Semtech Corp (NASDAQ: SMTC)Q1 2020 Earnings CallMay 29, 2019, 5:00 p.m. ET

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Operator

Good afternoon. My name is Erica, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Q1 FY '20 Semtech Corporation Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be question-and-answer session. (Operator Instructions).

Thank you. Mr. Sandy Harrison, Director of Business, Finance and Investor Relations. You may begin your conference.

Sandy Harrison — Director of Business, Finance and Investor Relations

Thank you, Erica. And welcome to Semtech's conference call today to discuss our financial results for the first quarter of fiscal year '20. Speakers for today's call will be Mohan Maheswaran, Semtech's President and Chief Executive Officer; and Emeka Chukwu, our Chief Financial Officer.

A press release announcing our unaudited results was issued after the market close today and is available on our website at semtech.com. Today's call will include forward-looking statements that include risks and uncertainties that could cause actual results to differ materially from the results anticipated in these statements. For a more detailed discussion of these risks and uncertainties, please review the safe harbor statement included in today's press release and in the other risk factors section of our most recent periodic reports filed with the Securities and Exchange Commission.

As a reminder, comments made on today's call are current as of today only, and Semtech undertakes no obligation to update the information from this call should facts or circumstances change.

During the call, we will refer to non-GAAP financial measures that are not prepared in accordance with generally accepted accounting principles. 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. All references to the financial results on Mohan's and Emeka's formal presentation on this call refer to non-GAAP measures unless otherwise noted.

With that, I will turn the call over to Semtech's Chief Financial Officer, Emeka Chukwu. Emeka?

Emeka Chukwu — Executive Vice President and Chief Financial Officer

Thank you, Sandy. Good afternoon everyone. For Q1 fiscal 2020, net sales as expected decreased 18% sequentially to $131.4 million. In Q1, shipments into Asia represented 78% of net sales, North America represented 12%, and Europe represented 10%. Total direct sales represented approximately 38%, and sales to distribution represented approximately 62%. Our distribution business remains balanced, with 54% of the total POS coming from high-end consumer and enterprise computing end markets, and 46% of total POS coming from the industrial and communications end markets.

Q1 bookings improved nicely Q-over-Q resulted in a book-to-bill above one. Accounts bookings accounted for approximately 47% of shipments during the quarter. As expected, Q1 fiscal 2020, GAAP gross margin increased 10 basis points sequentially to 61.9%, while Q1 GAAP operating expense declined 5% sequentially due to the onetime benefit from the reduction in the fair value of contingent earn-out obligations, a lower intangible amortization expense.

In Q1, GAAP interest and other expense was $1.4 million, an increase from the $548,000 in Q4, that had benefited from a $1.3 million gain on the sale of an investment. Q1 GAAP tax benefit of approximately 20.3% was driven by the discrete tax benefit from Comcast exercising its remaining warrants. We expect that our GAAP tax rate for the rest of fiscal year 2020 to be in the range of 15% to 19%. Our GAAP tax rate forecast excludes consideration of any impact from discrete items including excess tax benefits or deficiency from exercise of stock options.

Moving on the non-GAAP results which exclude the impact of share based compensation, amortization of acquired intangibles, acquisition related and other nonrecurring charges. In Q1, non-GAAP gross margin increased 10 basis points sequentially to 62.2% as expected, and we expect Q2 non-GAAP gross margin to remain flat. In fiscal year 2020, we expect our gross margin to remain stable driven mostly by end market mix.

Q1 non-GAAP operating expense was $53.1 million flat with Q4, as higher payroll expense was offset by low and new product spending due to timing. In Q2, we expect non-GAAP operating expense to be flat or decline 4% sequentially because of lower variable compensation expenses driven by lower revenue expectations. While maintaining our investments in our key growth drivers, we expect our non-GAAP operating expenses for fiscal year 2020 to be approximately flat or only modestly higher with the prior year. We expect our fiscal 2020 non-GAAP tax rate to remain in the 15% to 17% range. In Q1, cash flow from operations decreased sequentially due to lower net revenue and annual disbursements for supplemental compensation.

Our stock repurchase authorization has started up approximately $181 million. We expect to continue to use our cash to opportunistically repurchase our shares, make strategic investments, and pay down the debt. In Q1, accounts receivable decreased 16% (ph) sequentially due to lower net sales and represented 50 days of sales, which is above our target range of 40 to 45 days. In Q2, we expect the cash receivables to increase, but for days of sales to refund within our target range.

