Semtech Corp

NASDAQ:SMTC

Earnings Call Analysis

Semtech's Q3 results show strong growth and promising Q4 outlook.

In Q3, Semtech reported net sales of $236.8 million, a 10% sequential increase, with significant growth in infrastructure and data center markets, up 58% sequentially. The company improved gross margin to 52.4% and expects revenue growth to continue with Q4 guidance of $250 million. Operating income rose to $43.4 million, and EPS increased to $0.26. Looking ahead, Semtech forecasts further improvements in margins, with a projected operating margin of 19.7% and adjusted EBITDA margin reaching 22.8%. Strategic investments, particularly in data center products, aim to accelerate growth into fiscal 2026.

Steady Growth and Strong Performance

In the third quarter of fiscal year 2025, Semtech reported a robust performance with net sales of $236.8 million, marking a sequential increase of 10%. This reflects the company's ability to adapt and thrive in a competitive environment, particularly within infrastructure and data center segments which showed significant growth. The strong demand in these areas resulted in net sales for the data center segment reaching a record $43.1 million, up 58% sequentially and 78% year-over-year.

Margin Expansion and Operational Efficiency

Semtech's gross margin improved to 52.4%, up 200 basis points sequentially and 110 basis points year-over-year. The operating margin also showcased a healthy increase, at 18.3%, up 410 basis points sequentially and 810 basis points year-over-year. This consistent enhancement across margins illustrates Semtech's operational leverage and effective cost management strategies. For Q4, the company projects further improvements in gross margins to about 52.8%, while the operating margin is expected to be around 19.7%. The focus on maintaining operational excellence has contributed to these impressive results.

Future Guidance and Revenue Expectations

Looking ahead, Semtech has provided optimistic guidance for Q4 with anticipated net sales of $250 million, reflecting a 6% sequential increase. The growth is primarily driven by the infrastructure end market, where key applications are expected to lead the way. However, a seasonal decline is anticipated in high-end consumer markets, which has been factored into the revenue projections. Overall, continued growth in industrial sectors along with anticipated increases in LoRa and cellular IoT portfolios further contextualize the company's trajectory.

Investment in Growth Engine and Innovations

The company is placing emphasis on increasing investments in data center products, which are expected to drive long-term growth. This reflects a strategic pivot to capitalize on AI-driven product demands, reinforced by successful customer engagement and a disciplined investment plan. Furthermore, Semtech is aligning its roadmap with key end customers, which is anticipated to enhance market share and expand addressable markets significantly, particularly in the data center segment.

Debt Management and Cash Flow Generation

On the financial front, Semtech has demonstrated solid cash flow generation, with operating cash flow of $29.6 million and free cash flow at $29.1 million in Q3. This is indicative of the company's commitment to debt reduction, with a total principal payment of $15 million on its credit facility during and after the quarter. Moving forward, the management indicates that cash generated will be prioritized for further debt repayment, essential for improving the balance sheet.

Highlighting Sector Growth and Strategic Engagements

Notably, infrastructure sales experienced a remarkable year-over-year growth of 52%, demonstrating the market's positive reception to Semtech's offerings. The company has engaged strategically with key partners, highlighting its presence in the fiber optics and linear route optics (LPO) segments, forecasting significant demand in these areas driven by the growing data center requirements. As such, continued focus on meeting customer needs and enhancing product lines like CopperEdge positions Semtech favorably for the current fiscal year.

Earnings Call Transcript 2025-Q3

[Operator]

Good day, and thank you for standing by. Welcome to Semtech Corporation's Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference call is being recorded.

I would now like to hand the conference over to Mark Lin, Executive Vice President and Chief Financial Officer. Please go ahead.

[Mark Lin, executive]

Thank you, operator. Good day, everyone, and welcome. I am pleased to be joined today by Hong Hou, President and Chief Executive Officer.

Today, after market close, we released our unaudited results for the third quarter of fiscal year 2025, which are posted along with an earnings call presentation to our Investor website at investors.semtech.com.

Today's call will include various remarks about future expectations, plans, and prospects, which comprise forward-looking statements. Please refer to today's press release and see Slide 2 of the earnings presentation, as well as the Risk Factors section of our most recent annual report on Form 10-K for information on risk factors that could cause our actual results to differ materially from those made on this call.

Unless otherwise noted, all income statement-related financial measures will be non-GAAP other than net sales. Please refer to today's press release and see Slide 3 of the earnings presentation for important information regarding notes to our non-GAAP financial presentation. The press release and earnings presentation also include reconciliations of our GAAP and non-GAAP financial measures.

With that, I will turn the call over to Hong.

[Hong Hou, executive]

Thank you, Mark. Good afternoon, everyone. I'm almost 6 months into my tenure as Semtech CEO, and it has been a very productive period. My numerous engagements with Semtech employees, customers, suppliers, and partners, and the operational and financial progress we have made so far give me high confidence in Semtech's near-and long-term growth prospects.

We achieved a very strong Q3 result with net sales, growth margin, and EPS at the high end of our guidance range, while operating income and operating margin exceeded the high end of our guidance range. Further, our Q4 outlook projects continued growth in each of these metrics.

In the last earnings call, I shared 3 near-term priorities, and I'm happy to report that we are making progress on all fronts. First, on strategy, portfolio rationalization, and balance sheet improvement, we have completed an evaluation of our portfolio through our annual strategic planning process. The purpose of this evaluation expanded beyond a delineation of core and noncore assets, but provided a more granular assessment, correlating investment levels, and priorities to multiyear growth curves. In what might be a generational opportunity stemmed from AI-driven product demand, we'll be increasing the investment in data center products, which we project to be a long-term and transformational growth engine for Semtech.

In some other areas, we expect sustaining investment at the current level will suffice. And our focus is to improve the contribution margins of these businesses. The net effect is prudent investment levels, paired with regular reviews on forecasted return on investment. We are committed to making timely adjustments to the market direction change.

Our portfolio has broadly inflected to growth, but I want to ensure my message is clear. I expect the inflection to growth will benefit [ valuation ], but will not delay the portfolio rationalization process. I'm fully aware of the financial and the nonfinancial benefits of portfolio rationalization, and we are particularly focused on opportunities that accelerate our debt repayment and decrease our leverage ratio.

Second, on accelerating growth and driving margin expansion, we have made swift changes to intensify customer engagement with the customers to provide technical and operational solutions. And our Q3 results and Q4 outlook demonstrate the effectiveness of these initiatives. We continue to see strong tailwinds of customers and targeted markets are moving toward us.

We have instituted a disciplined investment plan, leveraging our design competency and incorporating performance objectives from key end customers and meeting their critical business needs. I believe we have achieved multigenerational roadmap alignment with the key customers, and we aspire to become their partner of choice for key technical and product solutions we provide. I expect this initiative will accelerate sustainable market share gain and SAM expansion.

Another growth driver is Semtech's operational excellence. Semtech has executed to meet customer delivery timelines in the current dynamic environment with noteworthy instances in our data center and high-end consumer end markets. Semtech's operational excellence in on-time delivery and superb quality contributes to our customer supply chain resiliency, which I know to be highly valued.

In this area, I would be remiss if I did not acknowledge the contribution from Semtech's foundry, assembly, and test partners amidst the current ramp. Thank you to our foundry partners that have prioritized our increased demand many times, well within natural lead times. Thank you to our assembly and test partners who have quickly installed additional capacity to support our growth.

Third, on energizing our people, I'm a firm believer in promoting a high-performance culture, and I'm proud that we have launched Semtech RISING, an initiative incorporating employee development, mentorship, recognition, and pay-for-performance elements to bring out the best from our employee base and elevating our determination and drive to win. This initiative also leverages expertise from Semtech's Board members. We modified the charter of our compensation committee to become the Human Capital and Compensation Committee. We firmly believe this change elevates the importance of human capital development and aligns with Semtech's focus on creating and fostering a diverse and vibrant workforce. In the coming quarters, these 3 priorities will continue to be my focus.

Moving to end markets. For Q3, infrastructure net sales were $65.8 million, up 24% sequentially and up 52% year-over-year. Net sales for the data center were a record $43.1 million, up 58% sequentially and up 78% year-over-year. Consistent with our outlook for Q3, shipments commenced on our CopperEdge 200-gig linear redrivers used in 1.6T active copper cable, or ACC applications. CopperEdge net sales were in the high-single-digit million dollars. We expect incrementally higher contribution in our Q4, followed by a ramp progressing through FY '26.

There have been multiple reports regarding Blackwell GPU rack designs and timing of volume shipment, which could potentially impact the TAM and timing of ACC market where we provide key enabling IC components. That said, allow me to provide some assurances based on our ecosystem engagement. We have invested time with our customer and end users of the racks over the past few months. We reaffirmed our expectation of exceeding the floor case provided a couple quarters ago based on the firsthand information from the ecosystem.

I connected with many CSPs, cable manufacturers, and ecosystem participants at the very well attended Open Compute Project or OCP Global Summit last month, where Meta presented, contributed, and demonstrated on the show floor its Catalina platform. Catalina is a dual-rack NVL36 design connected with a CopperEdge enabled ACCs. This appears to be a major platform that multiple CSPs will adopt in the near future for their AI data centers. Several companies are currently conducting design work using our CopperEdge chips in 200-gig traces on their boards to improve signal integrity.

Rack designs have varied and will continue to vary as CSPs deploy various configurations in their data centers. But the OCP Global Summit reaffirmed my belief that a count of 200-gig ports connected to cables with a length up to 3 meters is a more relevant measure of a CopperEdge SAM. At 200-gig and at a cable length up to 3 meters, CopperEdge will meet signal integrity requirements not readily achievable with direct attached copper, or DAC cables. And at a lower latency, lower cost, and much smaller power consumption required compared to DSP-based retime solutions.

