted for approximately 47% of shipments during the quarter. As expected, Q1 fiscal 2020 GAAP gross margin increased 10 basis points sequentially to 61.9%, while Q1 GAAP operating expenses declined 5% sequentially due to the one-time benefit from the reduction in the fair value of contingent earnout obligations and lower intangible amortization expense. In Q1, GAAP interest and other expense was $1.4 million, an increase from the $548,000 in Q4 that had benefited from a $1.3 million gain on the sale of an investment. Q1 GAAP tax benefit of approximately 20.3% was driven by the discrete tax benefit from Comcast exercising its remaining warrants. We expect our GAAP tax rate for the rest of fiscal year 2020 to be in the range of 15% to 19%. Our GAAP tax rate forecast excludes consideration of any impact from discrete items, including excess tax benefit or deficiency from exercise of stock options. Moving onto the non-GAAP results, which exclude the impact of share-based compensation, amortization of acquired intangibles, acquisition-related or other nonrecurring charges. In Q1, non-GAAP gross margin increased 10 basis points sequentially to 62.2% as expected, and we expect Q2 non-GAAP gross margin to remain flat. In fiscal year 2020, we expect our gross margin to remain stable driven mostly by end market mix. Q1 non-GAAP operating expense was $53.1 million, flat with Q4, as higher payroll expense was offset by lower new product spending due to timing. In Q2, we expect non-GAAP operating expense to be flat or decline 4% sequentially because of lower variable compensation expenses driven by lower revenue expectations. While maintaining our investments in our key growth drivers, we expect our non-GAAP operating expenses for fiscal year 2020 to be approximately flat or only moderately higher with the prior year. We expect our fiscal 2020 non-GAAP tax rate to remain in the 15% to 17% range. In Q1, cash flow from operations decreased sequentially due to lower net revenue and annual disbursements for supplemental compensation. Our stock repurchase authorization stands at approximately $181 million. We expect to continue to use our cash to opportunistically repurchase our shares, make strategic investments, and pay down the debt. In Q1, accounts receivable decreased 15% sequentially due to lower net sales and represented 50 days of sales, which is above our target range of 40 to 45 days. In Q2, we expect accounts receivables to increase, but for days of sales to return within our target range. Net inventory in absolute dollar terms increased 15% sequentially, and days of inventory increased to 125 days, which is above our target range of 90 to 100 days. In Q2, we expect our net inventory to be up in absolute dollars and days to be flat due to the export restrictions on a key customer and expectations for higher sales in the second half of the year. In summary, we were able to achieve our Q1 expectations in a difficult macro environment. Bookings grew strongly sequentially as we have seen signs of inventory levels in several markets beginning to normalize. While we sense geopolitical challenges from the export restriction are contributing to near-term customer uncertainty and impacting our revenue, we will continue to forecast execution and believe the long-term secular nature of our growth engines position us for a stronger second half of fiscal 2020. I will now hand the call over to Mohan.