The net inventory in absolute dollar terms increased 15% sequentially and days of inventory increased to a 125 days which is above our target range of 90 to 100 days. In Q2, we expect our net inventory to be up in absolute dollars and days to be flat due to the export restrictions on a key customer and expectations for higher sales in the second half of the year. In summary, we were able to achieve our Q1 expectations in a difficult macro-environment. Bookings grew strongly, sequentially, as we are seeing any signs of inventory levels in several markets beginning to normalize. While the recent geopolitical challenges from the export restrictions are contributing to near-term customer uncertainty and impacting our revenue, we will continue to focus on execution and believe the long-term secular nature of our growth engines position us for a stronger second half of fiscal 2020.

I'll now hand the call over to Mohan.

Mohan Maheswaran — President and Chief Executive Officer

Thank you, Emeka. Good afternoon, everyone. I will discuss our Q1 FY '20 performance by end market and by product group, and then provide our outlook for Q2 of fiscal year '20. In Q1 of fiscal year '20, net revenue decreased 18% over the prior quarter, $231.4 million. A weaker overall global demand environment in all our end markets contributed to the decline. We posted non-GAAP gross margin of 62.2% and non-GAAP earnings per diluted share of $0.34.

In Q1 of fiscal year '20, net revenues from the industrial market declined and represented 30% of net revenues. Net revenues from the enterprise computing end market declined and represented 27% of revenues. Net revenues from the communications end market declined over the prior quarter and represented 10% of total net revenues. Finally, net revenues from the high end consumer market increased 13% over the prior quarter and represented 33% of total net revenues. Approximately 25% of high end consumer net revenue was attributable to mobile devices and approximately 8% was attributable to other consumer systems. Our Q1 high end consumer revenues were impacted positively as expected by Huawei's increase in demand, which we believe was a result of them increasing their chip inventories in anticipation of a potential ban.

I will now discuss the performance of each of our product groups. In Q1 of fiscal year '20, net revenues from our Signal Integrity Product Group decreased 30% over the prior quarters record results, and represented 38% of total net revenues. As expected, demand decreased across all of our target market segments including the data center, PON and wireless base station markets. In Q1 of fiscal year '20, data center demand declined as cloud and hyperscale data center providers further reduced inventory levels.

Our ClearEdge CDRs continued to do very well in new 25 gig, 200 gig, NRZ based optical modules and active optical cables. We believe customer inventory levels are returning to more normalized levels and demand forecasts from our data center customers and bookings have started to improve. In fact, our Signal Integrity Products Group recently received the largest ever single order for our ClearEdge CDRs for a North American mega data center customer.

During Q1, our initial Tri-Edge PAM4 CDRs samples experienced strong customer interest, as its low cost, low power, and low latency characteristics are ideal for 50 gigabit per second, 100 gigabit per second, 200 gigabit per second, and 400 gigabit per second PAM4 applications. We recently announced our participation in the formation of the Open Eye Multi Source agreement. The Open Eye MSA launched with 19 initial member companies, targets low cost, low power, and low latency PAM4 optical modules, using analog PAM4 CDRs such as Semtech's Tri-Edge platform.

We expect to see our first Tri-Edge PAM4 revenues starting in Q4 this year. Our FiberEdge PMD platform, which complements our Tri-Edge and ClearEdge CDR platforms, continue to be qualified at key module customers, where we have collaborated with leading DSP providers for use in next generation 100 gig, 200 gig, and 400 gig PAM4 optical module solutions. Our FiberEdge platforms have garnered strong design win traction and we are seeing initial modest revenues from 100 gig PAM4 modules and from 400 gig PAM4 modules. We expect these modules to begin to ramp to volume beginning in FY '21.

In Q1 of FY '20, PON demand declined sequentially as expected. Our PON demand is largely driven by China, where demand has softened over the last two quarters. Semtech continues to be the PON PMD market leader, providing highly integrated solutions for 1 gig, 2.5 gig, and 10 gig PON ONU and OLT platforms. We currently expect stronger second half PON demand as PON tenders for this year in China indicate unit volumes similar to calendar year '18 volumes. However the medium term impact of the Huawei ban on our PON demand will not be clear for another quarter.

Our wireless base station demand was also weak in Q1, and we expect this business to also be negatively impacted in Q2, due to the Huawei ban. For FY '20, we expect to see further spending on 4G deployments as well as the ongoing ramp of 5G platforms throughout the year, with stronger growth expected in FY '21. We remain excited about our market opportunity for 5G base stations, which we believe could more than double from 4G and due to the larger volumes and additional content as we expect most optical links to require CDRs.

Despite the current challenges faced by our Signal Integrity Products Group in this fiscal year, we remain very confident in our strategy. And expect our SIP Product Group to grow nicely over the next few years, driven by the ongoing expansion of cloud and hyperscale data centers, the global transition to 5G base stations, and the acceleration of 10 gig PON deployments.

