Lattice Semiconductor Corporation (LSCC) Earnings Call Transcript & Summary

Great. Welcome back, everybody. I'm Joe Moore from the Morgan Stanley semiconductor team. Happy to be here today with Jim Anderson, CEO of Lattice Semiconductor. Jim?

Yes. Good to be here, Joe. Thanks for giving me some time. I appreciate it.

No. Thank you for coming.

Always happy to talk about Lattice.

Great. So maybe if you could just give us a little bit of an overview. You're midway through your fourth year as CEO. Can you give us an assessment of what you guys have accomplished so far and what the -- a quick look at what the pipeline looks like for you?

Has it been 4 years? Almost 4 years? Wow. Now do you want to -- you mean my assessment like on a scale from 1 to 10?

Sure. Whatever works for you.

Or like 5 stars, or swipe left, swipe right?

No. I just would like to hear, obviously, you've -- yes, you moved the company in a really positive direction. Can you just give us a sense for where you are today?

Yes. I think what I would say is when we look over the last few years, I think we're pretty proud of the progress that we've made. But we're much more excited about where we're headed from here. So the next -- when we look forward for the next year, 3 years, 5 years, we're much more excited, right? So when we did our, let's say, our first Investor Day back in early 2019, one of the things that we said is we said, "Hey, we're going to have to rebuild the foundation of the company," right? That means we're going to have to rebuild the product portfolio, we're going to have to rebuild our operational discipline, the customer momentum and that would take a couple of years, right? We said that will take 2019, 2020. But we said when we get to '21 and '22, we would start to enter a new phase of accelerated growth for the company. And we said that back in '19 and that's exactly what happened. We spent really -- you can think of '19 and '20 as, again, just really rebuilding the company and getting us ready for a new phase of growth. And so we're really pleased to be in that new phase of growth that started in '21. I think we're going to have another strong year this year. That growth is really underpinned by 3 things. #1, we're positioned in great end markets and end markets where we have Lattice specific, Lattice unique kind of applications that we're growing in. #2 is product cycles. We've got -- we haven't -- not just rebuilt the product portfolio, but we -- we're expanding it dramatically later this year with the new platform launch. And then the third is, look, our customer momentum, our customer engagement is fantastic. It's the best I think it's ever been in the company's history. So we're pretty excited about where we're headed from here.

Yes. And it's exciting for us because in addition to the momentum that you guys have shown, we've lost the other programmable logic standalone stocks. And I think that's a positive from a business standpoint for you, that you'll be the last kind of company solely focused on these opportunities and for us as well. Can you just talk about what are the best and most exciting opportunities ahead for you guys, whether you want to talk about products, applications or markets? What are you most excited about than revenue growth?

Yes. I mean, why don't I start with markets and applications and then maybe talk about products as well. So on markets, as I mentioned, we're positioned in great end markets, right? So communications, computing, industrial auto, these are our core strategic segments. These are -- if you look at those markets, we -- in the most recent quarter, we grew over 30% in those markets, right? And the applications that we're excited about is, first of all, servers that go into hyperscale data centers, enterprise data centers. We've dramatically grown our dollars of content per server over the past few years, and we think that continues to be a great growth opportunity for us. So for instance, our attach rate in servers, just a few years ago, was 25%, now it's over 1x, which means that there's more than 1 piece of Lattice silicon shipping per server, right? And we see additional headroom in attach rate. We think we can grow that even further. Our ASPs have been increasing. So dollars of content per server, we see a lot of opportunity there. 5G wireless infrastructure, we have 30% more content in 5G base station than we do in a 4G base station. And as you know, Joe, we're still early in the 5G wireless build-out. Another one would be -- and this is a greenfield growth opportunity, and that's client computing. So client computing PCs, that's a huge market by TAM, kind of unit volume TAM size, 350 million units roughly. We've been penetrating that segment, bringing new AI capabilities to that segment. We just announced a new partnership with Lenovo on the Thinkpad. And then industrial automation, robotics, automotive electronics are places we're growing really fast as well. So that's kind of on the markets where we're seeing good opportunity and faster than we think market growth. And then product-wise, we're going through new product cycles. So our most recent product generation is called Nexus, that's just started ramping. Last year was the first full year of revenue from Nexus. We have additional Nexus devices that are coming into production this year and in the future, and we expect multiple years of growth from Nexus. And then we've got a new platform that we're going to launch at the end of this year in the second half which doubles our addressable market and creates a whole new revenue stream for Lattice. So that's kind of a sense of where it's coming from, both product and market.

Well, we'll dig into some of those. I mean, it's interesting that you talk about markets that you lead with data center given that if there were 1 criticism I would have of both of your major competitors is that they were overly focused on data center and ignoring other opportunities.