Thank you, Emeka. Good afternoon, everyone. I will discuss our Q1 FY '20 performance by end market and by product group and then provide our outlook for Q2 of fiscal year '20. In Q1 of fiscal year '20, net revenues decreased 18% over the prior quarter to $131.4 million. The weaker overall global demand environment in all our end markets contributed to the decline. We posted non-GAAP gross margin of 62.2% and non-GAAP earnings per diluted share of $0.34. In Q1 of fiscal year '20, net revenues from the industrial market declined and represented 30% of net revenues. Net revenues from the enterprise computing end market declined and represented 27% of revenues. Net revenues from the communications end market declined over the prior quarter and represented 10% of total net revenues. Finally, net revenues from the high-end consumer market increased 13% over the prior quarter and represented 33% of total net revenues. Approximately 25% of high-end consumer net revenue was attributable to mobile devices, and approximately 8% was attributable to other consumer systems. Our Q1 high-end consumer revenues were positively impacted, as expected, by Huawei's increase in demand, which we believe was a result of them increasing their chip inventories in anticipation of a potential ban. I will now discuss the performance of each of our product groups. In Q1 of fiscal year '20, net revenues from our Signal Integrity Product Group decreased 30% over the prior quarter's record results and represented 38% of total net revenues. As expected, demand decreased across all of our target market segments, including the data center, PON, and wireless base station markets. In Q1 of fiscal year '20, data center demand declined as cloud and hyperscale data center providers further reduced inventory levels. Our ClearEdge CDRs continue to perform well in new 25 gig to 100 gig NRZ-based optical modules and active optical cables. We believe customer inventory levels are returning to normalized levels, and demand forecasts from our data center customers and bookings have started to improve. In fact, our Signal Integrity Products Group recently received the largest-ever single order for our ClearEdge CDRs for a North American mega data center customer. During Q1, our initial Tri-Edge PAM4 CDR samples experienced strong customer interest, as its low-cost, low-power, and low latency characteristics are ideal for 50 gigabit per second, 100 gigabit per second, 200 gigabit per second, and 400 gigabit per second PAM4 applications. We recently announced our participation in the formation of the Open Eye multi-source agreement. The Open Eye MSA launched with 19 initial member companies, targeting low-cost, low-power, and low latency PAM4 optical modules using analog PAM4 CDRs such as Semtech's Tri-Edge platform. We expect to see our first Tri-Edge PAM4 revenues starting in Q4 this year. Our FiberEdge PMD platform, which complements our Tri-Edge and ClearEdge CDR platforms, continues to be qualified at key module customers where we have collaborated with leading DSP providers for use in next-generation 100 gig, 200 gig, and 400 gig PAM4 optical module solutions. Our FiberEdge platforms have garnered strong design win traction, and we are seeing initial modest revenues from 100 gig PAM4 modules and from 400 gig PAM4 modules. We expect these modules to begin to ramp to volume beginning in FY '21. In Q1 of FY '20, PON demand declined sequentially as expected. Our PON demand is largely driven by China, where demand has softened over the last 2 quarters. Semtech continues to be the PON PMD market leader, providing highly integrated solutions for 1 gig, 2.5 gig, and 10 gig PON ONU and OLT platforms. We currently expect stronger second half PON demand as PON tenders for this year in China indicate unit volumes similar to calendar year '18 volumes. However, the medium-term impact of the Huawei ban on our PON demand will not be clear for another quarter. Our wireless base station demand was also weak in Q1, and we expect this business to also be negatively impacted in Q2 due to the Huawei ban. For FY '20, we expect to see further spending on 4G deployments as well as the ongoing ramp of 5G platforms throughout the year, with stronger growth expected in FY '21. We remain excited about our market opportunity for 5G base stations, which we believe could more than double from 4G due to the larger volumes and additional content as we expect most optical links to require CDRs. Despite the current challenges faced by our Signal Integrity Product Group in this fiscal year, we remain very confident in our strategy and expect our SIP product group to grow nicely over the next few years driven by the ongoing expansion of cloud and hyperscale data centers, the global transition to 5G base stations, and the acceleration of 10 gig PON deployments. For Q2 of fiscal year '20, we expect net revenues from our Signal Integrity Product Group to be approximately flat. Moving on to our Protection Product Group, in Q1 of fiscal year '20, net revenues from our Protection Product group declined 8% over the prior quarter and represented 30% of total net revenues. Demand from all end markets remained relatively weak in Q1. Our automotive protection business gained momentum in Q1 and reflects the need for high-performance protection used in advanced driver assistance systems. Semtech's superior protection performance, including that of our recently announced RClamp 3552TQ, enables our customers to offer enhanced robustness for infotainment systems incorporating ADAS functions. Additionally, newer high-speed interfaces such as USB 3.1 type C, 10 gig Ethernet, and HDMI 2.1 are rapidly proliferating across all end markets and applications. As a result, we see growing demand for our high-performance protection platforms that address these interfaces. Our Protection Product Group remains focused on diversifying from the high-end consumer market to the broader industrial markets where there is an increasing usage of more advanced lithography devices. We believe our investments in these broader markets will enable us to diversify our business over the next few years. In Q2 of fiscal year '20, we expect our protection business to increase as demand from the broad-based industrial end market is expected to recover. Turning to our Wireless and Sensing Product Group, in Q1 of fiscal year '20, net revenues from our Wireless and