For Q2 of fiscal year '20, we expect net revenues from our Signal Integrity Product Group to be approximately flat.

Moving on to our Protection Product Group. In Q1 of fiscal year '20, net revenues from our Protection Product Group declined 8% over the prior quarter, and represented 30% of total net revenues. Demand from all end markets remained relatively weak in Q1. Our automotive protection business gained momentum in Q1, and reflects the need for high performance protection used in Advanced Driver Assistance Systems. Semtech's superior protection performance including that of our recently announced our RClamp3552TQ enables our customers to offer enhanced robustness for infotainment systems, incorporating ADAS functions.

Additionally newer high speed interfaces such as USB 3.1 Type C, 10-gig Ethernet and HDMI 2.1 are rapidly proliferating across all end markets and applications. As a result, we see growing demand for our high performance protection platforms that address these interfaces.

Our Protection Products Group remains focused on diversifying from the high end consumer market to the broader industrial markets, where there is an increasing usage of more advanced lithography devices. We believe our investments in these broader markets will enable us to diversify our business over the next few years.

In Q2 of fiscal year '20, we expect our protection business to increase as demand from the broad-based industrial end market is expected to recover.

Turning to our Wireless and Sensing Products Group. In Q1 of fiscal year '20, net revenues from our Wireless and Sensing Products Group decreased 9% sequentially and represented 32% of total net revenues. Weaker demand from the industrial end markets contributed to the decline. Despite the recent softness in our Wireless and Sensing business, due to a weak China demand environment, we do expect to see improving demand throughout the rest of the year.

Our LoRa momentum continues to build and we are seeing very exciting momentum across the globe underlined by some of the key lower metrics we track. These include the number of public or private LoRa network operators increased in Q1 to approximately 113 from 100 at the end of fiscal year '19. We now expect a 130 LoRa network operators by the end of fiscal year '20. The number of countries with LoRa networks grew to more than 74 countries. By the end of fiscal year '20, we expect over 90 countries to have LoRa networks.

The estimated number of LoRa gateways deploy increased to more than 300,000. These gateways will support approximately 1.5 billion connected end nodes. We expect the number of LoRa gateways deployed to exceed 500,000 by the end of fiscal year '20 supporting a LoRa end mode capacity of over 2 billion end nodes. The estimated cumulative number of LoRa end nodes deployed — increased to approximately 97 million. We expect this number to exceed 140 million by the end of fiscal year '20.

The LoRa opportunity pipeline increased to over $450 million of LoRa enabled opportunities in that pipeline, with an additional $200 million of leads feeding the opportunity pipeline. We anticipate that on average 40% to 50% of this pipeline will eventually convert to full deployment over a 24 months timeline. In addition to the strong performance on our LoRa metrics, we also began to see a number of new exciting use cases and new ecosystem partners. Some examples of this are: Target announced its use of LoRa to improve retail operations and retail guest experience at the IOT FUSE conference in Minneapolis.

SIP recently announced the integration of LoRa into its Leonardo (ph) IOT platform to support LPWAN industrial IOT use cases globally. Machine Max a revolutionary wireless telematics company announced its LoRa based machine sensing system for construction and mining systems, enabling significant fleet management and efficiency improvements; an emerging leader in wireless industrial sensing applications announced its LoRa based sensing system to monitor and track manufacturing assets, in facilities exceeding 100,000 square feet. And Sonova a leader in advanced hearing aid technology and solutions announced it's latest IOT connected hearing aid which uses LoRa to deliver best in class wireless performance.

Our pipeline of opportunities includes many new use cases which include very high volume and very disruptive use cases for numerous industry segments. We will discuss these use cases in future earnings calls, as they move from opportunities to proof of concepts and design wins. We recently announced the release of our first cloud-based LoRa microservice. Our first microservice is a LoRa based geo location service, that is available to our partners and customers to track and locate their LoRaWAN devices using the cloud.

The interest in the service has been very high and we are starting to demonstrate the unique value of a LoRaWAN based asset tracking system to our global ecosystem. We believe that we will start to help customers transition from testing the service to full qualification and commercialisation of their services by Q4 of this fiscal year. We expect our LoRa microservices to grow to between $80 million and $100 million in revenues within the next five years.

Our Wireless and Sensing Product Group continues to focus on developing ways to enable the faster proliferation of LoRa. Specifically in Q1, we started to offer a full suite of hardware reference designs, software building blocks and a suite of development tools and services, that will enable solutions providers and system integrators to move from concept phase to end deployment more rapidly. In addition to these new platform development tools, we have also accelerated our LoRa design partner program and our LoRaWAN Academy program. Both of these programs have been specifically designed to simplify the development and deployment of LoRa based solutions and accelerate the time to market of total IoT solutions based on LoRa. Both programs already have large global interest from the developer and academic communities.

In FY' 20, despite the broader macro concerns and soft demand from China, we still expect our LoRa enabled revenues to be between $100 million and $140 million and we continue to expect LoRa to become the de facto standard for LC-1 use cases, over the next few years, in what we expect to be a multi-billion unit industry. In Q1 of fiscal year '20, demand for our proximity sensing platforms increased and delivered record quarterly revenues due to strong demand from Huawei and increasingly stringent global SAR regulations.

We believe our proximity sensing business should continue to expand as we see solid design win progress in new customers and regions, as global regulations drive an increase in the need for radio energy management on smartphones and other mobile devices. In addition, as 5G smartphones start to enter the market during the year, we expect to see an increased number of high performance radios which drives higher proximity sensing content in these devices. For Q2 of fiscal year '20, we expect net revenues from our Wireless and Sensing Product Group to be approximately flat.

Moving on to new products and design wins. In Q1 of fiscal year '20, we released 11 new products and achieved a record 2,884 design wins. Now let me discuss our outlook for the second quarter of fiscal year '20. Despite the strong improvement in our recent bookings, based on the near-term geopolitical uncertainty and the recent ban on shipments to Huawei, we are currently estimating Q2 net revenues to be between $128 million and $142 million.

To attain the midpoint of that guidance range or approximately $135 million, we needed net terms orders of approximately 34% at the beginning of Q2. This Q2 guidance reflects a reduction of approximately $7 million due to anticipated reduced shipments and associated reduced demand related to the Huawei ban. We expect our Q2 non-GAAP earnings to be between $0.32 and $0.40 per diluted share.

I will now hand the call back to the operator, and Sandy and Emeka and I will be happy to answer any questions. Operator?

Questions and Answers:

Operator

(Operator Instructions) And your first question comes from the line of Karl Ackerman with Cowen.

Karl Ackerman — Cowen & Company — Analyst

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

Emeka Chukwu — Executive Vice President and Chief Financial Officer

So, Karl, pretty much most of the revenue is going to come from our chip sales for the next couple of years, and chips for both end nodes and for gateways. And then I think as the — from a licensing standpoint, the licensing royalties from partners will start to pick up over the next few years, I would say still we'll take another couple of years. And then microservices revenues will start to — start to increase next year, and as I said, I think, I think a few years for that to really become material, but initially, at least for the next couple of years, I think it's still predominately chip sales both end nodes and gateway sales.

Karl Ackerman — Cowen & Company — Analyst

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

Emeka Chukwu — Executive Vice President and Chief Financial Officer

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

Mohan Maheswaran — President and Chief Executive Officer

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

Operator

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

Harsh Kumar — Piper Jaffray — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

Yeah, Harsh. I think, if absent the Huawei ban, I would still be suggesting that bookings are strong. We have seen China weak for a couple of quarters now, but demand is picking up. Our LoRa business is going great. We see data center demand starting to inventory levels as I mentioned on the call, starting to become more in line and we start seeing a pickup in orders on the data center side. So if I look across the different end markets and product lines, I think the second half is still looking quite strong. For us obviously the Huawei ban puts a little bit of a spanner in that works and we have to work through that, both the direct impact and also the indirect impact. But absent that, I would suggest that the second half is still looking to be quite strong relative to the first half, sure anyway.

Harsh Kumar — Piper Jaffray — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

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

Harsh Kumar — Piper Jaffray — Analyst

Hey, just one last quick one, the $450 million funnel for LoRa, is that including the $100 million you expect from services or excluding that?

Mohan Maheswaran — President and Chief Executive Officer

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

Harsh Kumar — Piper Jaffray — Analyst

Thanks guys.

Sandy Harrison — Director of Business, Finance and Investor Relations

Thank you.

Operator

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

Quinn Bolton — Needham & Company — Analyst

Hey guys, wanted to just first ask on the Huawei exposure. Can you give us some sense sort of where you're exposed across Signal Integrity, Protection, Wireless and Sensing, and specifically is there any exposure to Huawei on the LoRa business? And then I've got a follow up on the data center side of the business.

Mohan Maheswaran — President and Chief Executive Officer

So, first of all on the LoRa business, there is no exposure to Huawei, Huawei is actually one of the key proponents of NB-IoT, so it's really a competitor to the LoRa solution. Most of our exposure, Quinn, is on the Signal Integrity Product side, I would say on the PON base station side, those two areas. And then, there is some exposure on the protection side for smartphones for Huawei, that's predominantly where the exposure is. We don't see much exposure anywhere else.

And there is both a direct and an indirect exposure. So the direct exposure is what we ship directly to Huawei and through HiSilicon, and then the indirect is really through other module companies. And also when Huawei can't get components to build its system which we learned from the ZTE ban, a year ago, that could have a negative impact on us. So that we've tried to quantify that as best we can, obviously they're all estimates and approximations until we really see what happens through the quarter, but it gives you an idea.

Quinn Bolton — Needham & Company — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

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

Quinn Bolton — Needham & Company — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

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

Quinn Bolton — Needham & Company — Analyst

Great. Okay. Thank you.

Operator

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

Gary Mobley — Wells Fargo Securities — Analyst

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

Sandy Harrison — Director of Business, Finance and Investor Relations

Yeah, that's a good question Gary. I think first of all we are well positioned with most of the other players in these segments. But until we see the orders, until we see the demand it's very difficult to anticipate what will happen. In ZTE's case, you use example where they initially thought that they were going to be able to build a system, then they realized they couldn't build a system and then it wasn't until they started to realize — short of some components or some part of the system that their customers started to look at alternative solution providers. And then we started to see orders being picked up from other places. So I think we're in good shape but we just don't know and until we see that material orders coming in, we just can't make that assumption right.

Gary Mobley — Wells Fargo Securities — Analyst

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

Emeka Chukwu — Executive Vice President and Chief Financial Officer

So Gary, I think, I think it's just going to be a top line recovery story, so you haven't been hearing the past, when we had much higher levels of operating expenses. We've already done a lot of things that you've talked about. We've pruned a lot of our expenses, we've already forecast our strategy in some areas and making sure that we're focusing on product areas that are very high levels of return on investment. So having said that, we know about 20% of product expenses is still variable, but like you did say, a lot of that is tied on new supplemental compensation. So we do have some room in terms of what we can do. But clearly the runaway that we used to having it in past is no longer as much as what we used to have. So the other point I'd add to that is that, most of our investments are platform type of investments so we're investing for the next generation of LoRa platform, the next generation 400-gig optical platforms for next generation of protection platforms, so they — not investments that — are short term in nature. Most of our investments are much more strategic.

Gary Mobley — Wells Fargo Securities — Analyst

Okay. Thank you, guys.

Operator

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

Mitch Steves — RBC Capital Markets — Analyst

Hey guys, thanks for taking my questions, I had two. So first on the kind of focus on the gross margin lines, since Huawei doesn't really have the high end LoRa product, does that assume that or should we assume that gross margins improve sequentially starting in July to October to January?

Emeka Chukwu — Executive Vice President and Chief Financial Officer

Well we doesn't have any LoRa revenues at all. So I'm trying to understand the connection between Huawei and LoRa gross margin.

Mitch Steves — RBC Capital Markets — Analyst

So if you have no Huawei…

Mohan Maheswaran — President and Chief Executive Officer

Mitch — no Mitch, most of that Huawei business is PON, base station and smartphone related.

Mitch Steves — RBC Capital Markets — Analyst

Yeah. That's my point right. So basically we know that there is no high end — high margin business there, so does that mean the gross margins go up October to January?

Emeka Chukwu — Executive Vice President and Chief Financial Officer

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

Mitch Steves — RBC Capital Markets — Analyst

Okay. Yeah. And the second question is just kind of on the China exposure. So we kind of get the hallway number kind of 6%, right? But if I look at the China exposure to Asia to show — you're showing like 70% but that to shift two number. Is there any way to at least give us qualitatively what the actual — official sale to China is, versus just 78% (ph) Asia Pacific number you guys gave out?

Sandy Harrison — Director of Business, Finance and Investor Relations

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

Mitch Steves — RBC Capital Markets — Analyst

Okay. Perfect. Thank you.

Operator

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

Craig Ellis — B. Riley FBR — Analyst

Yeah. Thanks for taking the question. Mohan, I wanted to ask you a longer-term question, and I know it's an environment where we've got limited visibility, but the question's intent is really understanding better some of the Company's specific drivers that exist in the portfolio. So Harsh ask you about the second half, my question really ties back to some of your comments on Signal Integrity data center business and the business more broadly sounds alike. There is a PAM4 and a PMD product ramp coming as we head into calendar '20, fiscal '21. The question beyond that is, what do you see in the rest of the business that you're excited about — that's driving Semtech's grow as we look beyond what is clearly a cyclical and trade dispute characterized year, this year.

Mohan Maheswaran — President and Chief Executive Officer

Well, I think Craig, first of all just on the SIP business, on the Signal Integrity Products business, obviously we have the 100 gig to 400 gig growth. We also have the AptoVision, Pro AV, video-over-IP technology that we have — believe that's got good future growth. And then, outside Signal Integrity Product Group — growth engines, of course we have LoRa which is really doing quite well, continues to grow. And I think we'll largely continue to grow regardless of the type of geographical issues we're seeing because it's really tied to IoT which is really tied to efficiency improvements, and just brought up cost reductions and things like that, just the whole growth of IoT is driving that.

So we think that, that's going to continue for many years, obviously that's very exciting for us. The proximity sensing is tied to regulatory — global regulatory requirements for managing radio power and devices. So we think that will continue to grow. And as I mentioned in protection, our business of industrial kind of driven strategy now versus the — just pure consumer and consumer driven strategy. I think is really quite exciting because we see more advanced lithography devices going into — more systems outside just smartphones and handhelds and consumer devices and so into automotive, into communications equipment, into IoT. And those require kind of high end protection that we deliver.

So, we have a number of different growth drivers that are really independent of whatever is going on in China, independent of the Huawei ban, that I think are going to continue to allow us to drive good growth in the future.

Craig Ellis — B. Riley FBR — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

Yeah. So first of all, it is the expectation that we will start to get a little bit more balanced geographically. But I will tell you, our China LoRa business is going very, very well. So it's a question of, can the other regions continue to outgrow what's happening in China. And so I think that we have good momentum. We look at all these metrics not just for the purpose of — do we — is the business going in the right direction. But what things we need to do in the business to accelerate in certain areas, certain bottlenecks and that's one of the reasons I pointed out that we've made a conscious decision to invest in and enhance the ability for our customers to accelerate their time to market from going — from a proof-of-concept to actually having deployment, that means more software, more designed tools, more reference designs, having a better availability of partners, developer platforms and things like that. And so we put a lot of emphasis on that. I think we'll continue to see that this year. And I think that the momentum, as I said is the opportunity pipeline has increased still further which is great news for us. And I think if we can start to move some of that pipeline to revenue over the next year and a half year, I think we'll be in very good shape.

Craig Ellis — B. Riley FBR — Analyst

Thanks, Mohan.

Operator

And your next question comes from Tore Sandberg (ph) with Stifel.

Tore Sandberg — Stifel — Analyst

Yes. Thank you. First of all a question back to Huawei. So it sounds like $6 million to $10 million, if I look at your 10 — your last queue, it says, it's about $21 million. So should we just assume that half of that was kind of just inventory build and it's more the run rate that's going to be $6 million to $10 million going forward?

Mohan Maheswaran — President and Chief Executive Officer

Yeah, that's correct Tore. It was clear that and I mentioned it on my script that Huawei built inventory mostly for the smartphone business in Q1 which definitely inflated that Q1 number. They may even have built up some inventory from Q3 or Q4 of last year, more tied to the PON and base station business. But yeah, I definitely think that the run rate number you should look at it, is a run rate number, the $10 million.

Tore Sandberg — Stifel — Analyst

Yeah, thanks for clarifying that. As a follow up, you guided the Wireless and Sensing business to be flat sequentially. So I assume that means maybe some of the smartphone business is going to be down, so LoRa will actually grow sequentially?

Mohan Maheswaran — President and Chief Executive Officer

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

Tore Sandberg — Stifel — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

Data centers probably I think it's possible, I think it's probably more likely to be flat and then maybe start to increase in the second half. But we are seeing some good data points and some good bookings in this area.

Tore Sandberg — Stifel — Analyst

Okay. That feels like that business has indeed bottomed here the last two quarters?

Mohan Maheswaran — President and Chief Executive Officer

Yeah, it starting to feel that way.

Tore Sandberg — Stifel — Analyst

Great. Thank you very much, Mohan.

Operator

And your next question comes from Rick Schafer with Oppenheimer.

Rick Schafer — Rick Oppenheimer — Analyst

Yeah, thanks. I just had a couple of questions. I guess the first one maybe a follow up on LoRa. Mohan I think you've talked in the past, I think about LoRa potentially being a billion dollar type revenue stream looking forward three to five years, I guess. Is that still a realistic target in your mind and then as part of that answer, curious when you see (inaudible) revenue crossover? You talked earlier about licensing versus a chip sales but sort of when do we see that kind of seesaw kind of crossover?

