Earnings Call Transcript - SMTC Q2 2021

Sandy Harrison, Vice President of Investor Relations

Thank you, Victor, and welcome to Semtech's conference call to discuss our financial results for the second 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, 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. A discussion 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 also included in today's press release. 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?

Emeka Chukwu, CFO

Thank you, Sandy. Good afternoon, everyone. For Q2 fiscal year 2021, net sales increased 8% sequentially and 5% over the prior year to $143.7 million, which was above the midpoint of our guidance. In Q2, shipments into Asia represented 80% of net sales. North America represented 12%, and Europe represented 8%. Total direct sales were approximately 19%, and sales to distribution were approximately 81% of net sales. Our distribution business remains balanced, with 40% of the total POS coming from the infrastructure end market, 27% from the industrial end market, and 26% from the high-end consumer end market. Bookings decreased over the prior quarter, but resulted in a book-to-bill above 1. Tolls bookings accounted for approximately 21% of shipments during the quarter. Q2 gross margin increased 50 basis points due to a higher mix of infrastructure revenue. We expect our Q3 gross margin to decline slightly due to a higher mix of consumer revenue. Q2 GAAP operating expense increased 7% sequentially, due to higher share-based compensation expense. We expect Q3 GAAP operating expense to increase 1% to 4%, sequentially, primarily due to higher share-based compensation expense driven by higher stock price. Q2 GAAP order expenses were $2.9 million versus $4.8 million in Q1. The decrease was primarily due to lower write-down of our minority investments, slightly offset by higher foreign exchange losses on translation of foreign-denominated liabilities. In Q2, our GAAP tax rate was 2.6% as a result of several discrete tax items. 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. In Q2 non-GAAP operating expense increased 1% sequentially as expected. In Q3, we expect our non-GAAP operating expense to be flat to up 4% sequentially, primarily due to higher variable compensation and new product expenses. For modeling purposes, our Q4, the January quarter will be a 14-week quarter. Q2 non-GAAP order expenses increased to $2.2 million from $1.1 million in Q1, due to higher foreign exchange losses on translation of foreign-denominated liabilities. In Q2, our non-GAAP tax rate benefited from some discrete items and came in at 13.6%. We expect our Q3 fiscal year 2021 tax rates to be in the 15% to 17% range. In Q2, our cash flow from operations increased 43% sequentially, due to higher revenue and continued good management of working capital and represented 26% of revenue. Our CapEx was 5% of revenue in Q2 driving a free cash flow of 21% of revenue. As a reminder, our target range is 25% to 30% of revenue, and we expect continued revenue growth to get us into that range. We repurchased approximately 233,000 shares or $12 million of stock in Q2. And our stock repurchase authorization now stands at approximately $68 million. We expect to continue to use our cash to opportunistically repurchase our shares, make strategic investments and pay down the debt. In Q2, accounts receivable increased 4% sequentially, due to higher net sales and represented 42 days of sales, which remains below our target range of 40 days to 45 days. Net inventory in absolute dollar terms was flattish sequentially, and days of inventory decreased by 4 days to 127 days, which remains our target range of 90 days to 100 days. In Q3, we expect net inventory to be flat. In summary, we were pleased to deliver strong Q2 results. We grew earnings at almost three times the rate of revenue growth and significantly increased cash flow from operations. Our growth engines remain solid, our gross margin and operating expenses are stable, and our cash flow and balance sheet is strong. We believe we are very well positioned to continue to deliver solid financial results in the second half of fiscal year 2021 despite the ongoing macro headwinds. I will now hand the call over to Mohan.

Mohan Maheswaran, CEO

Thank you, Emeka. Good afternoon, everyone. I will discuss the Q2 fiscal year 2021 performance by end market and by product group and then provide our outlook for Q3 of fiscal year 2021. In Q2 of fiscal year 2021, net revenues increased 8% sequentially and increased 5% over the prior year to $143.7 million. Stronger demand for the infrastructure end market was offset by softness from the high-end consumer market. We posted non-GAAP gross margin of 61.8% and non-GAAP earnings per diluted share of $0.43. In Q2 of fiscal year 2021, net revenue from the infrastructure market increased 18% sequentially and increased 37% over the prior year, and represented 47% of total revenues. The industrial market net revenues increased 12% sequentially, and represented 31% of total revenues. Net revenues from the high-end consumer market decreased 11% over the prior quarter and represented 22% of total net revenues. Approximately 14% of high-end consumer net revenue was attributable to mobile platforms, and approximately 8% was attributable to other consumer systems. I will now discuss the performance of each of our product groups. In Q2 of fiscal year 2021, our signal integrity product group achieved a new quarterly revenue record and increased 20% sequentially and increased 30% over the prior year, and represented 50% of total net revenues. Record revenues from our data center, wireless base station, and 10 gig PON businesses contributed to the very strong results. In fiscal year 2021, record data center demand was led by strength from our global hyperscale data center customers. We experienced record demand for our ClearEdge CDR platform used in 100-gig optical modules as the need for higher bandwidth connectivity within data centers continues to increase. We expect 100-gig optical modules to remain the workhorse technology for global cloud and hyperscale data centers over the next few years. Customer design activity for our new Tri-Edge PAM4 short-reach platform continues to accelerate in Q2 and we achieved additional design wins in 200-gig and 400-gig PAM4 optical modules. We expect to release our longer-reach Tri-Edge platforms for both 200-gig and 400-gig optical modules, enabling up to 10 kilometers reach later this year. We are expecting revenue from our Tri-Edge products to begin to ramp in the second half of this year and increase nicely next year, as the lower cost, lower power, and lower latency of Tri-Edge provides a significant advantage over DSP-based solutions. We believe the strong secular trends in the data center market should provide nice growth for our data center business over the next few years. In Q2 of fiscal year 2021, we also saw record demand from the wireless base station market led by the emerging ramp of 5G base stations. Our ClearEdge CDR and FiberEdge PMD platforms are being used in 5G base stations, front-haul and mid-haul optical modules. Our 5G ClearEdge and FiberEdge portfolio continues to see solid design-in activity. And we expect these designs to move to volume shipments later this year and throughout next year. As 5G infrastructure deployments continue to increase globally, we expect to have 5G market opportunity to be triple that of 4G. In Q2 of fiscal year 2021, our 10-gig PON revenue also grew nicely over the prior quarter and achieved record revenues. We are expecting growth from our 10-gig PON products this year, led by the build-out in China, as well as a number of new PON initiatives outside of China that enable gigabit to the home, enterprise, and campus networks. Semtech has established itself as the leading supplier of 1-gig, 2.5-gig, and 10-gig PON PMD platforms for the ONU and OLT markets and we expect our innovative products to allow us to continue to benefit from the growth in PON deployments globally. While infrastructure deployments can be lumpy, we believe the ongoing secular trends driven by the upgrade of data center, PON, and wireless network capabilities should drive future demand for our higher bandwidth platforms across all our target infrastructure markets. For Q3 of fiscal year 2021, we expect net revenues from our Signal Integrity products group to be down slightly as 5G wireless growth is offset by lower data center and PON demand following the very strong first half demand. Moving on to our protection product group, in Q2 of fiscal year 2021 net revenues from our protection product group decreased 17% sequentially and represented 23% of total net revenues. In Q2 of fiscal year 2021, demand from our Korean smartphone customers declined due to COVID-19 related issues. We expect that Korean smartphone demand to recover beginning this quarter as new smartphones begin to ramp. Demand from our North American and Chinese smartphone customers remains solid through Q2. Our Protection Product Group continues to execute on its diversification strategy, focusing on applications in the industrial, automotive, and communications markets. Our high-performance protection solutions are gaining momentum in systems where high-speed interfaces such as USB-C, HDMI 2.1, and 10-gigabit Ethernet are being designed with advanced lithography processes. The faster interface speeds and the use of more sensitive components are driving demand for higher performance protection solutions. We expect these trends to continue and contribute to the further diversification of our protection business. In Q3 of fiscal year 2021, we are expecting our protection revenues to increase nicely led by stronger smartphone demand from North America and Korea, and growth from the broad-based industrial and communications markets. Turning to our Wireless and Sensing products group, in Q2 of fiscal year 2021, net revenues from our Wireless and Sensing products group increased 18% sequentially led by record revenue from our LoRa-enabled platforms, and represented 27% of total net revenues. Our LoRa business continues to make excellent progress despite the global challenges associated with COVID-19. In Q2 of fiscal year 2021, we made solid progress against the LoRa metrics we targeted at the beginning of the year. These included the number of countries with LoRa networks now stands at 92 countries. And we expect over 100 countries to have LoRa networks by the end of fiscal year 2021. The number of public or private LoRa network operators grew to 143 and we expect 150 LoRa network operators by the end of fiscal year 2021. The number of LoRa gateways deployed grew to over 1 million from the 642,000 gateways at the end of fiscal year 2020 and we are now expecting the number of LoRa gateways deployed to increase to over 1.3 million by the end of FY 2021. These 1 million deployed gateways enable a sensor capacity of approximately 5 billion end-nodes. The cumulative number of LoRa end-nodes increased to 158 million from 135 million at the end of fiscal year 2020. And we expect this number to exceed 180 million cumulative end-nodes by the end of FY 2021. 