Sensing Product Group decreased 9% sequentially and represented 32% of total net revenues. Weaker demand from the industrial end markets contributed to the decline. Despite the recent softness in our wireless and sensing business due to a weak demand environment in China, we do expect to see improving demand throughout the rest of the year. Our LoRa momentum continues to build, and we are seeing very exciting momentum across the globe, as underlined by some of the key LoRa metrics we track. These include the number of public or private LoRa network operators increased in Q1 to approximately 113 from 100 at the end of fiscal year '19. We now expect 130 LoRa network operators by the end of fiscal year '20. The number of countries with LoRa networks grew to more than 74 countries. By the end of fiscal year '20, we expect over 90 countries to have LoRa networks. The estimated number of LoRa gateways deployed increased to more than 300,000. These gateways will support approximately 1.5 billion connected end nodes. We expect the number of LoRa gateways deployed to exceed 500,000 by the end of fiscal year '20, supporting a LoRa end node capacity of over 2 billion end nodes. The estimated cumulative number of LoRa end nodes deployed increased to approximately 97 million. We expect this number to exceed 140 million by the end of fiscal year '20. The LoRa opportunity pipeline increased to over $450 million of LoRa-enabled opportunities in our pipeline with an additional $200 million of leads feeding the opportunity pipeline. We anticipate that, on average, 40% to 50% of this pipeline will eventually convert to full deployment over a 24-month time line. In addition to the strong performance on our LoRa metrics, we also began to see a number of new exciting use cases and new ecosystem partners. Some examples of these are: Target announced its use of LoRa to improve retail operations and the retail guest experience at the IoTFuse Conference in Minneapolis; SAP recently announced the integration of LoRa into its Leonardo IoT platform to support LPWAN industrial IoT use cases globally; MachineMax, a revolutionary wireless telematics company, announced its LoRa-based machine sensing system for construction and mining systems, enabling significant fleet management and efficiency improvements; Ineo Sense, an emerging leader in wireless industrial sensing applications, announced its LoRa-based sensing system to monitor and track manufacturing assets in facilities exceeding 100,000 square feet; and Sonova, a leader in advanced hearing aid technology and solutions, announced its latest IoT-connected hearing aid, which uses LoRa to deliver best-in-class wireless performance. Our pipeline of opportunities includes many new use cases, which include very high volume and very disruptive use cases across numerous industry segments. We will discuss these use cases in future earnings calls as they move from opportunities to proof of concepts and design wins. We recently announced the release of our first cloud-based LoRa microservice. Our first microservice is a LoRa-based geolocation service that is available to our partners and customers to track and locate their LoRaWAN devices using the cloud. The interest in the service has been very high, and we are starting to demonstrate the unique value of a LoRaWAN-based asset tracking system to our global ecosystem. We believe that we will start to have customers transition from testing the service to full qualification and commercialization of their services by Q4 of this fiscal year. We expect our LoRa microservices to grow to between $80 million and $100 million in revenues within the next 5 years. Our Wireless and Sensing Product Group continues to focus on developing ways to enable the faster proliferation of LoRa. Specifically in Q1, we started to offer a full suite of hardware reference designs, software building blocks, and a suite of development tools and services that will enable solutions providers and system integrators to move from the concept phase to end deployment more rapidly. In addition to these new platform development tools, we have also accelerated our LoRa design partner program and our LoRaWAN Academy program. Both of these programs have been specifically designed to simplify the development and deployment of LoRa-based solutions and accelerate the time to market of total IoT solutions based on LoRa. Both programs already have large global interest from the developer and academic communities. In FY '20, despite the broader macro concerns and soft demand from China, we still expect our LoRa-enabled revenues to be between $100 million and $140 million, and we continue to expect LoRa to become the de facto standard for LPWAN use cases over the next few years in what we expect to be a multibillion-unit industry. In Q1 of fiscal year '20, demand for our proximity sensing platforms increased and delivered record quarterly revenues due to strong demand from Huawei and increasingly stringent global SAR regulations. We believe our proximity sensing business should continue to expand as we see solid design win progress in new customers and regions as global regulations drive an increase in the need for radio energy management on smartphones and other mobile devices. In addition, as 5G smartphones start to enter the market during the year, we expect to see an increased number of high-performance radios, which drives higher proximity sensing content in these devices. For Q2 of fiscal year '20, we expect net revenues from our Wireless and Sensing Product Group to be approximately flat. Moving on to new products and design wins. In Q1 of fiscal year '20, we released 11 new products and achieved a record 2,884 new design wins. Now let me discuss our outlook for the second quarter of fiscal year '20. Despite the strong improvement in our recent bookings, based on the near-term geopolitical uncertainty and the recent ban on shipments to Huawei, we are currently estimating Q2 net revenues to be between $128 million and $142 million. To attain the midpoint of our guidance range or approximately $135 million, we needed net turns orders of approximately 34% at the beginning of Q2. This Q2 guidance reflects a reduction of approximately $7 million due to anticipated reduced shipments and associated reduced demand related to the Huawei ban. We expect our Q2 non-GAAP earnings to be between $0.32 and $0.40 per diluted share.

