Semtech Corp Q3 FY2021 Earnings Call

Greetings and welcome to Semtech Corporation's Q3 Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Sandy Harrison, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Dana, and welcome to Semtech's conference call to discuss our financial results for the third quarter of fiscal year 2021. 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 closed 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; 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. A discussion of why the management team considers such non-GAAP financial measures useful, along with the detailed reconciliations of such non-GAAP measures to the most comparable GAAP financial measures, are included in today's press release. As a reminder, all references to financial results in Mohan's and Emeka's formal presentations on this call will refer to non-GAAP measures unless otherwise noted. With that, I’ll turn the call over to Semtech's Chief Financial Officer, Emeka Chukwu. Emeka?

Thank you, Sandy. Good afternoon, everyone. For Q3 fiscal year 2021, net sales increased 7% sequentially and 9% over the prior year to $154.1 million, which was at the upper end of our guidance. In Q3, shipments into Asia represented 80% of net sales, North America represented 12%, and Europe represented 8%. Total direct sales were approximately 18%, and sales to distribution were approximately 82% of net sales. Our distribution business remains balanced with 39% of the total POS coming from the infrastructure end market and 30% from the industrial end market, and 31% from the high-end consumer end market. Bookings increased strongly over the prior quarter and resulted in a book-to-bill above 1. POS bookings accounted for approximately 25% of shipments during the quarter. Q3 GAAP gross margin decreased as expected by 40 basis points due to a higher mix of consumer revenue. We expect our Q4 gross margin to be flattish sequentially. Q3 GAAP operating expense increased 4% sequentially due to higher performance-based compensation expense offset by lower new product expenses. We expect our Q4 GAAP operating expense to increase 4% to 6% sequentially, primarily due to it being a 14-week quarter and higher share-based compensation expense driven by a higher stock price. Q3 GAAP other expenses were $1.6 million versus $2.9 million in Q2. The decrease was primarily due to lower foreign exchange losses than those that were recognized in Q2. In Q3, our GAAP tax expense was 7.9% as a result of a favorable regional mix of income, and several discrete tax benefits. In Q4, we expect our tax to range between 10% and 13%. Moving on to the non-GAAP results, which exclude the impact of share-based compensation, amortization of acquired intangibles, acquisition-related, and other non-recurring charges, gross margin was 61.5% and in line with expectations. Our gross margin remains stable, with the key driver being end market revenue mix. In Q4, we expect gross margins to remain flattish due to a higher mix of consumer revenue. In fiscal year '22, we expect to see gradual increases to our gross margin as we see an increase in revenue contribution from our higher-margin growth drivers of LoRa-enabled 5G Wireless PON datacenter infrastructure platforms. Our Q3 non-GAAP operating expense increased 6% sequentially on higher compensation expenses, offset by lower new product expenses. In Q4, we expect our non-GAAP operating expense to increase 1% to 4% sequentially, primarily due to the January quarter being a 14-week quarter. For fiscal year '22, consistent with our projects, we expect operating expenses to increase at approximately half the rate of revenue growth. In Q3, our non-GAAP tax rate came in at 14.8% and we expect our Q4 and fiscal year '22 tax rates to be in the range of 15% to 17%. In Q3, cash flow from operations decreased to 18% of net sales due to the adverse impact of withholding taxes paid in Q3 related to the Q2 repatriation of cash to the U.S. We repurchased approximately 440,000 shares or $24 million of stock in Q3, and our stock repurchase authorization now stands at approximately $44 million. We expect to continue to use our cash to opportunistically repurchase our shares, make strategic investments, and pay down our debt. In Q3, due to higher net sales and timing of shipments during the quarter, accounts receivable increased 14% sequentially and represented 33 days of sales, which remains well below our target range of 40 to 45 days. Net inventory in absolute dollar terms was approximately flat sequentially, while days of inventory decreased by 9 days to 118 days, which remains above our target range of 90 to 100 days. In Q4, we expect our net inventory to increase due to the strong demand that we’re seeing and the tightening supply lead times. In summary, we are pleased to deliver Q3 results that were at the upper end of our guidance. We look forward to ending a very challenging year on a strong note, and we believe that our strong business fundamentals position us nicely to continue to deliver growth and solid financial results. I will now hand the call over to Mohan.