Mohan Maheswaran — President and Chief Executive Officer

Well, I think let's take that one first. Rick, I think next couple of years still it will be mostly chip revenues, I think. I would expect probably three years from now the royalties both from chip licensing and from services to start to kick in nicely. And then they will — I expect those to accelerate quite quickly especially on the services side. And then coming back to the volume, the size of this business and how can you scale? One of the reasons I talk about these metrics and I point out for example the end of this fiscal year we expect to have 500,000 gateways out there, is because each one of those gateway supports certain number of sensors, and therefore the capacity to support 2 billion end nodes, and that 2 billion end nodes, if you translate to even at $0.50 an end node is a billion dollars, right? So to me I think it's a question of once the infrastructure is deployed, once the use cases are in place and once there is enough of a smooth runway from proof of concept to deployment, which is one of the things we're working on now. I just think it's a matter of time. And then a question of how many use cases and can some of them be very high volume, which I believe they can. I think we're starting to see a lot more use cases now, that are potentially very high volume, before it was more industrial in nature. And so now we're seeing more smart home, more smart enterprise and smart consumer, kind of things emerge as IoT potential LoRa targets.

Rick Schafer — Rick Oppenheimer — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

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

Rick Schafer — Rick Oppenheimer — Analyst

Okay. Can you talk about dollar content and maybe (inaudible)

Mohan Maheswaran — President and Chief Executive Officer

Yeah, it varies $5 to $10 I think on average, Rick, depending on the type of module, PAM4 versus NRZ versus different regions. So it really varies but I think typically $5 to $10 of JSB (ph).

Rick Schafer — Rick Oppenheimer — Analyst

Great. Thanks a lot.

Operator

And your next question comes from Christopher Rolland with Susquehanna.

Christopher Rolland — Susquehanna Financial Group — Analyst

Hey guys, on inventories, if Huawei doesn't come back, will these be fairly easy to shift to other customers? I mean you mentioned proximity sensing is a good demand there from other customers, and when my inventories normalize? Thanks.

Mohan Maheswaran — President and Chief Executive Officer

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

Emeka Chukwu — Executive Vice President and Chief Financial Officer

Yeah. And Chris I mean in terms of when inventory normalizes — our expectation is that, beginning with Q2, we expect to see the days of inventory coming down. And then in the next, like Q3, especially if we see the uptick in revenue, in the top line that we're expecting, we should expect to see inventories come back down to our normal levels.

Christopher Rolland — Susquehanna Financial Group — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

We have good exposure to the customers, but the majority of the volume for us anyway so far has been driven by out of China. And so obviously Huawei is the big guy there for us. We have exposure to other Chinese base station manufacturers, and of course some of the European, but I would say the volume is driven mostly — is for us, mostly out of Huawei.

Christopher Rolland — Susquehanna Financial Group — Analyst

Thanks guys.

Operator

And your next question is from Tristan Gerra with Baird.

Tristan Gerra — Robert W. Baird — Analyst

Hi, good afternoon. A question on LoRa, so obviously you guys have very good traction in industrial applications, that's including smart metering. What does it take for LoRa to gain momentum in the IoT U.S. market. I mean we still see a lot of WiFi and (inaudible) technologies in IoT. Is there kind of a catalyst that will create an inflection point for us to see more LoRa based IoT devices in the U.S. mass market?

Mohan Maheswaran — President and Chief Executive Officer

It's a good question, Tristan. I would say that a lot of the opportunities we have are in North America and some of them are high volume. So it is starting to emerge. I think the home is a important battleground for LoRa in the Smart Home, and I think that's one that we've just started to really spend some calories on understanding what it's going to take there. But some of our partners are helping us in that area.

And I think the other thing in the U.S. is, the U.S. has the large enterprise space in terms of smart buildings and smart asset tracking and logistics type of systems. And we are starting to learn more about how some of those systems and those verticals are going to use LoRa and how LoRa can really transform the way that those industries work and operate. And that's kind of part of what I said about, how it's important for us to understand the — how these opportunities translate to your full proof of concepts and then how the proof of concepts move through to design wins and then through to revenue and understanding where the friction and where the bottlenecks are, and removing those. And some of those are software. For example, and some of those are applications, so we're learning more about that and I think that's part of the reason why you're seeing a lot of emphasis from us on the tools we're bringing to market to allow our customers to move faster through that process. And I think you're going to see North America over the next couple of years really become a very nice revenue driver for LoRa.

Tristan Gerra — Robert W. Baird — Analyst

Okay. And then as a quick follow up, so you've talked about LoRa revenue increasing sequentially in your guidance. And you've also talked about in general for your whole business about your initial expectation for the second half. So is it regarding LoRa specifically, would you say that for now, revenue striking about in line with normal seasonality? Or is the restoration of your full year guidance embedding an expectation that your second half is going to need to be seasonally stronger than it's been in the past?

Mohan Maheswaran — President and Chief Executive Officer

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

Tristan Gerra — Robert W. Baird — Analyst

Great. Thank you very much.