And your first question comes from Karl Ackerman with Cowen.

Emeka or Mohan, perhaps to start off with, I'd like to focus on your LoRa business. What percent of your LoRa business today is from your own chip sales versus licensing or royalty revenue from third-party chip sales by your analog and mixed-signal partners? And I guess, as we contemplate your revenue funnel ramping from here, what's the right way to think about the mix of royalty revenue versus your own chip sales and the, of course, commensurate impact on your margin goals?

Most of the revenue in the coming years will primarily come from our chip sales, including both end nodes and gateways. From a licensing perspective, we expect licensing royalties from our partners to start increasing over the next few years, though it will still take some time before it becomes significant. Additionally, we anticipate that microservices revenues will begin to grow next year, but it will take a few years for that revenue to reach a material level. For at least the next couple of years, our revenue will continue to be driven mainly by chip sales for both end nodes and gateways.

I appreciate that. If I could ask one more question. Clearly, the revenue headwind from Huawei and the inventory overhang at some of your customers is impacting your margins near term. However, you've spoken on this call about a recovery in the second half. So how should we think about the progression toward your long-term 34% operating margin target? I guess, is there any certain revenue level we need to achieve that? Or are there certain efficiency programs and product mix that should help us attain that goal?

So Karl, thank you. I think we've said it before that a lot of the path to the midpoint of the revised operating margin range is going to be driven by top line growth. We've done really a very good job of managing our operating expenses and our gross margins are really very stable. We've also indicated in the past that we'll expect to see about $750 million to $800 million of annual revenue for us to get to that midpoint of that range. So that is how we look at it at this point. But clearly, the top line growth is going to be the key driver in that leverage expansion.

And Karl, if you look back at Q3 of FY '19, we had essentially 30% operating margins. So that's kind of the range of revenue that we need to get to.

And your next question comes from the line of Harsh Kumar with Piper Jaffray.

First of all, very good execution and very good commentary in light of all this macro weakness. Mohan, I'm going to put you on the spot. In the last earnings call, I think you mentioned you're looking for a pretty kind of a steep hockey stick like. You might not have used that term, but a pretty steep ramp in the second half. I'm curious with another quarter under your belt and given what all you're seeing in China at the macro level, what would be your best guess if you want to just give some color around how you expect the second half to go.

Yes, Harsh, I believe that even without the Huawei ban, I would still be making the same suggestion. Bookings are strong. We have observed weakness in China for a few quarters, but demand is starting to recover. Our LoRa business is performing well. We are noticing that data center demand is beginning to align better, and we have started to see an increase in orders for the data center segment. Looking across various end markets and product lines, the outlook for the second half remains strong. The Huawei ban creates some challenges for us, both directly and indirectly, but without that, I would still suggest that the second half looks promising compared to the first half.

Very good. And then, Mohan, if I can ask you, there's Huawei, which is one animal that you don't have control over. But I'm still curious. I mean your bookings sound really good. I was curious if you could differentiate or comment on bookings out of China, ex Huawei or outside of Huawei, and provide us any color. Are you still seeing ebbing or flatness there? Or are you seeing a flatter ramp ex Huawei in China?

Well, including Huawei, which is obviously it's a big part of the China demand, but excluding Huawei, I would say the China demand has been soft for the last couple of quarters, and we're starting to see some improvements in that area. So that's kind of promising, of course, with all of the uncertainty associated with the tariffs and now Huawei. How long that can be sustained, I don't know. But at least, from our perspective, that's what we've been seeing, a little bit of a pickup in the rest of the China demand like in China industrial and some of those other use cases.

One last quick one. The $450 million funnel to LoRa, is that including the $100 million you expect from services or excluding that?

We don't have any services at the moment in there, Harsh. The way we look at opportunities and the way we measure our pipeline, these are real proof of concepts and real opportunities that our customers are working on. Now with the geolocation, we've just announced that service. So we now have customers who are starting to look at that. I would say that, that is in addition to the $450 million plus $200 million pipeline.

And your next question comes from the line of Quinn Bolton with Needham & Company.

Wanted to first ask on the Huawei exposure. Can you give us some sense sort of where you're exposed across signal integrity, protection, wireless, and sensing? And specifically, is there any exposure to Huawei on the LoRa business? And then I've got a follow-up on the data center side of the business.

Regarding the LoRa business, there is no exposure to Huawei, which is actually a major supporter of the NB-IoT and competes with the LoRa solution. Most of our exposure is on the Signal Integrity Product side, particularly concerning the PON base station, along with some exposure related to smartphone protection for Huawei. This represents the primary areas of exposure. We don't anticipate significant exposure elsewhere. There are both direct and indirect exposures involved. The direct exposure pertains to what we supply directly to Huawei via HiSilicon. The indirect exposure relates to our other modules and the situations when Huawei faces component shortages, as we learned from the ZTE ban last year, which could adversely affect us. We have tried to estimate the potential impact as carefully as possible, although these are just estimates until we can assess the actual developments throughout the quarter, but this should provide some insight.