Semtech's low-power, low-latency CopperEdge solutions have gained positive attention in the data center ecosystem. And our technical collaboration with a number of CSPs and cable manufacturers has accelerated since last quarter. My team's engagement with architecture decision makers and technical executives in the ecosystem significantly streamlined the time between understanding our customers' challenges and delivering Semtech's proposed solutions. I believe this is proven to be a positive differentiator in CopperEdge proliferation and improved Semtech's NPI time to market.

In addition to CopperEdge, our Tri-Edge PAM4 products continue to contribute meaningful sequential and year-over-year growth. Our lead customer commenced a production ramp in 400-gig AOC product in Q3. Demand remains robust for our FiberEdge Transimpedance Amplifier, or TIA, and the laser drivers. Data center deployment at 100-gig has been ramping up strongly, and we believe we have captured incremental market shares thanks to our closer engagement with our customers and our operations excellence.

Moving to linear pluggable optics, or LPO, we have received initial TIA orders from several module manufacturers for test and qualification of both 800-gig and 1.6T LPO transceivers at CSPs. CSP engagement has proven insightful. It appears that LPO adoptability is meaningfully correlated with the SerDes signal-to-noise ratio at the host. Fortunately, both current and future generation switches supply significantly improved performance, and this enables easier LPO adoption in many specific use cases. Our confidence in LPO adoption has increased since last quarter, with a meaningful net sales contribution from TIAs and redrivers expected by the latter portion of FY '26.

Within the infrastructure, our telecom business consisting of PON and backhaul reported Q3 net sales of $20.5 million. We have been supporting a pilot build of triple-gen 50-gig PON with a major Chinese carrier, and a carrier CapEx noticeably for 5G advanced deployment is expected to nominally improve over the coming quarters.

Moving to our high-end consumer end market, net sales were $40 million, a sequential increase of 8%, reflective of market share gains and consistent with expectations of seasonally stronger Q3. Net sales in high-end consumer TVS grew to $28.3 million, up 9% sequentially and up 7% year-over-year, with a sequential growth in each quarter of the current fiscal year. We communicated market share growth in consumer TVS through last quarter, augmenting our prior commentary. Our expectation is for continued market share expansion at the world's largest consumer electronics company and at other key North American and Korean companies, based not only on our design-in activities for future generations of products, but also for Semtech's ability to deliver on time and to meet demand upsides. Thanks to our technology leadership, proven quality, and fulfillment capabilities, we are among the first to be added to a BOM for many products in the pipeline, so we have much greater visibility into the design cycles of next-generation products.

Our class-leading PerSe products continue to excite the market, with design wins across device manufacturers in smartphone computing, and wearables. We believe PerSe's capabilities are also highly valued by device manufacturers to maintain compliance with a specific absorption rate, or SAR regulations, while minimizing effect on device performance. In this area, the ability to detect and measure distance to a human allows the device to optimize RF transmission power and data throughput. We are pleased to be included in the leading smartphone chipset vendor's reference designs to meet SAR requirements.

Moving to our industrial end market. For Q3, industrial net sales were $131 million, up 5% sequentially. Within the industrial end market, LoRa-enabled solutions recorded Q3 net sales of $29 million, up 1% quarter over quarter and up 104% year over year. Encouragingly, consumption for our recent-generation LoRa product has been increasing, which signals market adoption of this enhanced capability. LoRa Gen 2 offers a smaller footprint and reduce the power consumption, while LoRa Gen 3 delivers improved radio performance and a further simplification of customer development through onboard LoRaWAN provisioning capabilities. Supporting LoRaWAN remains a key company strategy.

I benefited greatly from visiting The Things Conference in September. As I said during my presentation at the conference, LoRa has demonstrated tremendous potential with a comprehensive ecosystem that pushed the LoRa from concept to product and now to an industry. I gained very constructive input while at the conference on how Semtech can support ecosystem enablement and it enhanced what I believe to be Semtech's already robust hardware and software roadmap.

The infrastructure to cover [ gapless ] coverage for LoRa continues to gain momentum. In addition to EchoStar coverage throughout Europe, satellite operators are considering offering a similar service for Americas. We expect such availability of LoRaWAN will create a boundless potential for asset tracking.

Our IoT systems business recorded Q3 net sales of $57.9 million, up 11% sequentially, yet another quarter of net sales growth coupled with robust bookings and backlog. As previously discussed, Semtech started addressing channel and end customer inventories earlier in the cycle. And as the market inflects upwards, our growth is now muted by the channel congestion.

Highlighting customer engagement for this business, I believe we held a successful customer roundtable in October, where our customers provided valuable insights and helped shape our roadmap. The roundtable also allowed us to further highlight our in-house Trade Agreements Act, or TAA capabilities, something we expect to bring significant value as a North America supplier to the critical infrastructure markets we serve. Our in-house TAA capabilities have contributed to funnel orders, backlog, and sales to federal agencies, an area where we have identified as an adjacent market and renewed our focus.

In Q3, we launched the Australian instance of Airlink management services. Australia is one of our stronger markets outside of North America, and this instance meets ever-stringent local data resiliency requirements. Q3 net sales for IoT-connected services were $24.6 million, with a slight sequential and year-over-year growth for this reoccurring revenue business. AirVantage allows our customers a single panel to monitor lifecycle management, consumption, and SIM management, all packaged with a robust API. Our future growth expectations are bolstered by additional customer adoptions of AirVantage, including AirVantage Data Insights and its AI-enabled features to facilitate analysis and decision-making on connected equipment. We also expanded our smart connectivity platform to add voice-over-LTE coverage, which is now available in over 40 countries and territories.

In industrial TVS, net sales in Q3 were $10.2 million, up a robust 7% sequentially. We have noticed the current market sentiment in the industrial market, but we remain confident in Semtech's growth with our product offerings. Our industrial products address protection for electronics deployed in increasingly harsh industrial ESD environments. As factories increasingly automate, our customers are increasing their reliance on some type of solutions, where severe ESD challenges [indiscernible]. In the automotive market, demand has increased sequentially, with a growing prevalence of wired and wireless networks in automobiles. Also, Semtech has been the leading supplier of advanced display protection solutions in the high-end consumer market. As our display customers diversify into the automotive sector, we believe we are seeing a disproportional benefit in the automotive display market.

In summary, I'm very pleased with Semtech's execution and performance across our businesses in Q3. And now I'll turn the call back to Mark for additional details on our financial results and our Q4 outlook. Mark?

[Mark Lin, executive]

Thank you, Hong. For Q3, we recorded net sales of $236.8 million, up 10% sequentially. Net sales trend by end market, reportable segment, and geographic region is included on Slide 16 of the earnings presentation.

Gross margin was 52.4%, up 200 basis points sequentially and up 110 basis points year over year. Operating expenses were $80.6 million, slightly below the midpoint of our outlook, increasing 3% sequentially, and representing what we forecast to be prudent investments in the business to accelerate realization of growth opportunities. Operating income was $43.4 million, resulting in an operating margin of 18.3%, up 410 basis points sequentially and up 810 basis points year over year. Adjusted EBITDA was $51.1 million, and adjusted EBITDA margin was 21.6%, up 280 basis points sequentially and up 760 basis points year over year. Gross margin, operating margin, and EBITDA margin, all sequentially increased in each quarter of fiscal year '25, demonstrating our operating leverage. We expect to finish the year with sequential improvements in each of these metrics based on the midpoint of our Q4 outlook.

Net interest expense was $18.4 million, and we recorded net earnings per share of $0.26, up from $0.11 in Q2 and up from $0.02 in Q3 of last year. Operating and free cash flow for Q3 was $29.6 million and $29.1 million, respectively. We ended Q3 with a cash balance of $136.5 million, which included a principal payment of $5 million on our credit facility. Subsequent to the end of the quarter, we made a further principal payment of $10 million, and these payments are consistent with our previously stated capital allocation priority of reducing debt.

Now turning to our Q4 outlook. We currently expect net sales of $250 million, plus or minus $5 million, a 6% sequential increase at the midpoint. We expect net sales from the infrastructure end market to increase sequentially, with data center applications leading the growth. Infrastructure is expected to provide the strongest near-term tailwind. We expect net sales from the high-end consumer market to be down, reflective of typical seasonality. We have gained market share in this end market and do not believe channel inventory is a headwind to Q4 expectations.

We expect industrial net sales to be up, with increases across LoRa and our cellular IoT portfolio. Based on expected product mix and net sales levels, gross margin is expected to be 52.8%, plus or minus 50 basis points. At the midpoint of our outlook, this would be a 40 basis point sequential improvement. Operating expenses are expected to be $82.8 million, plus or minus $1 million, growing at about half the rate of net sales growth at the midpoint, and resulting in operating margin at midpoint of 19.7%, a 140 basis point sequential improvement. Adjusted EBITDA is expected to be $56.9 million, plus or minus $2.8 million, resulting in adjusted EBITDA margin at the midpoint of 22.8%, which would equate to a sequential increase of 120 basis points. We expect net interest and other expenses to be $19 million and expect an income tax rate of 15%.

These amounts are expected to result in a net earnings per share of $0.32, plus or minus $0.03, based on a weighted average share count of 80 million shares. Our outlook at the midpoint contemplates another quarter of growth in net sales, improving gross, operating, and adjusted EBITDA margins, and higher diluted earnings per share.

With that, I'd now like to turn the call back over to the operator for Q&A.

[Operator]

[Operator Instructions] And our first question comes from Quinn Bolton with Needham & Company.

[Quinn Bolton, analyst]

Hong and Mark, congratulations on the nice results and outlook, especially in the data center business. I guess, Hong, I wanted to start with the data center business. Sounds like you continue to be very comfortable with the floor TAM for ACCs. But hoping you might be able to elaborate on that. You mentioned the Catalina rack as an opportunity, but wondering if the ACC TAM that you see now starts to encompass other opportunities at hyperscalers or CSPs. And so, just wondering if you might be able to talk about some of the use cases you see starting to contribute to that $100-plus million opportunity.

[Hong Hou, executive]

Thank you, Quinn. Yes, so as we discussed at OCP, you participated as well, the Catalina is going to be the main platform. We know, one, major CSP is going to be used at the baseline for deployment in 2025 and beyond as long as they use GB200 GPU processors. And we know that standard is getting tractions, but I haven't [indiscernible] the detailed confirmation on which CSP is using in what proportion. Another major progress I will say since the announcement of ACC is awareness level by the CSPs on this elegant capability and solution to improve the signal integrity and improve the link budget by adding very small fraction of power consumption, no latency and very little, well, incremental cost as well. So now we are seeing many -- several CSPs and other companies are considering using the linear equalizer in their entire trace design can be on a board, can be in the connectors, can be in the cables as well. So that gives me the confidence that after the OCP that our floor case guided a couple of quarters ago is indeed a floor case.

[Quinn Bolton, analyst]

Perfect. Maybe just a quick follow-up there. Just for the CSPs looking to use linear drivers in cables or PCBs, does that ramp in calendar 2025, or do you think that that's a longer-term opportunity? And then my follow-up is, you seem to be more upbeat now about the LPO opportunity. I think you said you've got initial orders for TIAs for LPOs starting to ramp in fiscal '26 -- the back half of fiscal '26. Can you talk about what types of applications you're seeing LPOs starting to be deployed this year?

[Hong Hou, executive]

Yes. Let me just follow up on the first one on the ACC. So the applications on the board and in the cable and even in the connectors by the multiple CSPs are in the qualification phase and in the demonstration phase. So the typically good thing about the copper-based solutions is the qualification cycle is relatively short compared to the optical-related products. So I would say probably from the mid of 2025 calendar year, the other opportunities on the linear equalizer will start contributing to the revenue.

As for the LPO, as I mentioned in the prepared remarks that we have already got orders and shipped in low-volume, albeit, this is for 800-gig DR8, 100-gigabit per second per trace and 1.6T side, they're primarily on TIA. So they are building transceiver modules and shipping to different customers for qualification. And the applications are for both scale up and scale out. So the scale-out is primarily connecting the NIC card to top-of-the-rack or end-of-the-row switches, and scale up is to increase the cluster size for the GPU compute cluster, or ASIC compute cluster by some CSPs.

[Operator]

Our next question comes from Harsh Kumar with Piper Sandler.

[Harsh Kumar, analyst]

Mark, Hong, and the entire Semtech team, congratulations on a very strong quarter, very strong guide. I had one quick one on data center and another one on LPO. So Hong, for you, could you just give us an idea of what you're thinking about the growth for ACC in the January quarter as you're guiding? And then when do you think it'll steady out to a steady-state sales format? Is it second half, or will it continue to build through the year? And then I have a follow-up.

[Hong Hou, executive]

I will let Mark answer the ACC question.

[Mark Lin, executive]

Harsh, we said this in Q3, was high-single-digit millions in Q3. So it's a nominal ramp in Q4, and then it progressively ramps through FY '26 through Q1, Q2, Q3, and Q4. So we've been pretty consistent with that messaging, and we don't really see a change in that timing.

[Harsh Kumar, analyst]

And then for my follow-up, if I can talk about LPO, maybe a very theoretical question, Hong. So a lot of debate on LPO. There's a lot of nonbelievers that think it'll never happen because of interchangeability. Is it possible, in theory, to have a compatible, interchangeable module using LPO, or is that just theoretically impossible? Could this eventually just take over the whole optical business?

[Hong Hou, executive]

Yes. Harsh, that's a good question. And I think the debate is still ongoing, even after 2 years. And what I have found out is that the early sentiment developed by the impossibility of the LPO for scale-out was largely done on the previous switch version, where we understand that signal-to-noise ratio from the host is not as good as the current generation, say, for example, Tomahawk 5.

So if they did the LPO and tested in the previous version SerDes, and there might be a very little margin, and that makes interoperability very difficult. But in the current and future generations with switches, fortunately, the host has demonstrated really pretty superb signal-to-noise ratio. And so, the LPO is like an ACC, a linear equalizer is an essential part of it at the start.

So that's good signal-to-noise ratio, and the current and future switches can use LPO. But as the adoption timeline getting closer, and we noticed that many CSPs, they started pivoting to LRO, so basically using one side, the linearized, the other side retimed solution to be safe because they do need a low-power 1.6T interconnect solutions. To us, we have arguably the best TIA on the receiving side. So we'll benefit from either LPO or LRO. And as the industry progress and getting better understanding on the compatibility of different type of host with LPO and LRO capabilities, I do believe this type of transceivers can chip away a sizable total addressable market currently served by the DSP retimed solutions.

[Operator]

Your next question comes from Cody Acree with The Benchmark Company.

[Cody Grant Acree, analyst]

Congrats on the progress. Guys, could you -- Hong, could you talk about specifically to the Blackwell opportunity? Obviously, there have been talk about the 36x2 platform discontinuation of development support. It doesn't sound like that that's happening at a certain CSP that you're working with. I wonder, though, if that's more of a one-off in the industry. Is that something that you're seeing more broadly continue to be adopted? Or has there been a change at NVIDIA that is impacting the broader ACC opportunity at that customer program, but may not be impacting long-term opportunity beyond them?

[Hong Hou, executive]

Yes. So Cody, I definitely have talked to many CSPs, and everyone they have their views, but largely based on how much compute power they wanted to have in that cluster, so right now, 72 GPUs seem to be an ideal cluster size. But it's also bounded by their ability in the data center infrastructure to cool the racks. And 36x2 seem to be pretty ideal, and for one leading CSP, we know that is their baseline for 2025 and '26 and for as long as they use Blackwell.

And I have heard some others using NVL 72, and where we don't have the contribution for backplane, but at the front end, they either need to connect 1.6T ports or 800 gigabit ports to top-of-the-rack or end-of-the-row switches. I think that's where LPO can really have a good -- provide a very differentiating solution because of the low power consumption. So I think that is probably why the industry is pushing very hard on the LPO solutions.

But as for the different variety of racks, we're going to continue to hear reports in the future, just for the aspiration to continue to increase the number of GPUs in the cluster to be able to handle more -- the model with more parameters. So it's going to be dynamic. That's why I wanted to really -- I believe that counting the number of ports of the 200-gigabit per second will be a more relevant measure going forward, rather than just steer at how many of the NVL 36 racks are out there.

[Cody Grant Acree, analyst]

Can you maybe just help frame your overall data center opportunity? How much of that is Fiber and Tri-Edge in the future, and delineate that from your ACC and your LPO opportunity?

[Mark Lin, executive]

Typically or historically, we haven't provided that delineation where we gave a high-single-digit million figures for ACC. But realistically, the entire data center market is growing quite robustly for all of our products, ACC, PMDs, Tri-Edge. And we expect when LPO does ramp, it'll continue to support that growth level.

[Operator]

And our next question comes from Tore Svanberg with Stifel.

[Tore Svanberg, analyst]

Congratulations on the strong results. Hong, the CopperEdge revenue, high single million for this quarter, what's the mix there between 200-gig versus 100-gig? It sounds like it's primarily 200-gig. And as we think of fiscal '26, will, again, the majority of the mix be 200-gig per lane?

[Hong Hou, executive]

Thank you, Tore. Yes, the revenue in Q3 on CopperEdge is primarily 200-gig. And going forward, the 200-gig is going to be the primary driver as well. We do have some contribution for 100-gig, especially after the industry is aware of the capability that the linear equalizer is providing to improve the signal integrity. Some CSPs are revisiting their architecture in the data center and start considering using a 100-gig ACC instead of DAC cables. But the contribution we count, and we guide is primarily 200-gig.

[Mark Lin, executive]

Tore, let me just double-click on that. In our Q3, the 200-gig was substantially all of our CopperEdge revenues.

[Tore Svanberg, analyst]

And let me move on to a non-data center question. So you guys have done a good job to climb back to this $1 billion run rate that you've guided for, for the January quarter. As we just think about strategically, because, Hong, you mentioned you're still reassessing everything. So how much of that $1 billion should we think of as true strategic revenue versus perhaps segments of the business that are requiring less investments, at this point?

[Hong Hou, executive]

So Tore, that's a good question. For the Q4 guidance, we broke down the different -- the industrial segment we have right now. And so you can use that as a guideline.

[Operator]

Our next question comes from Tristan Gerra with Baird.

[Tristan Gerra, analyst]

Now that CopperEdge is ramping, how should we look at the free cash flow generation over the next few quarters? And any update on the type of debt leverage ratio you expect exiting next year?

[Mark Lin, executive]

Yes. I'm quite pleased, Tristan, Q3 operating cash flow was $29.6 million. Free cash flow was $29.1 million. So cash flow, definitely, we've inflected, consistent with the business. And I'm pleased that cash flow is really generation is broad-based across our businesses. We may have to build a little bit more inventory supporting demand, but we continue to generate cash. And as you see that, as soon as we generate the cash, we delever, right? We pay down principal. In terms of where we're going to exit, we only guide out one quarter, but you can maybe take a look at our EBITDA that we reported this quarter annualized. That might give you an indication of potentially where our leverage ratios are heading.

[Tristan Gerra, analyst]

And then if I look at the Coherent announcement of the NVIDIA-based DSP back in September, does that create opportunities for your TIA in terms of content? And is that a solution that eventually gets available outside of NVIDIA and would allow you in that particular transceiver to reach additional customers?

[Hong Hou, executive]

Yes, Tristan, so for every DSP retimed transceivers, we should have content in there. And we definitely -- our baseline data center revenue growth has been primarily driven by the DSP-based transceiver growth. And Q3 is the first quarter we had some meaningful revenue from the CopperEdge for ACC, but that DSP-based transceivers will continue to grow. We'll continue to benefit from that.

[Operator]

Our next question comes from Scott Searle with ROTH Capital Partners.

[Scott Searle, analyst]

Congrats on the data center performance. Maybe I'll shift away from the data center, since it seems like it's been covered. Hong, on the PON front, it seems like it was another decent quarter, still really China-focused. I'm wondering if you could give us some thoughts in terms of the incoming administration, any sort of impact on the PON business in China. If there is any, how you're thinking about growth there? And then, specifically, how you're seeing design activity outside of China, particularly as we start to talk about 10-gig and above?

[Hong Hou, executive]

Thank you, Scott. So the PON business up to this point has been primarily in China. And we expect another tender offer over the next quarter or two. And we have the product ready for it. We have a triple-gen demonstration in there, and it can operate at 10, 25, and 50-gig. And so that is really setting the benchmark of the capability. We're the leading provider in that market.

As for what is the future political situation there, we are absolutely very mindful about that. But so far, we have not seen any impact. As for you issued a report about Calix and Louisiana, they got the BEAD funding. So we have been engaging with all the leading equipment manufacturers in the U.S. for the U.S. PON opportunities as well. So we're really well positioned for the global infrastructure upgrade. And beyond China and the U.S., we're trying to, through our module manufacturers, address other part of the market. But those are the 2 major markets for the PON opportunities.

[Scott Searle, analyst]

And if I could follow up just on the LoRa front, continuing to stay away from data center for a minute. A nice recovery quarter. I think at $29 million, I think, it's still below where you had peaked a couple of years ago in the $40 million or so range. I wondered if you could talk a little bit about some of the applications where you're getting the traction. I know there have been some continental-wide buildouts being driven by guys like Netmore in Europe. It sounds like there's some opportunities in the U.S. But just give us some high-level thoughts in terms of where you're seeing that design traction and how we should think about that growth rate going forward from these levels.

[Hong Hou, executive]

Thank you, Scott. So yes, previously, couple of years ago, the LoRa market had the noise about Helium. So I think that noise dissipated. And right now, we're seeing clear signal of the continued growth. Say, Q2 to Q1, we had a strong growth. In Q3 to Q2, we have marginal growth, but year-over-year basis, we had a strong growth. Our use cases right now, I have spent a lot of time talking to ecosystem partners, I'm just totally fascinated. Traditionally, it has been smart metering, but in the connected spaces and for automation, for asset tracking, and now I see more and more use cases. And you mentioned about Netmore. They come out very strong. They are aspired to consolidate and to have multiple territory and multiple countries presence and to proliferate their successful and rewarding use cases. I think that is really showing that the industry starts maturing.

And so far, the major applications is smart metering and asset tracking. I think the asset tracking is going to be having a lot more applications. And then the smart homes, smart factories, and use cases has been more known right now. There are a lot of well-established solutions for those. And I talked to several companies. They are seeing tremendous growth in their business in those use cases.

So we're very excited about the LoRa growth perspective. And we will be having new products coming out, Gen 3 and Gen 4, make the development of downstream integrated solutions easier, and we plan to use LoRa Alliance to provide more enablement to the ecosystem and raise the level of awareness of the successful use cases.

[Operator]

Our next question comes from Craig Ellis, B. Riley Securities.

[Craig Ellis, analyst]

Yes, Hong, Mark, congrats on the execution, especially around growth and margins. Hong, I wanted to go back to data center, but maybe approach it in a more longer-term way. So I think it was at least 3 quarters ago that we started talking about what seemed to be a single company or single product opportunity as having a $100 million base opportunity to it that would be in the '25-'26 timeframe. The question is this, as the business looks like it's gotten significantly broader customer and application level exposure and design-in potential, how do we think about the size of this business 2 to 3 years down the road?

[Hong Hou, executive]

Craig, that's a great question. I think the opportunity started with as a single company, single platform, and that is a great trailblazer for this new product that's accelerated our time to market. But right now, as you mentioned, as we observed, this capability, is a broadly recognized and beyond that single company, beyond that single platform. So that's why we have been thinking about and to qualify the opportunity by counting the number of 200-gigabit per second ports.

The reason for that is everywhere you have 200-gigabit per second transport, you have the same challenge. You need the same solution for signal integrity. And with the Tomahawk 6 rolling out right around the corner, well, maybe 6 to 12 months, and all the ports, it's going to be 200-gig, and it's only increasing our opportunities. So, so far, the application has been for scale up. But with the scale-out added into the opportunity pool, we got a tremendous opportunity in there. So probably a better, a more relevant measure is the quantification of the number of 200-gigabit ports. And then you can put a multiplier on adoption ratio, 30%, 50%, or 70%. So we are in the process of establishing that model to quantify the opportunity so that people will not steer at, so how many NVL 36 racks are being forecasted and being built. So we will report that progress as we're making good progress.

[Craig Ellis, analyst]

Mark, I wanted to cycle back to you. You talked about things happening, and Hong talked about where we are in the calendar planning cycle with expense management. As we think beyond the fiscal fourth quarter and think through 2025, are there any discontinuities coming with expense investment, whether it be [indiscernible] costs or other things? And should we continue to expect that R&D and OpEx would grow with some small coefficient of revenue growth? Is that reasonable, or are there onetime things coming?

[Mark Lin, executive]

Yes, Craig, we don't see any onetime things coming. We've gone through our strategic planning. So we do expect incremental investments, but I believe those incremental investments will have near-term returns. And the other area is Hong has absolutely stressed, there's no evergreen R&D projects. So if something were to turn and the market moves away from that particular application, we don't mind just discounting the cost as sunk and redirecting our efforts.

In terms of growth, we've reiterated a number of times, healthy growth is probably -- OpEx grows at half the rate of revenue growth, and I think that's what we're sticking to. Now, just some of that operating expense investment will be redirected, as you heard in our prepared statements, probably a little bit more towards data center, but those are some near-term growth opportunities there.

[Operator]

And our next question comes from Christopher Rolland with Susquehanna International Group.

[Christopher Rolland, analyst]

I want to echo my congrats on a fantastic quarter and guide. So my first set of questions are around ACC, and I guess maybe first to level set, how much of CopperEdge were you shipping in Q2? Or was that high-single-digits million, all incremental? And then the bulk of these shipments, is this all to the big AI GPU guy directly, and they're going to be using it for branded cables? Or are these going to third-party cable OEMs for channel sales, or to the CSPs direct via EMS? How is the go-to-market here for these shaking out? And how might you expect that to change through the next 12 months?

[Mark Lin, executive]

Great question, Chris. We're looking at -- when we mentioned that it's high-single-digit millions of CopperEdge, effectively, you can consider that 200-gig active copper cable, and it's really directed -- our customer is cable suppliers, but I think we get the demand really from that large company. So at this point, just with the demand for the cables, I don't think, really anything is going into channel. It's really going to supply rack shipments.

[Hong Hou, executive]

And then just to add to that, Chris, you asked for Q2. Q2, basically, it's just a very minimal sample quantity. So the Q3, the high-single-digit million dollars is the first volume.

[Mark Lin, executive]

Yes. You consider that for 1.6T applications there, Chris.

[Christopher Rolland, analyst]

And then, just a quick clarification was, I guess PON was down, if I'm doing my numbers right. But just wanted a clarification, but a better question, perhaps, bigger picture, is around divestitures. Where do we stand there? Are you guys still interested in selling parts of the business? And conversely, what is the interest in, perhaps, buying parts of your business as well?

[Mark Lin, executive]

That's an area, of course, where we're a little bit sensitive. In our prepared remarks, we did keep balance sheet and portfolio as the number one priority. And we do believe order matters. So it is the number one priority. At this point, I think all of our businesses have inflected to growth. So as Hong mentioned in his prepared remarks, we believe that should help valuation, but that in no way will delay or maybe impede our desire to potentially divest these noncore businesses.

[Operator]

And our next question comes from Tore Svanberg with Stifel.

[Tore Svanberg, analyst]

I just had a quick follow-up for Mark. Mark, so 40 basis point improvement in gross margin for January. How should we think about gross margin for fiscal '26? Is it mainly mix at this point that will drive the gross margin? Or are there other things, maybe scale or anything like that, that could potentially also lift it as well?

[Mark Lin, executive]

Yes. Scale definitely helps. But definitely, the primary driver in our guide is mix, all right. So it's a 40 bps improvement. But we did get a little bit of a tailwind from the CopperEdge shipments this quarter, right? So that was definitely a tailwind. But as other portions of our business inflect upward, there's a little bit lower margin in IoT, our systems hardware business. So that's a little bit lower. We'll definitely take the gross profit, right? But definitely, that business doesn't contribute quite to the percentages, let's say, our infrastructure business.

[Operator]

Thank you. And there are no further questions at this time. I'll hand the floor back to Mark Lin for closing remarks.

[Mark Lin, executive]

Great. Thank you for joining. And please visit our Investor website at investors.seemtech.com, where we post upcoming investor conferences where Semtech will be in attendance. Have a great day.

[Operator]

Thank you. All parties may now disconnect.