Operator

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

Scott Searle — Roth Capital — Analyst

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

Mohan Maheswaran — President and Chief Executive Officer

Yeah, so I think that's a correct assessment. With regards to me, the way to look at it is that these opportunities we have in the pipeline, it's really a question of calling when they going to translate into revenues and how fast. And we don't have exact data right, we just look at it and say, OK, these design wins are ramping now and they're going to full deployments and so we can see that they're going to materialize in the second half. And we're expecting stronger revenue from that. And it's a very broad range of use cases and it's a very more balanced regional flavor as well.

Coming back to your question on China, yeah I mean China has been, I think over 50%, I can't remember exactly the number of LoRa business. But clearly it's been a significant contributor to our LoRa revenue. And so with the China's softness that has impacted our LoRa enabled revenue. But as I mentioned we have enough pipeline as long as those opportunities convert, then we'll still be able to achieve our goal this year which was a reduced goal $100 million to $140 million. It's still early on in the fiscal year, so we'll see how that plays out. And we're starting to see some good momentum now both on the revenue front and also on the conversion rate from opportunities to revenue.

Scott Searle — Roth Capital — Analyst

Hey just lastly if I could follow up, Mohan, that — that doesn't include any tags. There is no expectation for tags kicking in this year, right? That's more fiscal '21 and beyond, correct?

Mohan Maheswaran — President and Chief Executive Officer

That's correct. Yeah.

Scott Searle — Roth Capital — Analyst

Okay. Thank you.

Operator

And our next question comes from Hamed Khorsand with BWS.

Hamed Khorsand — BSW Financial — Analyst

Hey. Thanks for taking my question. Just two here. First off with the data center stabilizing, would you expect to regain some pricing control? Are you just happy managing the business for gross margin?

Emeka Chukwu — Executive Vice President and Chief Financial Officer

Well, I think Hamed, we don't look at it as, there is so many different use cases and the way this works typically is, we're selling into module manufacturers. The module manufacturers have to reach a certain cost per gigabit that they're trying to achieve for the end customers. And so one of the advantages of course we have with the ClearEdge family is the NRZ modules and the components and the optics related to those are much cheaper. So we are probably being as aggressive as we need to be there. On the PAM4 stuff, we probably don't need to be as aggressive and so it's really a — it's dependent on each situation.

Hamed Khorsand — BSW Financial — Analyst

Okay. And my other question was on the automotive side, with new models coming out, do you have any design wins on deck as — to the second half of the year when new models start shipping from the auto manufacturers?

Mohan Maheswaran — President and Chief Executive Officer

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

Hamed Khorsand — BSW Financial — Analyst

So is it the (inaudible) you reported from automotive is that all just trial based on our commercials?

Mohan Maheswaran — President and Chief Executive Officer

No, the revenue on protection, on the revenues that we are talking about is, it's revenue I mean although numbers we talk about, when we talk about automotive numbers it's real revenue. I'm talking about the ramp of other additional automotive opportunities.

Hamed Khorsand — BSW Financial — Analyst

Okay. Got you. Alright. Thank you.

Operator

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

Craig Ellis — B. Riley FBR — Analyst

Thanks for sneaking me back in for one more question. Mohan, I just wanted to follow up, the Company has got a real nice $100 million net cash balance at (technical difficulty) you certainly got the flexibility to repurchase shares. Does the — does the uncertain macro cause you to think any differently strategically about how you deploy that cash? I do detect tuck-ins or other deals like any more appealing in this environment?

Emeka Chukwu — Executive Vice President and Chief Financial Officer

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

Craig Ellis — B. Riley FBR — Analyst

Got it. Thanks, Emeka.

Operator

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

Sandy Harrison — Director of Business, Finance and Investor Relations

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

Operator

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

Duration: 63 minutes

Call participants:

Sandy Harrison — Director of Business, Finance and Investor Relations

Emeka Chukwu — Executive Vice President and Chief Financial Officer

Mohan Maheswaran — President and Chief Executive Officer

Karl Ackerman — Cowen & Company — Analyst

Harsh Kumar — Piper Jaffray — Analyst

Quinn Bolton — Needham & Company — Analyst

Gary Mobley — Wells Fargo Securities — Analyst

Mitch Steves — RBC Capital Markets — Analyst

Craig Ellis — B. Riley FBR — Analyst

Tore Sandberg — Stifel — Analyst

Rick Schafer — Rick Oppenheimer — Analyst

Christopher Rolland — Susquehanna Financial Group — Analyst

Tristan Gerra — Robert W. Baird — Analyst

Scott Searle — Roth Capital — Analyst

Hamed Khorsand — BSW Financial — Analyst

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