And then I know you're not guiding beyond the July quarter, but if I just look at the ban that went into effect May 21, you might have been able to ship approximately 3 weeks before Huawei went to a ban. And so if we're trying to think about what the Huawei impact for future quarters might be if there's no resolution, would a full quarter effect be more likely in the, say, $8 million to $9 million range? Is that a good ballpark for a full quarter basis?

Yes. We think between $6 million and $10 million is a good range. That's what we see today. Obviously, we'll learn a lot over the next quarter, but it's kind of what we're projecting.

Great. And then on the data center business, in the script, you mentioned receiving the largest order in the company's history for the ClearEdge 25 gig CDRs from a North American data center customer. Just wondering if you could provide a little bit more color on that application. I assume that's probably for a CWDM4 100 gig module type application. But just wondered if you could give us a little bit more color on that design win or that order.

Well, other than the 100 gig, CWDM4 and that is a North American data center customer, that pretty much nails it, right? Quinn, I think I can't really give you a lot more color other than this is a customer that has been looking at PAM4 solution and other solutions and decided some of the optics weren't ready and concluded that it's going to stick with NRZ module for now.

And your next question is from Gary Mobley with Wells Fargo Securities.

Great to be on the call for the first time. A question about Huawei. I appreciate the fact that, certainly, a shock to the supply chain, a shock to Semtech and certainly takes, what, $7 million of revenue away from the second quarter. But presumably at some point, somebody is going to pick up the slack of Huawei can't ship and somebody on the Android smartphone front will pick up the slack, somebody on the 5G base station infrastructure might pick up the slack. And then ZTE perhaps on the PON side might pick up some share. So how are you positioned with the alternatives to Huawei? And how do you see sort of the shock Huawei going away and transition to other customers?

Yes, that's a good question, Gary. First of all, we are well positioned alongside most other players in these segments, but until we see the orders and demand, it's very difficult to predict what will happen. In ZTE's case, they initially believed they could build a system but later realized they couldn’t due to a shortage of some components. This led their customers to explore alternative solution providers, resulting in an uptick in orders from other sources. I think we're in a solid position, but the uncertainty remains. Until we receive substantial orders, we cannot make any assumptions.

Okay. So your OpEx guidance for the second quarter appears to be flat to down slightly and flat for the overall year. It appears as though you're managing OpEx by just simply having less bonus accruals perhaps and maybe some other items. But is there any consideration to maybe being a little more streamlined on some R&D activities, maybe making some deeper cuts to OpEx to get back to the target operating margin level? Or is this just going to be top line recovery story?

So Gary, I think it's just going to be a top line recovery story. You're new to the story, so you haven't been here in the past when we had much higher levels of operating expenses. We've already done a lot of the things that you've talked about. We've pruned a lot of our expenses. We've already forecasted our strategies in some areas and making sure that we're focusing on product areas that are very high levels of return on investment. So having said that, we know about 20% of our product expense is still variable, but like you did say, a lot of that is tied on the supplemental compensation. So we do have some room in terms of what we can do. But clearly, the runway that we used to have in the past is no longer as much as what we used to have.

The other point I'd add to that is that most of our investments are platform type of investments, so we're investing for the next generation of LoRa platform, the next generation 400 gig optical platforms for next generation of protection platforms. So they're not investments that are short term in nature. Most of our investments are much more strategic.

And your next question comes from Mitch Steves with RBC Capital Markets.

I had two questions. First, regarding the focus on the gross margin line, since Huawei does not have a high-end LoRa product, should we expect gross margins to improve sequentially from July to October and then to January?

Huawei doesn't have a lot of revenues at all. So trying to understand the connection between Huawei and LoRa and gross margins.

So if you have no Huawei...

No, Mitch, so most of our Huawei business is PON base station and smartphone related.

No, No. Yes, yes, so that's my point, right? So basically, we know that there's no high-end, high-margin business there. So doesn't that mean the gross margins go up October to January?

Well, I think we just have to see how everything comes into mix. What we've said in the past is that we expect our gross margins to be stable. We expected to have a little bit of an upward bias, but we have to see how everything comes in before we know exactly what happens with gross margin. But the expectation here is that our gross margins will be stable going forward.