Thank you, Emeka. Good afternoon everyone. I will discuss our Q3 fiscal year '21 performance by end market and by product group and then provide our outlook for Q4 fiscal year '21. In Q3 of fiscal year '21, net revenue increased 7% sequentially and 9% over the prior year to $154.1 million. Stronger demand from the high-end consumer and industrial end markets was offset by softer demand from the infrastructure end market. We posted a non-GAAP gross margin of 61.5% and non-GAAP earnings per diluted share of $0.47. In Q3 of fiscal year '21, net revenue from the high-end consumer market increased 43% sequentially and 21% over the prior year and represented 29% of total net revenues. Approximately 19% of high-end consumer revenue was attributable to mobile platforms, and approximately 10% was attributable to other consumer systems. The industrial end market net revenue increased 14% sequentially and 4% over the prior year and represented 32% of total net revenues. Net revenues from the infrastructure end market decreased 13% sequentially and increased 6% over the prior year and represented 39% of total net revenues. I will now discuss the performance of each of our product groups. In Q3 of fiscal year '21, as expected, our signal integrity product group decreased 14% sequentially and increased 5% over the prior year and represented 40% of total net revenues. In Q3 of fiscal year '21, demand from our datacenter customers softened following the strength experienced in the first half of the year. We believe the demand for higher bandwidth datacenter connectivity remains very strong and our ClearEdge, FiberEdge, and Tri-Edge platforms, all have significant design-in momentum in 100 gig, 200 gig, and 400 gig optical modules being deployed in global cloud and hyperscale datacenters. Design activity for our Tri-Edge PAM4 platform remains strong, and we now have customers working on almost two dozen design-ins for use in 100 gig, 200 gig, and 400 gig PAM4 optical modules. The lower cost, lower power, and lower latency performance enabled by our Tri-Edge analog CDR platform provides a significant advantage over existing DSP solutions. We believe the secular trends that have been driving growth in the data center market should continue to drive our data center plans over the next few years. In Q3 of fiscal year '21, demand from the wireless base station market softened from the prior quarter’s record, as build outs in China slowed from first half levels. Global customers are increasingly deploying 25 gig optical modules for front-haul links in 5G base stations. As a result, we are seeing increased design-in activity for our high-performance CDR and PMD platforms for 5G wireless base stations globally. We expect 5G infrastructure spending to increase in fiscal year '22 and expect this market to continue to grow for several years. In Q3 of fiscal year '21, revenue from our PON customers was flat with the prior quarter. While demand for our PON platform has been largely driven by China, we are continuing to see a number of new PON initiatives outside of China, where PON is used to channel high-speed data to the home, enterprise, and campus networks. Semtech remains the leading supplier of 10 gig PON platforms for the ONU and OLT markets. And we expect our latest innovative 10 gig products to enable us to further benefit from the global trend toward increased PON deployments. Despite the inherent lumpiness associated with the infrastructure markets, we believe the secular trend led by the upgrade of data center connectivity and the expansion of 10 gig PON and 5G wireless network capabilities should drive future demand for our optical platforms across all our target infrastructure markets. For Q4 fiscal year '21, we expect net revenues from our signal integrity product group to increase, driven by all infrastructure segments and a recovering video market. Moving on to our protection product group. In Q3 of fiscal year '21, net revenue from our protection product group increased 25% sequentially and 3% from the prior year and represents 27% of total net revenues. In Q3 of fiscal year ‘21, demand from our Korean smartphone customers rebounded strongly from the COVID-related issues that had impacted them in the first half of the year. Demand from our North American smartphone customers also remained solid. We expect that protection product group to continue to benefit from our ongoing diversification strategy. Many of today's high-performance systems across all industry sectors are starting to incorporate advanced lithography devices and high-speed interfaces such as USB-C, 10 gigabit Ethernet, and HDMI 2.1, resulting in the need for Semtech’s high-performance protection. We expect these trends to continue and contribute to the long-term growth of our protection business. In Q4 of fiscal year ‘21, we are expecting our protection revenue to increase, led by growth from the broad-based industrial and communications markets and stable smartphone demand in what is typically a seasonally weaker quarter. Turning to our wireless and sensing product group, in Q3 of fiscal year '21, net revenue from our wireless and sensing product group increased 32% sequentially and 21% over the prior year and represented 33% of total net revenues, resulting in a new quarterly revenue record for our wireless and sensing product group. Our LoRa-enabled platform continued its steady growth and experienced another record quarterly performance. In Q3 of fiscal year '21, we continued to see excellent progress against the goals for our LoRa metrics we had targeted at the beginning of the year. These include the number of countries with LoRa networks now standing at 99 countries and we expect over 100 countries to have LoRa networks by the end of fiscal year '21. The number of public or private LoRa network operators grew to 148, and we expect 150 LoRa network operators by the end of fiscal year '21. The number of LoRa gateways deployed grew to nearly 1.2 million from the 642,000 gateways at the end of fiscal year '20, and we are expecting the number of gateways deployed to increase to over 1.3 million by the end of fiscal year '21. The cumulative number of LoRa end-nodes deployed increased to 167 million from 135 million at the end of fiscal year '20, and we expect this number to exceed 180 million cumulative end-nodes by the end of fiscal year '21. In Q3, we shipped a record number of LoRa devices. Finally, the LoRa opportunity pipeline, which includes both opportunities and leads, stands at approximately $500 million, with approximately $200 million of leads feeding the future opportunity pipeline. We expect the opportunity pipeline to increase rapidly in fiscal year '22 as we anticipate that the inertia associated with the global pandemic will gradually subside. Our opportunity pipeline remains geographically well-balanced with approximately 70% of the opportunities now coming from the Americas and Europe, and includes an increasing number of use cases in the smart home, asset tracking, and supply chain logistics markets. In addition to the record revenue and the continued progress on our LoRa metrics in Q3, we made several important announcements related to our LoRa business. These include Amazon's use of LoRa in their new Sidewalk network, unique capabilities of LoRa extends the range of smart home networks to connect both indoor and outdoor sensors, enabling new use cases. These include smart lighting, smart safety, pet trackers, asset tracking, smart irrigation, and many others. The use of LoRa in the smartphone segment demonstrates the value and versatility of LoRa in low power LAN and low power WAN segments of the IoT market. We believe that Amazon's use of LoRa in Sidewalk opens up a huge opportunity for Semtech's LoRa-enabled business starting in fiscal year '22. And Cisco's use of LoRaWAN towards industrial asset vision systems for enhanced visibility into physical spaces for IT and operational technology environments. This LoRa-based system is a simple and secure solution for remote asset management, equipped well with a cloud-based dashboard to monitor and manage the condition of assets and facilities that can be deployed in minutes using a simple QR code. We also announced the availability of our LoRa Edge tracker reference design that includes our new LoRa cloud geolocation service. Our LoRa Edge platform is our first LoRa-based software-defined radio platform that integrates Wi-Fi and GPS sniffing along with LoRa. We are seeing a significant ramp in new design-in activity and believe that LoRa Edge is the ideal platform for asset tracking and asset management use cases and will be the main enabler of our future cloud services revenues. We believe that the flexibility, long range, and low power of LoRa-based networks are critical components of any successful low power IoT deployment. With the record Q3 performance and anticipation of a record annual performance, and with exciting smartphone opportunities driven by Amazon, as well as numerous new industrial IoT opportunities, we continue to expect that LoRa-enabled revenues to grow at a 40% CAGR over the next five years and to become the de facto standard for the fast-emerging LPWAN market. In Q3 of fiscal year '21, net sales from our proximity sensing platforms grew nicely over the prior quarter, helped by the recovery in the smartphone market, along with several new design wins that moved to production and should continue to ramp. We are also seeing increased design activity as global RF safety regulations become more stringent as new 5G base phones emerge. For Q4 fiscal year '21, we expect net revenues from our wireless and sensing product group to increase and achieve another quarterly record, led by another record performance from our LoRa-enabled business. Moving on to new products and design wins. In Q3 of fiscal year '21, we released 12 new products and achieved 3,397 new design wins, which also represented a new quarterly record. While this year has presented its share of unique challenges, I believe that our key stakeholders, including our investors, customers, suppliers, and employees have all played a critical role in driving the company's growth and success. We remain committed to considering the impact of key environmental, social, and governance factors in our decision-making processes. We also are focused on developing products that will make the planet a smarter, more connected, and more sustainable place to live. We view our employees as the company's most important resource, and have an established set of core values that hold each of us responsible and accountable for doing the right things for the company and its employees. I'm excited about the company's future opportunities. I believe that our vision, our strategy, and our focus on providing products for a smarter, more connected planet and our commitment to a more diverse and inclusive workforce should enable the company to continue to be extremely successful. Now, let me discuss our outlook for the fourth quarter of fiscal year '21. We believe the underlying secular demand for our growth platforms remains solid. Based on very strong bookings and record highs starting backlog entering the quarter, we are currently estimating Q4 net revenues to be between $153 million and $163 million. To attain the midpoint of our guidance range or approximately $158 million we needed net terms orders of approximately 20% at the beginning of Q4. While we have been issued some licenses that allow us to ship to Huawei, our guidance assumes no more shipments to Huawei or HiSilicon. We expect our Q4 non-GAAP earnings to be between $0.45 and $0.51 per diluted share. I will now hand the call back to the operator, and Sandy, Emeka, and I will be happy to answer any questions.