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 continue to expect the opportunity pipeline to exceed $700 million, with an additional $300 million of leads feeding these opportunities by the end of fiscal year 2021. This 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 performance, and the solid progress on our targeted metrics, Q2 also represented a quarter of many important achievements for LoRa. These include the recent release of our LoRa Edge platform has been met with extremely strong customer interest. LoRa Edge is our first LoRa-based software-defined radio platform that includes Wi-Fi sniffing and GPS sniffing functions, and enables true silicon-to-cloud connectivity. LoRa Edge is an ideal platform for asset tracking and asset management use cases and is expected to be the enabler of our future cloud services revenues. We recently announced a collaboration with Amazon Web Services, or AWS to offer asset tracking and smart building kits that integrate LoRaWAN straight into the Amazon cloud. These kits will simplify IoT solution development by system integrators and enterprises that can now leverage AWS’ leading IoT services and network infrastructure to accelerate the introduction of new solutions. In addition to the hardware, the kits provide out-of-the-box cloud dashboard capabilities. The Asset Tracking Kit allows users to locate and track outdoor assets using a cloud dashboard, while the Smart Building Kit allows users to monitor doors and windows, manage occupancy, detect water leaks, detect fires, assess environmental conditions, detect chemical or other hazardous situations, and ensure a quick and safe evacuation path. We expect these initial offerings for Asset Tracking and Smart Buildings to pave the way for many other future industry verticals, such as smart utilities, smart homes, and smart healthcare to also deploy LoRa and AWS. Korea Expressway Corporation or KEC has built a LoRaWAN network for its expressways in Korea. The network will monitor parking spaces, trash and rest areas, barriers, and guardrails in real-time. In the future, the network will be expanded to provide detection of road freezing, tunnel management, and expressway-like management. Using LoRaWAN KEC expects to reduce operating costs by $2 million per year, and it is widely anticipated that 5G deployments in the region are expected to be an additional catalyst for lower demand. H3C announced the integration of LoRaWAN into its new intelligent door lock applications to increase safety, efficiency, and convenient management of dormitories in schools. The use of LoRa enables entry via wireless fob or keycard and enables campus staff to monitor who enters and exits buildings. YoSmart integrated LoRa Technology into its new YoLink line of residential IoT products that provide many advantages, including simple deployment and quick connectivity for a variety of home applications, including smart doors, security systems, electrical outlets, and water leak monitoring. YoSmart’s LoRa devices enable smart home connectivity over half a mile, enabling a number of new smart home use cases. Finally, opportunities associated with COVID-19 where LoRa is ideally suited for applications such as contact tracing, distance tracking, hygiene monitoring, and occupancy management continue to expand. We now have a fast-growing catalogue of customers and partners that have announced LoRa Solutions for COVID-19 use cases in the emerging smart health market. The flexibility, low cost, long range, and low power of LoRa Networks are critical components of any successful LPWAN IoT deployment. And we expect LoRa to continue to make inroads in new markets that demand these benefits. Despite a record Q2 performance and anticipation of another record performance in Q3, for fiscal year 2021, we are now expecting our LoRa-enabled revenues to be between $85 million and $95 million due to significant customer program push-outs related to COVID-19. We continue to believe the momentum behind our LoRa metrics and the increasing geographic diversity in our opportunity funnel should enable our LoRa-enabled revenues to grow at our target of a 40% CAGR over the next five years, and enable LoRa to become the de facto standard for IoT LPWAN applications. In Q2 of fiscal year 2021, net sales from our proximity sensing platforms remained soft due to the weak smartphone market. Despite this weakness, customer design-in activity remains high as global RF safety regulations are expected to become more stringent as new high power radios become deployed. We have won several new design wins in new smartphones and wearables that should ramp nicely in the second half of this year and into fiscal year 2022. For Q3 of fiscal year 2021, we expect net revenues from our Wireless and Sensing Product Group to increase nicely, led by another record performance from our LoRa-enabled business and stronger proximity sensing demand. Moving on to new products and design wins. In Q2 of fiscal year 2021, we released 16 new products and achieved 2,592 new design wins. Now, let me discuss our outlook for the third quarter of fiscal year 2021. Despite the ongoing geopolitical challenges and the macroeconomic headwinds associated with COVID-19, we believe the underlying secular demand for our key growth platforms remains solid. Based on our bookings and record high backlog entering the quarter, we are currently estimating Q3 net revenues to be between $145 million and $155 million. To attain the midpoint of our guidance range or approximately $150 million, we needed net terms orders of approximately 22% at the beginning of Q3. Our guidance once again assumes no more direct shipments to Huawei or HiSilicon this quarter. We expect our Q3 non-GAAP earnings to be between $0.43 and $0.49 per diluted share. I will now hand the call back to the operator and Sandy, and Emeka, and I will be happy to answer any questions.

Operator, Operator

Thank you. Our first question comes from Tore Svanberg with Stifel. Please proceed with your question.

Tore Svanberg, Analyst

Yes, thank you and congratulations on the results. I noticed that, you know, Huawei was still 4% of revenue in the quarter. I know you're guiding sort of zero Huawei going forward, but can you just talk a little bit about the dynamics there Mohan? You know, why were you able to still ship last quarter and what are some of the restriction issues for you going forward?

Mohan Maheswaran, CEO

Yeah, so Huawei is an ongoing dynamic situation Tore as you know. They used to be an $80 million to $100 million account for us, so it's much lower now. The numbers are and what I choose to do on that guidance is essentially eliminate any risk for our investor community, so we're assuming no more shipments. That said, you know, we – it's an ongoing process to look at, see what we can ship and what they need, and what products they want. And if they can take the products, and if we can ship them, then we will. It's not a question of us not wanting to ship them. You know, obviously, we're restricted to what we can ship at times and we have to go through that process. And the regulations as you know are changing quite frequently. So, we take the approach of let's be conservative and assume no shipments, but if we can, then we will, and of course that will be upside for us.

Tore Svanberg, Analyst

Very good. And as a follow up on LoRa, so you talked about these push-outs. I'm just wondering, what needs to happen, you know, for those push-outs to go into production? And I mean, is this kind of getting the networks up and running? If you could add a little bit of color on how the push-outs are happening that'd be great?

Mohan Maheswaran, CEO

Yeah, I think it's more a question of just priorities, Tore. I don't think there's anything fundamental there. I think, you know, with COVID-19, a lot of companies are just kind of hunkering down and, you know, trying to figure out, you know, how to make sure their business operations are just running normally. And so, some of the emerging programs of which, you know, IoT is one of them, some of these smart cities, and smart home use cases are just not quite getting the priority. I will say that, specifically for the bigger programs, I don't think there's any change to the value of the program or the needs and the want to execute on the program. I just think it's more of a timing thing. And so, we're still anticipating most of these programs are going to ramp up, especially the consumer smart home ones, you know, in the second half of this year and maybe early next year.

Tore Svanberg, Analyst

Very good. Thank you, Mohan.

Operator, Operator

Thank you. Our next question comes from Harsh Kumar with Piper Sandler. Please proceed with your question.

Harsh Kumar, Analyst

Hey, guys, first of all, congratulations on a solid quarter and guide. I had a question on LoRa, to begin with, so you talked about the - you talked about the run rate you expect for the year, you talked about a lot of good activity, and then you also talked about push-outs, I'm trying to get the sense of like, all this activity, you know, why isn't it happening? And is it predominantly one or two kind of large players that you were anticipating in the United States that had got pushed out? Or is it a bunch of just smaller push-outs as you saw? And then I had another follow-up?

Mohan Maheswaran, CEO

Yeah, I would say it's a little bit of both Harsh. Obviously, the bigger ones affect the revenue in a larger way. So, there are, specifically one very big one in North America that has pushed out, but I think there's a lot of different POCs that are in place that are just going to take a little bit longer, and you know, some regions shut down, some regions, you know, our operations, some POCs their manufacturing operations not even just coming back to real manufacturing and now starting to deploy IoT has not been our highest priority. But I think it's starting to come back. We're definitely seeing across the globe more activity and some of these POCs now starting to generate revenue, but yeah, the main reason for the change in the range is specific to North America and some fairly large customers that have just pushed out the timeline.

Harsh Kumar, Analyst

Understood. Do you have any idea, Mohan, about how long the delay is? Is it essentially waiting for COVID to subside, which has an uncertain timeline, or is it simply delayed because they couldn't complete the technical work in time to set the mark of a launch?

Mohan Maheswaran, CEO

Well, as far as I'm aware, the activity is still continuing. I think that, you know, the launch may – launches may have been pushed out, but, you know, one of the metrics we look at is gateway deployments. As you can see, you know, we increased quite dramatically this quarter from 800,000 gateways to over a million gateways. The vast majority of that is actually tied to smart home activity. And so I think that's an indication that there's no real change to the ambition, I would say. It's more a question of, you know, just waiting for the right time point to execute on the launch.

Harsh Kumar, Analyst

Got it. I’ll now get back in line. Thank you.

Operator, Operator

Thank you. Our next question comes from Rick Schafer with Oppenheimer. Please proceed with your question.

Rick Schafer, Analyst

Thanks and let me add my congratulations. I guess, I just had a couple of questions. The first is on the 5G brand market opportunity, I know you've mentioned it's up 3x versus 4G, and I was just curious how much of that is Semtech's content gain versus or content growth versus share gains that you guys are winning in the market?

Mohan Maheswaran, CEO

Yeah, it's a bit of both. Rick, I would say the content gain is the fundamental architectural change from 4G to 5G, where 5G optical modules need a CDR, whereas the 4G modules didn't necessarily need a CDR. So, we have more content, we have a PMD function and CDR function in the 5G base stations. I would say also that typically on the 5G base stations there's more optical modules on the fronthaul side. Sometimes – actually double the number versus 4G, maybe even triple the number of modules versus 4G. So, more modules, more content and then I think we have a good portfolio of products that's doing very well. I just think we will take share in that space because of the capability of our products that are doing very well. Again, they're based on our ClearEdge, FiberEdge, and emerging Tri-Edge platform. So, which have all proven success in the data center market already? So, yeah, we feel pretty good about where we are in 5G.

Rick Schafer, Analyst

Thanks, Mohan. And then just a follow up on protection, if you could give some color on how big industrial is now for that segment, and maybe talk about the relative growth rate of the industrial, you know those industrial wins versus mobile, maybe, you know, how does the design pipeline split between industrial and mobile for kind of gauge what’s coming? Thanks.

Mohan Maheswaran, CEO

Yeah. So, our industrial business, I think it's about 30% to 35% of the total protection business. So, consumer is still the largest part and one of the nice things there, Rick, even though our industrial business is growing nicely and the pipeline is good, and we've got lots of good wins in automotive, IoT common infrastructure, you know, really targeted by USBC, HDMI 2.1 10-gig Ethernet ports. But on the consumer side also, we've really done a pretty good job of diversifying within that business. You know, North America was never really a strong participant in our protection business, but is now in the consumer space. And also, you know, on the wearable side, we're getting more traction. So, our consumer business in general has diversified nicely. And then of course, we add to that the industrial business, which is really a combination of industrial communications, automotive, you know, video, those types of things is all doing quite well. So, we feel pretty good about where we are, obviously last quarter, Q2 was challenging because of the drop-off of Korean mobile phones, smartphones, but I think now we expect that to come back this quarter and actually do quite well in the second half.

Rick Schafer, Analyst

Great. Thanks Mohan.

Operator, Operator

Thank you. Our next question comes from Karl Ackerman with Cowen & Co. Please proceed with your question.

Karl Ackerman, Analyst

Good afternoon, gentlemen. Two questions, if I may. First, I wanted to go back to LoRa for a moment. You know, it's nice to see the 200,000 unit increase in gateways this quarter, but if my model is right, and I'm wondering if it is, but if my model is right, it seems that you're still about half the level of your recently updated LoRa guide, year to date. And so I guess, first is your implicit outlook for LoRa revenue assume a second half seasonal ramp of LoRa nodes from some of the Smart Home design wins you announced entering the quarter. If you could just help me bridge the – perhaps the linearity of LoRa, that would be helpful. And I have a follow-up.

Mohan Maheswaran, CEO

Yeah, so I think Karl the way to think about remember that Q1 was really a soft quarter for LoRa. China was shut down pretty much and you know, we had a very poor quarter, so when we set the range it was prior to COVID-19 and then we thought, you know, last quarter we thought that the second half was going to be extremely strong and we just wanted to wait and see how it played out. Q2 was a record quarter where we’re anticipating a record Q3 and even record Q4. I just don't think we can catch up and especially with some of the larger program push-outs I mentioned, but I think the main thing to remember is the timing. There are two timing elements that are very critical. One is, when the customers actually deploy their networks, whether that's a home network or whether that's an operator network. That's important. So that kind of demonstrates that they have now gone over the POC. The POC is completed and they've decided to deploy a network and decided to deploy LoRa. But then the second aspect on the timing is when sensor nodes are connected to those network gateways, which is really when we start to generate the revenues. Now, the deployments on the gateway side is really a precursor, right? It's really saying, okay, now we can expect end-nodes to be deployed. And the timing of that is usually dependent on software and other things, but you know, it's going to happen once the customers have deployed the gateway. So, I think the most telling milestone this quarter is the very large increase in the gateway deployments, which is very encouraging for future end-node devices.

Karl Ackerman, Analyst

Thank you for the information. For my follow-up question, how do you assess your visibility regarding 10-gig PON or PON in general in China for the second half of the year? I'm asking because there seem to be various trends at play. On one hand, U.S. carriers are upgrading their home networks and Wi-Fi 6 is gaining traction, but on the other hand, some suppliers in Asia have mentioned a slowdown in 5G deployments in China during the third quarter, whereas you're indicating that your business is expected to grow. Could you provide some insights into the factors affecting PON, especially from the perspective of service providers in China? Thank you.

Mohan Maheswaran, CEO

Yeah, I think the first thing to remember about 5G and 10-gig PON are they are both driving more bandwidth, right? And so that's not going to change. That requirement is not going to change. We may have lumpiness from quarter to quarter, but the trend is going to be upward. And China, much like everybody else in the world wants to still be the first. The other thing to remember about 10-gig PON is that it's a kind of a natural handoff for 5G. So, I think as 5G increases, 10-gig PON will increase as well. There is, obviously with the whole Huawei ban, there's some kind of question marks as to the timing of 5G rollouts in China. I don't think it's going to be a long-drawn-out kind of issue. I think it's going to be one where we just have to monitor and see what happens, but that aside, I think, you know, one of the nice things that we have seen is the globalization of some of these platforms. You know, as you mentioned, PON being deployed more in North America, Europe, certainly 5G now being picked up in Europe and North America, which I think is very encouraging for us. So, to just see a little bit more geographical balance, but yeah, I think there’s still, you know, the way we look at Q3 is, currently that PON is likely to be down and 5G base stations slightly up, but you know, those metrics could change in Q4. We'll see what happens.

Operator, Operator

Thank you. Our next question comes from Craig Ellis with B. Riley. Please proceed with your question.

Craig Ellis, Analyst

Yeah, thanks for taking the questions and congratulations on the results and strong overall guide, guys. Mohan I just wanted to take a different look at the LoRa update on revenues. So, the new revenue mid-point is lower, but your range is much tighter than it was. So, maybe speak to the confidence that you have in that new tighter range and within that range, what would dictate the high-end versus the low-end of the range as you look at the back half of the year?

Mohan Maheswaran, CEO

Craig Ellis, Analyst

Got it. And then maybe one more for you before flipping to Emeka. There's been a lot of talk and a lot of press around smartphone release timing this year, and certainly for some, but it's a little bit later than normal. So, what does that mean for protection and proximity sensing, seasonal dynamics both in 3Q and 4Q? I think 4Q we would typically expect those to be down, but this model release timing mean that those two businesses could be up in 4Q?

Mohan Maheswaran, CEO

I think the answer is, yes Craig. You know, obviously we’ve had a very weak Q2, which is somewhat unusual and for sure with the Korean smartphone manufacturers that was mostly COVID-19 related. North America and China didn't have the same issue. So, we're not expecting strong second half from China, but we are expecting pretty strong second half from Korea and North America. So, we'll see how that plays out. But I think you're right. You know, one of the things that normally happens in Q4, of course, is everybody, especially in Korea, they bring their inventory way down, but it seems to me this year might be different, but we'll see. Yeah.

Craig Ellis, Analyst

Great. Thanks for that. And then Emeka, I think a quarter ago, we had been looking for gross margin to rise through the year and it looks like it will be down a little bit, unless I've got something wrong in the fiscal third quarter. So, please correct me if I've got the inaccurate perception. If I've read it right, then should we expect gross margin to be up in the fourth quarter and what would be a reasonable expectation beyond that? Can you continue with an upward trajectory or would there be any cross currents that we should be aware of in fiscal 2021?

Emeka Chukwu, CFO

So, Craig, you know, one of the pleasing things about our gross margin has been how relatively stable it has been. I think for several quarters now we have guided to gross margins being between 61%, on a non-GAAP basis being between 61% and 62%. And as you know, the key driver for our gross margin is the market mix, right. So, when we get more revenue from the infrastructure market and industrial end-market, it's good for gross margins and the rest. We get more from consumer is somewhat of a headwind to our gross margin. So, I think you know, you're right. A few months ago, probably in the last call, at that point the expectations for the infrastructure market was that it was still going to be much higher mix of revenue from Mohan’s commentary. I think, yeah, he had guided through our SIP signal integrity business being flat to slightly down this quarter. So, that is a headwind for gross margin. But my expectation is going to be that depending on the mix of revenue, where it's coming from, but as we go forward, I expect a lot of revenues coming from – continue to come from the PON market, from the 5G base station, from data centers, and of course, LoRa continuing to grow. So, I would hope, you know, I would think that starting from the fourth quarter, we'll see gross margin going back up again, and that would be my expectation that will continue to go up as we go into the next fiscal year.

Craig Ellis, Analyst

Thanks, Emeka, and if I could just sneak in one more. Any color on how we should think about the 14-week dynamic per revenue versus COGS and OpEx as we look to fiscal fourth quarter?

Emeka Chukwu, CFO

Yeah, I think, you know, in terms of revenue, right, I think from Mohan’s prepared remarks, you know, typically the fourth quarter for us, we're usually down 5% to 10%, right? You know, but I think maybe because of probably because of the extra week, we are now sort of expecting maybe something that is flattish, not slightly up, slightly down, and we just have to see, and on the operational expense side of things on a non-GAAP basis, as I think about it, I think about 60% of our run rate operating expenses linked to time, right? So, you know, things like employees, salaries, traveling supplies, those types of things. So, I would expect that the extra week will probably impact more on the 60% of our operating expenses.

Craig Ellis, Analyst

Thank you. Good luck, guys.

Operator, Operator

Thank you. Our next question comes from Christopher Rolland with Susquehanna International. Please proceed with your question.

David Haberle, Analyst

Hi, guys, it's David Haberle on behalf of Chris Rolland. Thanks for taking our questions. I guess just digging a little further on the 5G base stations side and we appreciate the magnitude of this opportunity for you guys. So, we wanted to ask how the current tax rate is for CDRs and 5G and what sort of revenue you're generating from CDR versus PMD at this point. Do they like sort of go hand-in-hand or are we still waiting on some of the CDR ramp, any color there that'd be great?

Mohan Maheswaran, CEO

So, the 5G optical modules typically are all using CDRs, and some of them have integrated drivers and some of them will use separate PMD functions, but they will all have some combination of a PMD and CDR, the 4G base stations don't, they only typically will use PMD devices. So, yeah, you know, obviously, 4G base stations are still being sold and used. So, it's a mix there, but as 5G becomes the predominant base stations being deployed, we'd expect our revenues to increase nicely. And also, as I mentioned, on 5G, typically there's more frontal optical modules than in 4G base stations. So, we just see we're expecting that to increase as well. So yeah, as I said, that position is good. We have good products. It's just a question of timing.

David Haberle, Analyst

Understood. Thank you there. And then on LoRa, it seems like you guys are making good progress and kind of the cloud side and getting set up there. I know, it's a longer-term opportunity for you, but how are you thinking about kind of the microservices side of LoRa business at this point, and how big it can be down the road here?

Mohan Maheswaran, CEO

Yeah, that's important. And I think, you know, one of the reasons I mentioned LoRa Edge, which is our kind of new platform that really is the enabler for our device-to-cloud services. It's getting really very good momentum, and the pipeline of opportunity has grown dramatically in just a handful of months. And so, yeah, we're very excited about it. You know, it's still early days, but I think it's going to be a very important part of our strategy and revenues really starting next year, I think.

Operator, Operator

Thank you. Our next question comes from Tristan Gerra with Robert W. Baird. Please proceed with your question.

Tristan Gerra, Analyst

Hi, good afternoon. So, it sounds like you implied earlier that in base station, you see continued growth that will be primarily driven by geographic diversification. I just wanted to confirm that I heard this well, just in relative to some other companies commentary about base station guidance for the quarter? And then, additionally, I was wondering given, you know, the transition away from Huawei on the base station side, once they went out of finished goods, do you expect – what is your timing in terms of when you think there's going to be a major pickup of non-Huawei base station vendors that are starting to ramp in China? And would you be benefiting from that?

Mohan Maheswaran, CEO

So, first of all, the answer is, yes, we will benefit from that, Tristan. The timing is very difficult to say because it really depends on how much inventory they have, and you know, how well equipped others are to take over and things like that. So, and how much, you know, business the operators are going to give them, right? So, that one is tricky to answer. I would say that our 5G revenues are still mostly based on China deployments, but we are seeing more and more opportunities outside of China, which I think is encouraging. So, as I just talked about, our content increases across the 5G space versus 4G is significant. So, yeah, all-in-all, I think, you know, as I mentioned, 5G is not going away, it's going to continue to grow. You know, there's going to be a little bit of lumpiness based on tenders that go out and volumes that get deployed, but I think in general, we're all expecting a pretty good year next year. And my expectation is it will continue for quite a few years.

Operator, Operator

Thank you. Our next question comes from Craig Ellis with B. Riley. Please proceed with your question.

Craig Ellis, Analyst

Yeah, thanks for taking the questions and congratulations on the results and strong overall guide guys. Mohan I just wanted to take a different look at the LoRa update on revenues. So, the new revenue mid-point is lower, but your range is much tighter than it was. So, maybe speak to the confidence that you have in that new tighter range and within that range, what would dictate the high-end versus the low-end of the range as you look at the back half of the year?

Mohan Maheswaran, CEO

Yeah, I think Craig it’s still depending on customer rollouts, right. I mean, you know, we've got good momentum. As I said, we're expecting another record in Q3, I'd expect another record in Q4, and that to continue the number of deployments, the end-nodes deployed is really driven by when customers decide to ramp out, you know, to kind of start connecting devices to their networks and how they do that. The Smart Home initiative is the one – one of the catalysts for us, and I think, you know, good progress on the gateway and deployments on the kind of infrastructure side, but I think on the Smart Home side, we have to see kind of that really start to pick up, and to me that's going to be the, you know, the difference between the low-end and the high-end. Thank you. In closing, I want to once again thank all of our talented and committed employees across Semtech for their enduring efforts to limit the impact of the COVID-19 pandemic on our business operations. We expect our multi-sourcing strategies, investments in our IT operations and sales infrastructure, and systems, along with our secular demand drivers, diverse product offering, balanced end-markets and strong customer relationships to enable us to deliver a solid performance in fiscal year 2021. With that, we appreciate your continued support of Semtech and look forward to updating you all next quarter. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's web conference. You may now disconnect your lines at this time. Thank you for your participation and have a great day.