Okay. Yes. And the second question just kind of on the time exposures. So we kind of get the Huawei number kind of 6%, right? But if I look at the China exposure to Asia, you're showing like 70%, but that's a ship to number. Is there any way to at least give us qualitatively what the actual official sell to, to China is versus just the 78% Asia-Pacific number you gave out?

Yes. So what we've said, Mitch, is that our shipments to China overall, about the 50%-55% type range. And we've said on prior calls that if you look at that as to what's actually probably consumed in China, it's probably closer to the mid-30%, upper 30% range.

And your next question comes from Craig Ellis with B. Riley FBR.

Mohan, I wanted to ask you a longer-term question, and I know it's an environment where we've got limited visibility. By the question's intent is really understanding better some of the company-specific drivers that exist in the portfolio. So Harsh asked you about the second half. My question really ties back to some of your comments on signal integrity, data center business, and the business more broadly. So it sounds like there's a PAM4 and a PMD product ramp coming as we head into calendar '20, fiscal '21. The question beyond that is what do you see in the rest of the business that you're excited about that's driving Semtech's growth as we look beyond what is clearly a cyclical and trade dispute characterized year this year.

I believe the SIP business, particularly in the Signal Integrity Product sector, is experiencing significant growth from 100 gig to 400 gig. Additionally, AptoVision's Pro AV video over IP technology shows strong potential for future growth. Outside of the Signal Integrity Product Group, LoRa continues to perform well and is expected to keep growing, as it’s closely linked to IoT and improvements in efficiency and cost reduction. This trend in IoT will likely continue for many years, which is very promising for us. The proximity sensing market is also set to grow, driven by global regulatory requirements related to managing radio power and devices. Furthermore, our strategy has shifted towards industrial applications rather than just consumer-driven ones, which is quite exciting. We are seeing advanced lithography devices being integrated into various systems beyond smartphones and handhelds, including automotive and communications equipment, all of which require the high-end protection we provide. Therefore, we have multiple growth drivers that remain unaffected by the current situation in China or the Huawei ban, allowing us to anticipate strong growth in the future.

That's helpful. And the follow-up question is just on LoRa. If my tally was correct, as you walked through the different milestones, it seems like the business is performing to all 5 milestones that you just talked about on the last call. One of the things you pointed to was an increase in LoRa's business mix outside of China this year. One, is that still the expectation? And two, any further color on just milestones and how you're thinking about the company's progress?

Yes, we expect to achieve a more balanced geographic distribution moving forward, but our China LoRa business is performing exceptionally well. The key question is whether the other regions can continue to grow faster than what's happening in China. We have strong momentum. We assess all these metrics not only to determine if the business is on the right track but also to identify areas where we can accelerate progress and address specific bottlenecks. This is why we intentionally decided to invest in enhancing our customers' ability to shorten their time to market, transitioning from proof of concept to actual deployment. This involves increasing software availability, expanding design tools and reference designs, and improving access to partners and developer platforms. We have focused heavily on this and expect to maintain that focus this year. Our opportunity pipeline has expanded even further, which is excellent news, and if we can convert some of that pipeline into revenue in the next year or year and a half, we will be in a very good position.

And our next question comes from Tore Svanberg with Stifel.

First of all, I would like to ask Huawei a question. It appears that the figure is between $6 million and $10 million, but based on your last quarterly report, it indicates around $21 million. Should we assume that approximately half of that was just inventory build? Is the more accurate run rate going to be between $6 million and $10 million moving forward?

Yes, that's correct, Tore. It was clear that I mentioned in my script that Huawei built inventory mostly for the smartphone business in Q1, which definitely inflated that Q1 number. They may have also built up some inventory from Q3 or Q4 of last year more associated with the PON base station business. But yes, I definitely think that the $10 million should be viewed as a run rate number.

Yes. Thanks for clarifying that. As a follow-up, you guided the wireless and sensing business to be flat sequentially. So I assume that means maybe some of the smartphone business is going to be down, so LoRa will actually grow sequentially.

That's correct. Yes, yes, the proximity sensing was one of the areas that we believe Huawei has built inventories in Q1, so that will be down in Q2, and LoRa is expected to have very good growth in Q2.

Great. Just one last question. You said data center bookings are improving, and you talked about that one win. But is this broad based enough now where maybe data center could actually grow sequentially in the July quarter?

The data center is likely to remain flat for now, but it may begin to see an increase in the second half of the year. We are observing some positive data points and good bookings in this area.

Because that feels like that business has indeed bottomed here in the last 2 quarters.

Yes, it's starting to feel that way.

And your next question comes from Rich Schafer with Oppenheimer.