Our first question comes from Rick Schafer with Oppenheimer.

Mohan, I got a question on LoRa. I mean, you’ve gained a lot of momentum there, I think after a slow start in Q1, obviously COVID-related. I mean, do you see continued linear ramp next year, sort of in line with that 40% CAGR that you just mentioned or could we see a step function in revenues there next year as LoRa sort of starts to hit a critical mass or it seems like it's hitting critical mass?

Yes, I believe there are specific catalysts that can accelerate our growth, which is why we have consistently projected a 40% compound annual growth rate based on historical data and the new use cases that are gaining traction, particularly the smart home initiative associated with the Amazon Sidewalk announcement. If the adoption of that architecture and network is strong, we could expect a rapid increase in sensor sales, potentially resulting in a significant boost in our revenue. While this might not fully materialize in the fiscal year '22, it may happen in fiscal year '23, as it takes time to deploy the necessary infrastructure and develop the sensors. I anticipate that the Amazon Sidewalk business alone could generate $100 million in revenue within five years, making it a key growth driver. Additionally, the industrial IoT sector has experienced slower growth this year due to COVID-related challenges, but I expect that to improve over time as many of these use cases focus on enhancing efficiency and supporting greener initiatives. Therefore, I believe we will see some catalysts emerge in the next year or two, particularly from the smart home initiatives.

I should have asked, just a quick follow-up on that question. I mean, are there any capacity issues that you guys have there? I mean in the past you kind of planned to catch up on the LoRa business this year, so is there any capacity supply constraints that you're seeing there or anything?

Well, there are supply constraints across the board. I would say, it's definitely a tightening of supply chain, as you know, across all segments, nothing specific to our LoRa business or anything like that. I just think, as Emeka had mentioned, we are seeing some lead times on the supply side increase, and that is challenging. But generally that means the beginning of an upcycle in the industry in my view, and I think that's a good thing for us and for everyone.

If I could sneak in a follow-up, I think most LoRa revenues today are still coming from hardware. I'm just curious when do you sort of expect to start monetizing the services? I know we talked about that in the past, but the license and royalty opportunity that you see there. Thanks.

Yes. So there are two elements there. One is the IP licensing royalties from our partners ST and other collaborators. We do expect next year we start to see some of that coming in, but also our cloud services, we did announce that this last quarter, the first cloud service using geolocation, again using LoRa Edge platform, and this is another area where we're expecting pretty good growth. It'll be a slow ramp initially, but the cloud services revenues will be recurring revenues, remember. So again, we're expecting something between $50 million and $100 million over the next five years on an annual basis, and a lot depends on the quality of the geolocation and the other services we bring to market. But this is our first real initiative and we're very confident and feel very good about the type of customers and the type of use cases and how quickly that could ramp in the future.

Our next question comes from the line of Quinn Bolton with Needham & Company. Please state your question.

Just wanted to follow up on the Sidewalk question. With Amazon now announcing Sidewalk and I believe the fourth-generation Echo product including that Sidewalk network in the gateway, have you seen an increase in end-node activity for sensors compatible with Sidewalk? And just wondering if you could give us an update on that design activity around Sidewalk, more on the end-node side?

It's really just starting, Quinn. Amazon had made the announcement. They haven't yet talked about the sensors that are connected to it. They've talked about what they anticipate they will be, but they haven't yet rolled out their development platforms to enable companies to do that, but that's pretty close I think, and it's going to happen very soon. And so, my expectation is by mid-next year, we'll definitely start to see real Sidewalk networks being deployed and sensors being attached and that type of thing.

Great. I have a follow-up question regarding the 5G front-haul aspect of the business. It seems that performance was a bit weaker in the October quarter after a strong showing in July, but it appears you are optimistic about growth in that segment moving into the January quarter. I'm somewhat surprised by this, as other companies have indicated that the 5G buildout in China is currently experiencing a pause between the first and second phases. Yet, you seem to be defying that trend. Could you share your insights on the 5G situation in China and perhaps provide an update on the timing for the next round of tenders for base station and front-haul construction? Thank you.

Yes, well, I think largely your comments are correct, Quinn. I would say that there's anticipation that next year is going to see some good growth, and that starts in Q1. And therefore, the build for us suddenly and the demand starts to pick up in Q4, which is what we're seeing. And so, yes, I think it's just a timing thing. We sell into module manufacturers, obviously, and then their module guys sell into their base station guys. And so some of that dynamic is just timing. But yes, we're expecting a pretty strong FY '22. The other thing is not just China; I think that's one of the nice things about all of our infrastructure segments now is that they're fairly global. We're seeing opportunities in Europe and North American OEMs as well, both on the 5G side and on the PON side as well. So that's encouraging.

Our next question comes from line of Tore Svanberg with Stifel. Please proceed with your question.

Yes. Congratulations on the results. First question, going back to LoRa. Do you have the range update for us for this calendar year, Mohan?

We’re still keeping our range $85 million to $95 million. We're going to be in that range, I think, for this year. And we're still keeping our 40% CAGR going forward. Obviously, a lot depends on the timing of Amazon Sidewalk and some of the higher volume, faster time to market opportunities. But in general, I would say with the exception of kind of COVID-related impact, we're seeing pretty good industrial momentum, a lot of new use cases. But as we see these use cases kind of come out, we're seeing adoption across the globe. So I think, again, the timing of when proof of concepts move to revenue, it’s challenging to really comment exactly how it's going to happen. But once it starts to materialize, and I think, as I mentioned, once COVID stops, and then we start to get some return to normality in terms of manufacturing and industrial IoT, I think that's going to continue to also drive revenue.

That's very helpful and you talk about 5G coming back next quarter, or I mean this quarter. What about the data center? How are some of the dynamics being there because that obviously paused a little bit this last quarter, but are you starting to see that grow again as well?

Yes. I wouldn't say it's as positive as the 5G story. I think there's still inventory there in the channel, and then maybe the customers. But we are starting to see that pick up also. And so I expect Q1 for sure to be up. Data center is probably going to be flattish for Q4 and then I'd say up in Q1 timeframe, but yes, positive signs, a lot of design-in activity there.

Lastly on the PON business, you expect to start to see 10 gig. Is that going to be a fiscal '22 event or is it going to be further out than that?

Actually, our 10 gig PON is doing well already, and I think continues to do well. And we expect in Q4 to do quite well; this quarter to be quite strong for PON, and next year we're also projecting good growth for PON. So yes, infrastructure just continues to make give us good indications that FY ‘22 is going to be another solid year for our SIP business.

Our next question comes from the line of Craig Ellis with B. Riley.

I'll ask one that ties together a few points. So you mentioned that the inventory would be up quarter-on-quarter, and I can see that all the segments are guided up. But Mohan, can you help us with some color on some of the gives and takes across your different segments, which would you expect to be growing more robustly, which are more muted? And then within any of the segments, are there any sub-segments where you'd expect a meaningful deviation from the broader overall segment trend?

Yes, as you know, the first half was very weak for consumers. However, we are seeing a relatively strong second half for consumer sales, and I expect this trend to continue, especially in Q4, even though it is typically a down season for us. The consumer business appears to be doing very well, and I believe that will persist. On the infrastructure side, there has been some softness, but that is mainly due to a strong first half, and all signs point to the majority of the infrastructure segments we are involved in rebounding this quarter and likely growing in Q1. In terms of wireless and sensing, LoRa is performing excellently, and on the proximity sensing front, which is linked to consumer performance, we anticipate good results in Q4. Regarding inventory and supply concerns, we are facing a tighter supply chain, particularly in end markets with short lead times, like consumer. We are taking some calculated risks in increasing our internal inventory. Demand appears to be very strong, and we are being cautious about our market participation to avoid overstocking. Our channel inventory is currently low. If we manage our inventory wisely, I believe we can expect solid consumer growth next year without the volatility we've experienced in the past.

Got it. And then turning to LoRa, you mentioned in your prepared remarks, both Amazon and Cisco, and I've looked at Cisco's product announcement. It was actually a very impressive array of products that help create a really nice ecosystem. As you look at fiscal ‘22, what potential does Cisco have to really drive incremental sales for LoRa? Or is that just much more of an analog-type business where those would be the kind of classic volume design-ins we would see with industrial versus anything high volume like Amazon?

From a revenue perspective, it's more about the latter, Craig. The key point to keep in mind is that once customers adopt LoRa and establish their infrastructure around it, that investment will last for a long time, likely the next 10 to 20 years. This creates significant opportunities, especially in the industrial sector, not just for additional sensors but also for potential cloud services and new use cases. We are excited about LoRa and LPWAN because we are essentially creating a new industry. It's noteworthy to have major players like Cisco and Amazon involved in promoting LPWAN and supporting the ecosystem, which highlights the value that this technology offers to the market and its customers. Thus, it's thrilling to witness both the emergence of new use cases and the involvement of leading companies in advancing this initiative.

And if I could on that just two clarifications, I'll throw them out at the same time. One. You talk about rising gross margin in fiscal '22. Can you give us a sense for the magnitude of that increase? For example, could we see gross margins up 100 basis points or so over a four-quarter period? And secondly, I thought I heard you mention that the fourth quarter was a 14-week quarter? And if so, what's included in revenue and expense guidance for the extra week?

Let me address the question about gross margin first. As I mentioned in my prepared remarks, when we look at our expected revenue growth for the next fiscal year, we anticipate continued strong growth in our LoRa business. Our data center business also appears to be a promising area for growth, along with PON, 5G Wireless, and additional industrial and automotive opportunities within our protection business. These areas are exciting for us due to the higher gross margins they offer. While I can't provide a precise quantification at this moment, I would expect to see an expansion in the range of 50 to 100 basis points over the year, which is positive. Regarding the fourth quarter with its 14 weeks, it can be challenging to estimate the contribution of the extra week to revenue. However, there is likely some contribution. It is easier to assess the impact on operating expenses. About 60% of our total operating expenses is time-based, covering items like salaries and operational supplies. If you take 60% of operating expenses and distribute that over 14 weeks, you can get a reasonable estimate of the impact on operating expenses.

Our next question comes from Mitch Steves with RBC Capital Markets.

I have a broader question regarding Semtech's strategy. Previously, there were discussions about possibly separating the LoRa business into its own entity or considering selling that segment. Could you provide an update on the current outlook for the LoRa business and how it fits into Semtech's overall plans now that you've navigated the downturn in 2019 and 2020?

Yes, Mitch, the thought has always been that if LoRa becomes the de facto standard in the industry, we are generating around $100 million of recurring cloud services revenues, then we could start to look at some ideas about how to move that business to a different level. And so, that's the thought. And I would say we're still probably 2, 3 years away from that. Obviously, every day we get good momentum and new announcements like Amazon Sidewalk and LoRa Edge announcements get closer, but we're not there yet. I think I would say 2 to 3 years still is the timeframe.

Yes. And then, can you provide us, say, sort of cloud service kind of a recurring revenue? What's kind of the revenue right now, relative to kind of just the straight sales you guys are doing?

It's brand new. We just announced the cloud service and geolocation service, making it the first of its kind. We're in the early stages of getting contracts in place. I would suggest that by the end of next year, we should be positioned to reach $100 million within the next 3 to 5 years. The uptake and value we provide will rely on our new LoRa Edge platform, and I believe we will start to understand its impact as customers begin to deploy it and provide feedback on the value it brings.

Yes. I guess just one last one, if I could, just to clarify those comments. So what would be kind of the first major customer, major launch you guys would expect, call it in '21 and '22? Not looking for logos or anything like that, but how should we think about the rollout of that new product or business line?

The asset tracking and management is really the initial focus in geolocation. Once our customers begin testing and recognize the value, we will discuss the specific applications more. I believe these will be related to asset management and tracking, particularly using LoRa Edge both indoors and outdoors. LoRa's flexibility allows for tracking assets from home to outdoor locations, warehouses, and manufacturing facilities, even deep within buildings or in rural areas, all on a single platform that optimizes battery power consumption effectively. It's a compelling concept and a unique capability we possess, but we need to showcase it and demonstrate its value.

Our next question comes from the line of Scott Searle with ROTH Capital. Please proceed with your question.

Just a couple of quick clarifications. I missed what you said about the sequential outlook for protection. Just wondering if that was up, down, or flat? And what Huawei was in the quarter? I know you were indicating your guidance doesn't reflect any incremental contribution from Huawei, HiSilicon in the fourth quarter. And then I had a couple of follow-ups.

We expect protection to continue increasing. It was up in Q3, and we anticipate it will remain up in Q4, primarily due to growth in the consumer sector and also in broader industrial areas such as telecommunications and automotive, all of which are performing well for us. On the other hand, regarding Huawei, we do not expect significant activity this quarter. Our shipments have been minimal, and we do not project much shipping in Q4 either, leading to fairly modest revenues from Huawei. While we have some licenses, as mentioned in the prepared remarks, any revenues from that are quite small. Additionally, it's unclear whether Huawei has built up their inventory, so we have removed them from our guidance.

Great, perfect. And on wireless and sensing, absolutely a huge quarter. Part of that, it sounds like a combination of proximity sensors and LoRa. I was wondering if you could parse that a little bit more, up 32% sequentially, the smartphone market broadly in general was up about 20% plus I think, on a global basis, so you're benefiting from that. Was there something in there? Was proximity bigger versus lower just to kind of get calibrated on that? Because, given the performance of that segment, I would have thought you'd be at the higher end or even above the higher end of the range of $85 million to $95 million for LoRa this year?

Yes, both are performing exceptionally well. The growth in proximity sensing has been primarily driven by the smartphone sector, which saw strong performance in Q3. We expect even better results for proximity sensing in Q4. Typically, consumer demand weakens in Q4, but this year is different since the first half was quite sluggish. We are beginning to see some effects of that likely impacting Q4. However, with LoRa, the growth is steady and consistent. The focus with LoRa is how quickly the POCs convert to revenue. We have a substantial pipeline, totaling $500 million, so it's just a matter of how fast those opportunities can translate into revenue. The recent Amazon Sidewalk announcement is beneficial because LoRa has proven effective for industrial applications, particularly in utilities and asset management. We have been hopeful about its potential for smartphone and consumer applications, which typically generate revenue more quickly. These areas can be unpredictable and may have shorter lifecycles, but they also tend to ramp up faster. While we may not see significant growth until around mid-next year, we are confident it is on the way.

If I could, Mohan, could you follow up on the lower front regarding Sidewalk? Can you discuss the ecosystem that is building around it at this moment? You have the anchor with the Echo Dot; how is the rest of the ecosystem and design activity taking shape? Additionally, can you provide an update on tags? We haven't heard much about that recently; I know it was further out on the horizon, but you're beginning to speak about cloud and recurring opportunities. What are the latest thoughts on tags?

Yes, I'm quite excited about the tags. However, I think it's still early, and we need to lower the price points. We also require something like a Sidewalk network to make it an effective vehicle. Regarding the ecosystem, it is primarily driven by Amazon. While we are not directly participating in facilitating this, much of the momentum will come from them, and we will continue to support that process. Looking at the ecosystem, there is a clear opportunity for sensor manufacturers to connect to a gateway in homes, particularly in areas like lighting, tracking, security, safety, and irrigation, among others. There are significant opportunities for software companies to partner with Amazon and find ways to connect with them and their Sidewalk network. Additionally, system integrators seeking to connect with home-based networking opportunities also have potential. Overall, the ecosystem around the smart home is shaping up well, and I anticipate we will see more developments, likely in the second half of next year. As the network is rolled out and customers begin deploying Sidewalk networks, that will be the point where we can effectively implement these solutions.

And lastly, if I could just on signal integrity PAM4 product line. I think you're starting to see some 100-gig contribution, I thought in the third and fourth quarters start to see some initial revenues. So wonder if you could update us on that front. And then looking forward to the 200-gig and 400-gig, I thought there was design activity, which would start to translate into revenue in the first half of fiscal '22. I was wondering if you could just update us on those two fronts. Thanks.

Yes, we’re starting to see revenues now. It's small, but we are seeing Tri-Edge revenues now, PAM4 revenues, and we've got some very good momentum. As I mentioned, we have over 2,000 design-in opportunities that are in play at various stages, some early-stage evaluation, some qualification type of stages. And so that's going to start ramping. And next year should be a very good year for Tri-Edge, I think.

Our next question comes from the line of Christopher Rolland with Susquehanna.

I believe most of the important questions have been addressed. So I'll just ask a couple. First, regarding the 5G opportunity, could you share your expectations for growth rates in this business over the next few years? Additionally, could you provide details on units or average selling prices, especially since it seems you're transitioning to 25G? I'd like to delve deeper into that opportunity. Thank you.

The main thing to remember with 5G in the optical modules is that while 4G typically involved just a PMD device, 5G will include both a CDR and a PMD device. This creates opportunities for us with ClearEdge CDR and FiberEdge PMD devices for 25 gig links. If they upgrade to 50 gig links, we will offer Tri-Edge PAM4 and FiberEdge devices for those links, leading to an increase in average selling prices. Additionally, with 5G, we expect an increase in the number of ports, likely going from 6 to 12 for front-hauling. This results in increased content and more ports. Historically, China has been the main volume driver for 5G, and while it will continue to be significant, we're seeing global OEMs becoming more proactive in this market, with opportunities influenced by regional demands for local suppliers to support their 5G infrastructure. For 4G, we hold around 30% market share and plan to maintain that share for 5G as well. Overall, we anticipate solid double-digit growth in the coming years.

Could you discuss the data center opportunity, particularly the broader data center end market? Intel has mentioned a potential demand slowdown, and I would like to know if you share that view. Additionally, could you elaborate on your optical opportunity with Tri-Edge? You referenced the cost compared to analog—what discount do you receive for using analog? Also, how are sales performing in that area?

Yes, the data center had a particularly strong first half, achieving record results. There were some expectations that the pace would slow down a bit in the second half, and that’s what we are experiencing. However, on an annual basis, we are still showing growth, and I believe we will continue to grow well next year. There has been some softness in Q3, and I expect Q4 to be relatively stable compared to Q3, but then we should see an uptick again next year. Similar to 5G, the hyperscale data center market serves a wide variety of global customers. We are selling to optical module manufacturers who are producing their modules for different data center clients, and we have made good progress in that area. We anticipate production increases for most of the 200 gig and 400-gig PAM4 modules in the upcoming quarters, which has already begun. Over the next few quarters, we expect to see this production ramp up. Essentially, you can take a 100-gig optical module that currently uses our ClearEdge CDRs and replace it with a similar module using our Tri-Edge CDRs, which delivers double the bandwidth at a minimal additional cost. This demonstrates the value we offer, and we expect the market to recognize this advantage.

Our next question comes from the line of Tore Svanberg with Stifel.

Just a quick follow-up. Mohan, I think you said that the Sidewalk opportunity alone could be $100 million over the next 5 years. Is that on chip revenue? Or is there some royalty or even services revenue in that number as well?

Yes. I would say it includes everything, Tore. So mostly chip and royalties.

Our next question comes from the line of Harsh Kumar with Piper Sandler.

First of all, congratulations on the solid guidance and results. We appreciate it. I have two questions, Mohan. Prior to the ban, you seemed very optimistic about the opportunities in China, particularly with a new presidency. Can you discuss how Semtech views the potential opportunities in China if trade restrictions were to be lifted?

We've always been optimistic about China because we have invested there for the past 15 years. It's challenging to turn away from a region that has fueled so much growth and still holds great potential. The situation with Huawei is specific; the ban on Huawei has affected us significantly, but that's behind us now. The main concern now is whether we can continue to grow all our businesses in China or if there will be further separation between the U.S. and China. That's still uncertain, and we're awaiting clarity on that. Any improvements in relationships would certainly benefit our business, given the success and momentum we have across all our segments. However, we're not relying on that happening. Many markets, like 5G and PON, are becoming more globalized, with other regions realizing the necessity of having their own infrastructure providers rather than solely depending on Chinese manufacturers. In summary, while we see potential benefits from improved government relations, we're preparing for various outcomes.

Mohan, I have a follow-up question and another to ask. Do you see opportunities opening up again for Semtech in the data center business in China? Also, regarding Amazon Sidewalk and LoRa, I believe you were the only supplier of baseband ICs for the gateways used in your infrastructure. Is that still true? Will typical consumers rely on the Amazon infrastructure being set up in the city, or will they need to purchase their own gateway, like a Dot or Echo or something similar?

Let me start by addressing that, and then we can talk about the data center. Yes, Amazon Sidewalk will definitely have connectivity through a gateway, which will be an Echo. Amazon will provide the Echoes, and the connections between different Echoes and the roaming capabilities will be handled by Amazon's decisions. Our focus will be on facilitating that. Initially, this is aimed at enhancing connectivity within the home, promoting smart home functionalities, and extending to tracking pets and connecting different Echoes together. This constitutes a broader vision that we're eager to see develop. Regarding the data center, all major Chinese hyperscale data center companies are indeed our partners and potential clients for Tri-Edge. We are actively collaborating with them and have not encountered any significant issues so far. We have strong relationships and anticipate positive growth in this area.

Our next question comes from the line of Tristan Gerra with Baird.

You've mentioned that Amazon was a 10 to 20 year opportunity. So clearly, there's a long-term investment. Could you give us a sense of what's the magnitude of those large potential and customers like Amazon? And given those investments, is there any incentive for them to eventually use the same technology in other platforms? Outside of consumers, Amazon, for example, is also pushing IoT solutions in industrial. Is that an opportunity that you see, not specific to this customer, but elsewhere versus cellular-based networks? And generally, what's the incentive large customers have to, once they invest in LoRa, to leverage that into different end markets?

Yes, Tristan, all the companies we work with, including Cisco and Amazon, are beginning to recognize the value of LoRa. The value actually increases when LoRa is integrated with other technologies. For instance, when you pair it with Bluetooth, Wi-Fi, or GPS—like with our LoRa Edge platform that incorporates Wi-Fi sniffing and GPS. LoRa, by itself, has certain limitations, particularly in terms of bandwidth. However, as we begin to roll out these use cases, we anticipate applications across various segments. I believe the largest value will be found in industrial applications due to its very low power consumption and extensive range. Furthermore, the smart home initiative driven by the Sidewalk initiative will significantly transform our approach to home automation, allowing us to extend smart technology to areas like attics, garages, basements, and outdoor spaces. This shift presents a substantial opportunity. Though we are progressing slowly, we have major players supporting this technology.

Great. And then just a quick follow-up. So you've mentioned a little bit earlier about lean inventories in the channel and tightness in supply across the board and you mentioned nothing specific to LoRa. Are you shipping exactly in line with the demand in LoRa? Or are you still catching up for what was following supply chain disruptions earlier in the year? Just trying to see if there is any catch-up revenue or if it's really just linear with end demand?

Yes. I would say if the question is specifically about LoRa, I think we're shipping to demand. I think it's in good shape. I think the real question there is in FY '22, if the consumer demand picks up rapidly, then hopefully we'll be able to supply to that, and I think we can. So we're in fairly good shape. With regard to the rest of the business, demand is extremely strong. Bookings have been extremely strong. So we're a little bit cautious, particularly on the consumer side, with regard to making sure we understand how much inventory is being built and trying to maintain some balance there by keeping our channel lean and things like that. So it's hard to know, to be honest with you, Tristan, exactly, but we'll see it play out. We're expecting a very strong Q4. We're expecting a strong Q1. I think the first half of next year looks like it's going to be strong. Then the question is, what does second half look like, right? But we'll see by then.

Our next question comes from the line of Karl Ackerman with Cowen.

Yes. On your signal integrity business will grow mid-teens at least in fiscal 2021. How do you think about the trajectory of that business entering fiscal 2022 in the context of your longer-term 12% growth rate? I asked because it would seem another healthy year with 10-gig PON is on the come. Demand remains healthy for 25-gig and 100-gig optical products in Asia. Yet at the same time, proponents of 400-gig would argue the second half of 2021 will begin the demise of NRC for short reach applications. So just would love to hear your thoughts on that.

Well, we think 100-gig modules and connectivity will continue for some time. I don't think there will be a demise. It may start to flatten out and PAM4 and 200-gig and 400-gig PAM4 modules will start to pick up for sure. But we're hoping to participate in that. Of course, with Tri-Edge, and we see good design and momentum, as I said. So to answer your question, we think all the infrastructure segments are going to do quite well next year. Part of that is working from home and all of the COVID-related dynamics that have driven infrastructure investments and the need for more bandwidth and all those things. So yes, signal integrity product group, we're expecting pretty good growth next year across the board. This year has been an extremely weak year for video, for example, as well. So we're expecting FY '22 to see that pick up also in that segment. We anticipate that to contribute to the growth next year also.

Understood. Last question, if I may. What order trends are you seeing by Asia-based data center customers? I asked because your primary peer spoke about that strength for 25-gig and 100-gig products. Again, just to double-click on the channel inventory commentary. We've kind of heard some mixed commentary, but I’d appreciate your thoughts on how you feel about the situation for optical components, particularly for data center and long haul?

The channel is currently somewhat light, but it's within a range that we feel comfortable with. Demand remains very strong, and our bookings reflect that strength. As I mentioned earlier, while Q4 was expected to be a bit light for data centers and likely flatter, we anticipate that 5G will show some improvement, and PON will perform better in Q4. We're also optimistic about infrastructure segments in Q1. Overall, despite the light channel, demand and bookings are robust, and we believe we are in a good position.

And our final question comes from the line of Craig Ellis with B. Riley.

Mohan, I really appreciate all the metrics that you give with LoRa and the transparency they provide. But I missed what you said about the opportunity funnel. So one, can you repeat that number? And two, did it change from the last quarter? And three, when we go through a period that’s as dynamic as what we've seen year-to-date, where the whole world has turned upside down with a COVID crisis, how does the company manage its funnel and kind of quality check and resiliency check, the items that are in that funnel as we get to the other side and now, are looking at what should be a global recovery? But can you just walk us through how you maintain that funnel and where it stands currently versus prior expectations?

Currently, the pipeline is approximately $500 million, with leads contributing around $200 million. This indicates a substantial pipeline relative to our current revenue, and our primary focus is on converting these pipeline opportunities into actual revenue. The pipeline remains fairly balanced, with about 21% coming from China and 70% from Europe and the Americas, which is advantageous as it better aligns with our current revenue distribution of 49% from China and 40% from Europe and the Americas. Achieving this balanced distribution is a goal for us, and we believe that if we execute effectively, the conversion of the funnel to revenue as anticipated will result in a more balanced revenue stream. We are seeing a multitude of use cases, with a significant emphasis on smart home technologies, along with utilities, asset management, smart cities, and buildings. This year has been particularly challenging for our customers in terms of prioritizing new initiatives, as their focus has been primarily on ensuring safety and job security. However, we are beginning to observe a turnaround, highlighted by the Amazon Sidewalk initiative, which has been introduced later than initially planned. As our customers adapt to the pandemic and chart a path forward, we expect to see a rapid increase in opportunities next year.

And with that, we’ve reached the end of our question-and-answer session. I would like to turn the floor back over to management for any closing remarks.

Thank you. In closing, we were pleased to deliver another solid quarter and remain encouraged that our strategies for multi-sourcing, our investments in IT, operations and sales infrastructure, and systems continue to limit the impact of COVID on our business operations. I want to once again acknowledge all of the talented and committed Semtech employees across all our global locations. And thank them for their ongoing efforts. We believe our strategy, along with our diverse offering, balanced end market approach, and strong customer relationships should enable us to continue to deliver growth. With that, we appreciate your combined continued support of Semtech and look forward to updating more next quarter. Thank you.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.