Well, we're in a -- we're also in a different function within data center, right? So what we're providing in data center is things like platform management security, so platform hardware security. That's something that's critical to every server. So we're not -- just to be clear, we're not addressing machine learning, which there's a lot of competition for machine learning cycles. We're in platform management and security.

Yes, understood. Okay. So maybe talk a little bit more about Nexus. You mentioned this is the first full year. What types of opportunities does it open up for you? And where are we in the life of those?

Yes. So first of all, Nexus is a brand-new FPGA platform that we launched a while back. A complete rebuild, incredibly competitive. If you look at Nexus versus competing devices, 4x better power efficiency, so better performance and 4x the power efficiency of our competitors. That's a big deal to our customers because for all of our customers, the primary design constraint is usually around system power. And so when we're able to bring a solution that's 4x better on power efficiency, that's kind of a game changer for our customers. So it's been an incredibly competitive product. We've seen really, really strong engagement. It's tracking at or above our expectations. Again, last year was the first full year of revenue. We expect it to grow this year, and it will really grow for multiple years as that platform fully ramps.

Okay. Great. And then the Avant platform that you're launching, I guess, second half of this year. Can you talk a little bit about that? And when should investors start to anticipate revenue?

Yes, definitely. So on Avant, the way to think about that is that product line doubles our addressable market. So it moves us from -- today, we're focused primarily on small FPGAs and it brings us into mid-range FPGAs. And so that doubles the addressable market. It creates an entirely new revenue stream for the company. It's completely additive to the products that we have today because it addresses a different part of the market. When we -- and it's really our customers that drove us to develop this product line. Back when we introduced Nexus back in 2019 to our customers, we got really good feedback on Nexus. They said, "Hey, we love the product. We're going to design it in. But could you extend your capabilities into mid-range FPGA, because we're not really seeing any other innovation in the market in mid-range FPGA. You guys are clearly innovating in small FPGA. Can you extend that into midrange?" And we had enough large strategic customers ask us that, that we started investing. And we're really excited about it. It will increase our capabilities in terms of platform capability by 5x. As I mentioned, double the addressable market. And one of the really great things is when you look at the target customer set for Avant and you compare that to our existing customer base, 90% overlap. So that means that we don't have to go bang down the doors of a bunch of new customers, 90% of the customer -- target customer list, we already do business with today. So this is about expanding share of wallet, bringing a new product to customers that already enjoy working with us, have been with us sometimes for decades, customers that we've supported really well through the supply chain, the supply chain tightness, et cetera. And so yes, we're really excited about Avant. The engineering team is excited. The sales team is especially excited.

And what is the time frame in terms of...

On revenue. Yes. So we will launch the product in the second half of this year. And if you use Nexus as kind of a reference, we're using that as a reference in terms of ramp, we would expect revenue -- a little bit of revenue before the end of 2023, but it to have a more meaningful impact in 2024 and '25 and beyond as it ramps.

Okay. Is that tied to a particular process node?

It is, but we are going to announce that at the launch event.

Perfect. Okay. Great. So can you talk about software. Obviously, that's always a key consideration for FPGA market share and is an area where at least one of your competitors has not innovated very much. Can you talk a little bit about the software innovations that you guys have provided in your capabilities?

Yes. And this is actually a key part of our strategy. We started investing significantly more in software shortly after I joined and the new leadership team joined in 2018. And we've been investing in what we call application-specific software solution stacks. And what that means is, think about that as a package of prebuilt software tools, libraries where we've done a lot of work for the customer and the customer can take that software stack and can get to market much more quickly, can design a Lattice device into their system very quickly, can switch from a competitor's device to our device much easier with that software stack. And again, get to market quickly, but it also creates stickiness for our customers. We brought out four of these to date, the first one was SenseAI around artificial intelligence, the next one was around embedded vision. We brought out a security software stack around platform security. And the most recent one is around industrial automation and robotics. So really well-received by our customers. It's helped open new applications. The other nice side effect is it works on both our new Nexus devices as well as our pre-Nexus devices. It's also helped extend the life of some of our older products because we're able to bring kind of new capabilities on the existing piece of silicon. And so we've kind of breathed new life into older pieces of silicon as well and helped drive new design win growth. So it's a really important part of our investment strategy.

Yes. I mean, that's really interesting. I mean one of the nice things about this business is that it does have the stickiness that you talk about.

Yes, it does.

And I guess for you guys, where are you now? I don't know if you measure like number of users or things like that. But is Lattice getting that kind of stickiness to their own business in a demonstrable way?

Definitely. So the -- it does 2 things. So with those software stacks, what it's able to do is open new applications or speed up time to revenue. And I would say if we looked at how many customer engagements now have some sort of software component associated with them, it's well over 50%. So over half of our new design wins, new engagements, involve our software in some way, right? So the customer is leveraging that software. And the nice thing about that is not just it speeds up time to revenue for the customer and us, but it also creates stickiness over time because those customers integrate that software into their own system-level software. So it creates a better, stickier solution over time.

Great. And along the lines of software, can you talk about the Mirametrix acquisition and what that entails?

Yes. Yes, this is good. Think about this, first of all, think about this as just an extension of our organic software strategy. So we're just talking about how we're organically building out our software capabilities. Mirametrix is really an extension of that. So Mirametrix is a software company that was focused in AI, in general, but computer vision in particular. And we had actually been partnering with them at some key customers for almost 2 years actually. And so we knew them really well. And what we realized is that if we brought them inside Lattice and combined their higher-level software with our silicon and software, that we could combine those together to provide a complete solution stack, all the way from hardware up to application layer. And Mirametrix itself had already been quite successful. So they had already deployed their software on over 20 million devices, they had an existing revenue stream, a very profitable company. So they're immediately accretive to us on gross margin, on profitability, et cetera. And where we see the synergy with them is they -- they're a smaller company. We have a very wide customer base. We have over 9,000 customers. So first, we can take that Mirametrix software and just introduce that to a very wide set of customers. And then secondly is around what I just talked about, that being able to provide a full solution from silicon all the way to application layer. So we're pretty excited about it. The integration has gone smooth. And yes, I think it's a really good addition to the company.

And software as a revenue opportunity, I guess, is kind of relatively comes with that acquisition, some relatively new. Where do you see that going forward -- do you see more opportunities to get revenue streams from?

Yes. Good question. So prior to Mirametrix, we were selling our software kind of along with the hardware as a complete solution. Now Mirametrix you can think of that as it gives us a foundation of a dedicated software stream to build on moving forward. The first way we'll build on that is what I just talked about, we'll just -- we'll take the existing Mirametrix software and just try to bring that to a wider set of customers to drive more revenue. But I think over time, having that in-house software team that's already monetizing revenue, gives us the opportunity to take some of the more Lattice classic software that we've developed organically and start to monetize that through the same engine that we gained with Mirametrix. So it's a good opportunity for the future.

Yes. Yes. Very interesting. Okay. Maybe we talk a little bit about supply chain, which is coming up a lot these days. How tight is capacity from your perspective? And your assessment of kind of customer channel inventory around that.

Yes, Joe, I don't know if you've heard this, but the supply chain around semiconductor is a little tight. I don't know if you've tried to buy a car.

FPGA especially or I don't think it's you, but I've heard -- just this week, I've heard 3 companies that really haven't been tripped up by supply chain have alluded to FPGAs as problematic.

All right. All right. That's probably an opportunity for us, I would guess.

I think it was both of your competitors that...

It's good. Yes, so there's only 1 other place to go then. So that sounds like a good opportunity for us. But, yes, so certainly, we're not immune to the supply chain tightness. But there's a couple of things that we did proactively to kind of get ahead of the current tightness. So first thing is in 2020, when the pandemic first hit, when everybody else was canceling all their orders, actually, this is in kind of March, April of 2020, we decided, hey, we're going to invest in inventory. We're actually going to increase our inventory levels. And we did that for 2 reasons. #1 is we had new product ramps that we knew were ahead of us. And then the second thing is that we were worried that if there was -- if the market did start to snap back, that the supply chain will get tight quickly. And so to get ahead of that, we started to build inventory. So we exited 2020 with the highest level of inventory we had in a long time. And through '21, we've been able to maintain that inventory level. So part of it was having the right inventory to support our customers. But the other piece was, and this goes back a little bit further to the beginning of 2019, we put in place a new supply chain strategy. And we talked about this back in 2019, where we worked with our suppliers on multiyear road maps around product cost reductions, capacity planning, et cetera. And I think those 2 things combined just have helped us navigate the tightness well. And I think our customers would agree. I think if you asked our customers, they would generally say, "Hey, Lattice has done a pretty good job supporting us."

Does that mean you don't have elevated lead times and all the...

No, I mean we're not -- that's not to say we're not immune, that we're somehow immune. We certainly have tightness. We can have a particular silicon or package combination that's in tight supply. We can have longer lead times on certain parts. But I think if, in general, if you compare -- if you asked a customer, "Hey, how has Lattice done versus, say, others," I think they would say, "Hey, they've done a pretty good job supporting us." And that's helped us, by the way. Some of the customers that were already planning to shift over to Lattice anyway for product reasons, that's helped them decide to accelerate that or to embrace us even more as long-term strategic partners.

Yes, I can definitely see that. That's great. I think the last 2 years is going to change the way everybody thinks about inventory.

Definitely.

Definitely going to go back to be [indiscernible]

Definitely. Yes. Yes. Absolutely.

Especially for stuff like this, that doesn't have obsolescence risk.

Yes, we have -- with our inventory, our parts have such long lead times or lifetimes, I mean, that with a long lifetime like that, obsolescence is just not a big concern.

Yes. Yes, makes sense. So your assessment of customer inventory then around that. I mean, do they have to start building buffer? And have they started building buffer?

Yes. So actually, let's talk about distributor inventory. Because most of our revenue first flows through distribution and then into customers. And so we have very good visibility on distribution inventory. If you look at relative to historical levels, very lean levels of inventory and distribution. And at some point, that distribution inventory will need to be replenished, rebuilt, right? But at least at this point, it's very lean. In terms of end customers, look, we have a lot of -- we have thousands of customers. So we don't have perfect visibility into end customer inventory. But with some of our big strategic customers, we do have -- they do share with us levels of inventory. And we do work with them to make sure that it's a healthy level, not too much, not too little, and we work really strategically with them, not just next quarter or the following quarter, but really the next 4 to 8 quarters or even beyond, right, to make sure we've got the right stuff for them.

Yes. Okay. Great. Can you talk generally about the areas that you focused on kind of more from the M&A standpoint? Areas that you're looking at strategically?

Yes. And actually, I think we talked about Mirametrix, that's a good example. So -- well, first of all, we're never confused. Job 1 is about the organic business. So we're always primarily focused on the organic business. But that said, we're always looking in parallel at what sort of inorganic opportunities are out there for us. But we have a very disciplined process. What we're looking for are things that are very complementary, very adjacent, that are additive to the organic strategy. What we're not looking for is we're not looking for something that's unrelated product line, just to paste it onto Lattice just to get bigger. That's not what we're interested in. What we're interested in is how do we accelerate our organic strategy, how can whatever we acquire add to that organic strategy, because we think we have the right strategy in place. Mirametrix, good example. It clicked right into our existing organic software strategy. So the acquisitions could be software or hardware. They could be small. They could be larger in size, but they have to be in the fairway in terms of our strategic focus.

Okay. Great. So year-over-year revenue growth, you're up to 32% this last quarter, double-digit growth in each of the 3 market segments. I guess, how do you assess kind of the longer-term growth? Obviously, there's some -- it's a very healthy market underlying that 32%, also some share gains and product cycle momentum. And how are you thinking kind of multiyear trajectory?

Yes. Look, we're excited about it. Back in 2019, we said, in '21, '22, we're going to start to enter a new growth phase for the company. And we think that that lasts beyond '22 as well. It's a combination of those markets that I talked about. We're positioned in good end markets, but we also have Lattice specific growth drivers within those markets, right, that are unique to Lattice. And we're just at the beginning of multiple new product cycles, right? So we've only had 1 year of revenue ramp on Nexus. We've got multiple years of Nexus ramping, Avant launches second half of this year, that will bring revenue further out in time. And that Avant is a totally new revenue stream, right? That doesn't -- Avant doesn't replace Nexus. It adds on top of Nexus. So we look forward and we see really good growth prospects for the company. We're pretty excited about that.

Great. And then gross margin, you've made some good progress there. What -- where do you see kind of long-term gross margins? And when you look at where your FPGA competitors have been historically, is that achievable for you guys?

Yes. I think if you look -- first of all, look back in time over the last 3 fiscal years, we've driven about 200 basis points of expansion over each of the last 3 years. And if you look at -- so I started in 2018, if you look at kind of 2017 as a reference point to our most recent quarter, it's actually 800 basis points of margin expansion over that time. So gross margin is, clearly, that's been a big focus of ours is to continue to expand gross margin. We made good progress to date. We're going to continue to be focused on that. I don't see any structural impediments to us to continuing to drive more improvement moving forward, right? So we're -- yes, that will remain a key focus area for us.

And can I just understand that a little bit better? I mean, you talk about 800 basis points over the last -- like why were gross margins at that point in the first place? Like as a company, I know there was more consumer focus and things like that, but what was it that those gross margins were?

Variety of reasons for that, right? But I would say that when I was doing my due diligence on the company before I joined, one of the things that I thought was wow, the gross margins of this company are way too low. I mean, it was -- it's kind of obvious from the outside looking in, I mean, you look at it versus comparables, you look at it versus the type of products, the type of market that, I mean, our products have a tremendous amount of software content on top of them. There's no reason we should have been at that gross margin. And so that was one of the, I thought, the key opportunities in the company is beyond just driving top line revenue growth was to drive margin expansion. And that margin expansion came through a number of different things. #1, we did a lot of work on pricing optimization. We just -- when I joined the company, we just were not doing a good job of pricing our products. So we've really improved the culture around pricing our products for the value they bring to the market. Product cost reductions. We've had multiple -- we put in place a multiyear focus on product cost reductions. And then new product cycles. So as we said, the new product cycles that are just starting to ramp, our new products are designed to be margin accretive to the company's average. So as the new products ramp, they're designed to be higher than the gross margin average of the company and pull the company's margin up over time, right? So there's multiple factors that have gone into it.

Yes. I mean, I'm just curious if you see the future of this any differently. I mean, for my whole career, I covered Altera and Xilinx. And as public companies, their gross margins in a very tight range, and if they went down 50 basis points, we'd all yell at [ Greg ] and ask him why that was happening and that's sort of enforced sort of amount of discipline. Now you have Altera is within Intel, Xilinx now within AMD. You don't have that anymore, that scrutiny on their gross margin. Has that changed at all pricing dynamic or anything? Or are we still kind of pricing these to the same pie that we have?

No. I think for us, the issue is more that, independent of our competitors, we needed to do a better job pricing our products, right? There was just -- there was a lot of operational discipline that we needed to put into the organization around pricing, right? And so -- and that took some time, right? But that definitely yielded results over the last 2 to 3 years. And now we're in kind of a different dynamic where we've got products that are designed to be at a higher margin level than the company average and that will start to pull the company up over time as well. So look, I think we've demonstrated a good track record of gross margin expansion, and I think there's more room for improvement.

Great. So let me see if there's any questions from the audience. If not, I have a couple more. Anyone? Cool. So maybe you can talk about your free cash flow generation and the use of that cash. How are you thinking of that in terms of -- obviously, you've talked about M&A still being part of the strategy, so what's the right cash balance, how much cash do you return?

I'll do my best, but my CFO, Sherri Luther, is sitting in the front row. So that -- she'll correct me if I get this question wrong. But -- and by the way, Sherri really deserves all the credit around cash flow. This has been -- since she joined in early '19, this is -- her mantra has been cash per share, right? That's -- we got to drive faster cash per share. And she has been -- put a whole bunch of systems and metrics in place to whip us into shape on cash. And so the way we look at it right now is if we look at -- as we exited last year, we exited last year with a healthy level of cash, more than we need to operate the business, just from an operational standpoint. Our leverage ratio is now below 1x. So debt really isn't an issue. And so the free cash flow is really focused on investment in the core business, making sure that we're fully investing in the organic opportunity in front of us, potential M&A acquisitions and then share repurchases. We've now built a really good track record of share repurchase, many quarters in a row of steady share repurchase. I think we're on our -- Sherri, our third share repurchase authorization. And the current one is $100 million that runs through the rest of this year, right? And so I think we've also demonstrated a track record around returning cash to shareholders as well. But look, we still think there's more opportunity to drive expansion in cash generation.

Yes, that's great. That's not always something we see from companies of your size and scale to have 3 years of buybacks. I think that's great.

Yes, thanks.

So just to wrap up, what do you think is the 1 thing that investors either don't know or sort of underappreciate about Lattice?

Yes, that's a good one. It's actually something we touched on earlier. I think that it's probably around our software strategy. Like I think that's a little harder to fully appreciate. Like because we're a chip company, I think people get our hardware road map. They get that, hey, we're ramping a new generation of products around Nexus. We've got a new architecture coming out around Avant in the second half of this year. But I think the nuances around our software strategy and how much benefit that can provide to our customers, I think that's probably still underappreciated. I mean, it's really about the software is really about making it super easy for customers to adopt the Lattice device or to switch from a competitor's FPGA or a microcontroller, to switch off a microcontroller and switch on to a Lattice device, make that switching cost as low as possible. And then also what it does is not just speed up time to revenue, but it creates stickiness for us over time, right? Because as the customers become more dependent on that software, that means they're more dependent on our solutions over time. The other thing I would add is that -- we've seen a nice benefit in the software, is it's extended the life of some of our older products, right? So that software works on the new products, but it also works on some of the older products, and that's helped extend -- kind of breathes fresh life into our older products as well, which has helped those continue to grow.

That's great. Well, that brings us up to the end of our time. Thank you very much.

Yes. Thanks, Joe. Appreciate it. Thank you.