I have a couple of questions. First, I want to follow up on LoRa. Mohan, you've mentioned before the potential for LoRa to become a $1 billion revenue stream in the next 3 to 5 years. Is that still a target you consider realistic? Additionally, when do you anticipate the revenue from licensing will surpass that from chip sales?

Well, I think let's take that one first, Rick. I think next couple of years, still it will be mostly chip revenues I think. I would expect it's probably 3 years from now the royalties both from chip licensing and from services to start to kick in nicely. And then I expect those to accelerate quite quickly, especially on the services side. And then coming back to the volume, the size of this business and how can it scale, one of the reasons I talk about these metrics and I point out, for example, the end of this fiscal year, we expect to have 500,000 gateways out there, is because each one of those gateways supports a certain number of sensors and therefore, the capacity to support 2 billion end nodes, and the 2 billion end nodes, if you translate even at $0.50 an end node, is a $1 billion. So to me, I think it's a question of once the infrastructure is deployed, once the use cases are in place, so once there's enough of a smooth runway from proof of concept to deployment, which is one of the things we're working on now, I just think it's a matter of time.

And then just as another follow-up on data center. Can you remind us what CDR attach or just what overall attach, whether we're talking about CDR, PMD attach, looks like at single Lambda 100G versus 25G? And maybe part of that answer, just give us a sense of what Semtech content can do.

For CDRs, I mean for 100 gig, I think, and above, pretty much all of the modules will require some type of CDR functionality. And that's also true of base stations. We see base stations now starting to deploy faster optical links. We think most of those will also require CDR functions. So that's been our thesis for a while, and we are definitely seeing that happen.

Okay. Can you talk about dollar content and maybe a sense of...

Yes, it varies. It varies, $5 to $10, I think on average, depending on the type of module, PAM4 versus NRZ versus different reaches. So it really varies, but I think typically, $5 to $10 is the ASP.

And your next question comes from Christopher Rolland with Susquehanna.

On inventories, if Huawei doesn't come back, will these be fairly easy to ship to other customers? I mean you mentioned proximity sensing. Is there good demand from other customers? And when might inventories normalize?

Yes. So most of our products are standard products. Some of them are application-specific, but they're not customer-specific in general. There may be a couple of million dollars of inventory that may be targeted specifically for Huawei. But in general, I would say that they're for a broader set of customers.

Yes, Chris, we expect that starting in Q2, the days of inventory will begin to decrease as it normalizes. By Q3, particularly if we see the anticipated increase in revenue, we should see inventories return to our typical levels.

Great. And then on the signal integrity side for base station in particular, can you guys talk about your exposure to the various OEMs outside of Huawei? Is it all Huawei? What percentage of shipments here are not Huawei? And how do you expect that to ramp through the year?

We have good exposure to other customers, but most of our volume so far has come from China, particularly from Huawei. We also have connections to other Chinese base station manufacturers and some in Europe, but primarily, our volume is driven by Huawei.

And your next question comes from Tristan Gerra with Baird.

Question on LoRa. So obviously, you guys have very good traction in industrial applications. That's including smart metering. What does it take for LoRa to gain momentum in the IoT U.S. market? I mean we see a lot of WiFi and DAC 6 technology in IoT. Is there kind of a catalyst that will create an inflection point for us to see more LoRa-based IoT devices sort of into the U.S. mass market?

That's a great question, Tristan. I believe there are many opportunities for us in North America, particularly in high volume areas. We're beginning to see progress. The home is a crucial area for LoRa within the smart home sector, and we've just started to focus on understanding what will be required there, with support from some of our partners. Additionally, the U.S. has a substantial enterprise sector related to smart buildings and systems for asset tracking and logistics. We are beginning to understand how these systems and sectors can leverage LoRa and how it can significantly change their operations. This relates to our need to comprehend how these opportunities evolve into proof of concepts, which then transition into design wins and revenue, as well as identifying and addressing any friction or bottlenecks, which may include software and application-related issues. We're gaining insights on this, which is why we're intensifying our efforts on the tools we're developing to help our customers expedite this process. I anticipate that North America will become a significant revenue driver for LoRa in the coming years.

As a quick follow-up, you've mentioned that LoRa revenue is expected to increase sequentially in your guidance, along with your initial expectations for the second half of the year. Could you share if LoRa revenue is currently aligning with typical seasonal trends? Or does your full year guidance suggest that the second half will need to show stronger seasonality than in previous years?

Definitely the latter, Tristan. But I think if you'll recall, it's partly what I've been saying about China. LoRa has been doing extremely well in China, and we started to see that softness in Q4. It's nothing related to IoT or LoRa. It's really just a, in China, demand softness issue for us. But we are starting to see signs that that's now picking up. And then I think second half, we do expect it to be strong based on the metrics, I mean based on opportunities and design wins and real momentum we see. Now how strong it's going to be, whether it's as strong as we're expecting or whether it's going to push out to the following fiscal year, to me, it really doesn't matter that much. I think it's more a question of the fact that once we have this momentum, there is going to be a catalyst at some point that takes this from being a $20 million, $30 million, $40 million a quarter run rate to $100 million a quarter run rate.

And your next question comes from Scott Searle with Roth Capital.

Just, Mohan, to follow up on the LoRa front. I just wanted to clarify. I'm not sure if I heard it. Were LoRa revenues up sequentially? And then the mix, it sounds like China was a little seasonally weaker. Is China less than 50% of the mix? And as part of that, looking out to the year, you're maintaining the guidance for the year of $100 million to $140 million. The metrics all seem like they're in line in terms of what you articulated a couple of months ago. So things seem like they're tracking. It's still a pretty wide variance, so considering that we've got 8 months to go in the fiscal year. So I'm kind of wondering what the potential big swing factors are that gets you to the higher end of the range versus lower end of the range because it basically implies that revenues are doubling probably from where you were in the current April quarter.

I think that's an accurate assessment, Scott. We should consider that the opportunities in our pipeline will be evaluated based on when they will generate revenue and how quickly that will happen. We don't have precise data yet, but we observe that these design wins are starting to ramp up and will lead to full deployments. We anticipate that they will begin to yield results in the second half of the year, resulting in stronger revenue. There are a wide variety of use cases, and the regional distribution is more balanced as well. Regarding your question about China, it has typically accounted for over 50% of our LoRa business, though I don't have the exact current figure. It has certainly played a significant role in our LoRa revenue. The recent softness in China has affected our LoRa-enabled revenue; however, we still have a solid pipeline. If those opportunities convert, we should meet our adjusted goal of $100 million to $140 million this year. It's early in the fiscal year, so we'll see how things develop. We're beginning to observe positive momentum on both revenue and the conversion rate from opportunities to revenue. That's correct. Yes.

And your last question comes from Hamed Khorsand with BWS.

Just 2 here. First off, with data center stabilizing, would you expect to regain some pricing control? Or are you just happy managing the business for gross margin?

Well, I think Hamed, we don't see it that way. There are numerous use cases, and typically, we sell to module manufacturers. These manufacturers need to meet a specific cost per gigabit for their end customers. One of our advantages with the ClearEdge family and the NRZ modules, along with the related components and optics, is that they are much more affordable. Therefore, we are likely being as competitive as necessary in that area. For the PAM4 products, we likely don't need to be as aggressive, so it really depends on the specific situation.

Okay. My other question is about the automotive sector. With the new models being released, do you have any design wins on DAC as we move into the second half of the year when you start shipping to some auto manufacturers?

I know we have a lot of design wins on the protection side. We have some on the LoRa side. I don't know exactly the timing of those. To be honest with you, I think they typically take longer than 12 months for qualification. But we have good momentum with that protection business and the automotive space.

And your last question comes from the line of Craig Ellis with B. Riley FBR.

Mohan, I just wanted to follow up. The company's got a real nice $100 million net cash balance, and you certainly got the flexibility to repurchase shares. Does the uncertain macro cause you to think any differently strategically about how you deploy that cash? Do detect tuck-ins or other deals look any more appealing in this environment?

No, Craig. I know that we're not thinking differently about that at all. And the reason we don't think differently is because we still have very high expectations for the future. We still believe very much in the secular nature of the growth drivers that we have a lot of platform. We believe that the due date of the hyperscale data centers is going to continue. We believe that the PON deployment's transition into 10 gig is going to continue, and these are all markets where we're nicely positioned. So despite the current macro headwinds that everybody is seeing right now, we still very much believe the future and what we have to deliver. So we're not thinking about it any differently. Having said that, we always remain to look to be really opportunistic with our buyback. We have the $181 million authorized. So if the opportunity is there, we will continue to buy back our stock, but also continue to make the strategic investment that will continue to ensure our future.

And there are no further questions at this time. Your closing remarks, please.

In closing, despite the near-term uncertainty driven by the macro and geopolitical environment, we remain confident in the underlying strength of the secular drivers behind our growth engines, which we believe are clearly intact. We see early indications from our customers that suggest a stronger second half fiscal year '20 despite the slow start to the year. With that, we appreciate your continued support of Semtech and look forward to updating you all next quarter. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect.