Lattice Semiconductor Corporation (LSCC) Earnings Call Transcript & Summary

[Audio Gap] I cover semis here at KeyBanc Capital Markets, and we're pleased to have Jim Anderson, President and CEO; and Sherri Luther, CFO of Lattice Semi. Welcome, guys.

Thanks, John.

Thanks, John.

Appreciate it. Thanks for the time.

Sure. Maybe we can kind of recap the quarter. I think you put up pretty strong results and guidance last week in contrast to some of the pre-announcements we've seen over the last couple of days. I'm wondering if you could just highlight the growth drivers in the quarter for you.

Yes. No problem. Yes. So we had good growth in the first half of the year. If you look at first half growth, about 30% year-over-year. really pleased about where that growth is coming from. And maybe, John, I'll talk about where it's coming from both a market perspective but also from a product perspective, too. So from a market perspective, if you look at Q2, we saw 35% growth in communications and computing. That follows multiple years of strong growth. We're on track to have our fourth consecutive year of double-digit revenue growth this year. Seeing good growth in data center servers, 5G wireless infrastructure. And then we've got a new greenfield growth opportunity that we're just starting to penetrate in PCs. So those are some of the key growth drivers there. We also saw good growth in industrial and automotive. So a 30% growth year-over-year in Q2, in things like industrial automation, robotics, automotive electronics, Lattice solutions are just a really great fit for that market. And those markets that I just talked about represent about 90% of our market. We consider those are core strategic markets. We did see a little bit of softness in consumer electronics. That's our smallest market, that accounts for about 8% of our revenue. We did see some softness that we attribute to kind of the broader macroeconomics offer that we're seeing. But really pleased with the growth that we're seeing in our strategic markets. And then from a product standpoint, a number of new product cycles that we're going through right now. Our newest platform generation that's in production now is our Nexus products. We now have 4 of those products in production ramping into full revenue. We just announced in Q2, our fifth device family based on the Nexus platform generation that should go to revenue next year. And then we've got some additional Nexus devices coming out over the future quarters that you should expect. But that product generation is still really early in the ramp up. We're only in our second full year of revenue for the Nexus platform, and we expect that to continue to grow for multiple years to come. So a really good new product cycles, too. So some really good new product cycles, too. Look, we're really cautious and watching very carefully sort of the macro economy, the recessionary pressures. So we're cautious about that, watching demand signals very carefully. But quite bullish about some of the lattice specific growth drivers that we're seeing right now.

Great. Jim, I think you guys are still supply constrained. I think you've talked about that. Is the weakness that you're seeing in consumer, maybe not only in your business but also more broadly, is that freeing up additional capacity for you right now?

Yes. Good question, John. I think -- if I talk first at an industry level, I think definitely, the softening that we've seen in some of the more consumer-oriented segments has definitely freed up capacity for some of those other segments, whether that's industrial or automotive, et cetera. Now not all of that supply is completely fungible from one segment to the other, but it certainly has freed up some level of supply. I think we expect the industry to continue to remain pretty constrained through the end of this year into next year. But for Lattice, we are seeing some signs of additional capacity or improvement in supply. We saw some additional supply allocations from our suppliers for the second half of this year. And we view that as a positive indication that supply and demand are starting to rebalance. We're certainly not immune to supply constraints, but we are seeing some incremental improvements in our capacity.

Great. Sherri, you've done a great job on gross margins. Are there still opportunities for us to see additional expansion? What are some of the levers and puts and takes for that going forward?

Yes. Sure, John. So we're really excited about the record gross margin that we achieved in Q2, 69.1%. You may recall back in 2019 is when we laid out our gross margin optimization strategy that had multiple elements to it, including pricing optimization, really getting the value for our products, also including included cost efficiencies and new products as we announce new products, they add value as well. And so since the end of 2018, we've actually increased our gross margin by 1,200 basis points. So really pleased with that progress and the elements of that related to the pricing optimization and new products adding value. And as we look ahead to Nexus as well as our Avant products will continue to look to have those products add value to our gross margin.

Great. Data center, I know has really been strong for you. I think we had kind of mixed reports this earnings season from the two biggest kind of chip providers there. Obviously, you're seeing kind of the large incumbent really having some challenges there. What's your perspective in terms of your success? Is it tied to one or the other if kind of the share shifts continue in that space?

Yes. Definitely not tied to any particular CPU vendor. And yes, you're right, John, data center has been a great growth area for us. actually not just this year, but really over the last 3 years. And we're certainly -- certainly, the end market demand affects us, but the much bigger factor on our growth over the last few years and where we see our growth moving forward in this segment has been in the increase in the dollars of content per server that we've seen with each new server generation. So we've seen a significant increase in those, Lattice dollars of content per server, and that's coming from a significant increase in attach rates. When we -- when I started our attach rates in the server segment, we're kind of around 20%. We've now driven that over the last 3 to 4 years to over 1x, meaning on average, server ships with more than 1 Lattice piece of silicon per server. So that's driven a tremendous amount of our growth. The other factor has been ASP expansion. With each new server generation, we brought new capabilities, new functionality, both from a hardware and a software perspective. And so that's helped us increase our ASPs with each generation. When you add the ASP increases with the attach rate, you get a significant increase in the dollars of content per server. So that's really been the much bigger factor on our growth than the underlying market growth. And we still see a significant opportunity to continue to expand attach rates and to continue to bring more value with each new generation. And then you mentioned on the different CPU vendors. Yes, we are completely agnostic to CPU vendors. If you look at today, we're in production on Intel platforms, AMD platforms and our based server platforms. And that's actually one of the values we bring to our customers is we are not tag to one particular CPU vendor. Our solution works across multiple CPU vendors. And then to the extent that their share shift between CPU vendors or kind of buffered from that.

Okay. Both of CPU providers are both launching new platforms, as you know. I'm wondering if you could talk anything more specifically about how this transition impacts you? And then also, obviously, one of the providers' offices is facing some challenges and pretty significant delays. Is that impacting you from a...

Yes. I think I'd go back to that last comment. Because we're kind of agnostic, and we're supporting multiple different CPU-based platforms. If there's one vendor that's a little slower than the other and their share shifts because of that, we kind of get buffered from that. As new server generations have shipped with each generation, again, we've brought -- we've increased our dollars of content per service. So we may be affected a little bit short term. But because of that, again, that CPU agnostic solution, we're buffered to a large extent.

Great. Any questions? Great. I wanted to touch base on the PC opportunity. Clearly, a greenfield opportunity for you. I'm wondering if you could just talk more specifically about what your solution and opportunity there? And how does that differ from your opportunity within the core data center?

Yes. We just see PCs as a large greenfield growth opportunity for us. I realize that at this particular moment in time, PCs may be a little out of favor. But for us, it's just a big unit TAM, greenfield unit TAM. And -- if you think about a bridging of kind of what we said in servers, right, so servers where we've been able to grow our attach rates steadily over the years and now have the over 1x attach rate. We look at the PC segment and see a large system unit TAM opportunity above 300 million units, roughly 20x larger than the server system unit. So big number of system units. And what we're able to do is bring some new capabilities and new user functionality to those PCs. It just hasn't existed before on a PC. So gesture recognition, human presence detection, some unique security functionality that again, just hasn't been on those systems. And so we were just at the beginning of penetrating this segment. And if you look at the total TAM unit -- even if we get a relatively modest attach rate in that space, it can translate into a lot of unit growth for us and a significant revenue stream for us. At the beginning of this year, we announced with Lenovo that we're now in their ThinkPad system. So a high-end enterprise system where we're bringing new capability, new technology to that system based on artificial intelligence. We also had an announcement with Lenovo on a Chromebook system that they now have in the market. We just announced another one with LG and the Gram Series road map. So A lot of good initial progress here, but I think we've got a lot of opportunity ahead of us, too.

Yes. So if I look at kind of how you ramped and grew your data center business, -- you went from roughly about 20% attach rate 3 years ago to over 1x right now. Realistically, what can we expect from you in the PC business maybe 3 years from now in terms of attach rates?

Yes. We'll see -- we haven't put a marker out there but, as I said, because it's such a large TAM, even a modest attach rate percentage creates a significant revenue stream. But, yes. But we're excited moving forward in that segment.

Got it. You recently also talked about some of your growth is being coming from displacing kind of microcontrollers. What's driving this? And do you kind of feel that the gains here are durable?

Yes, definitely. In fact, if you look at that 30% growth that we had in the first half of this year, if you kind of dissect that, there's actually 3 sources of growth. And that's the one you mentioned is just one of them. The -- so the other two sources of growth are, again, where we're bringing new capability, new functionality to a platform that's never existed before. That's kind of the PC example. There's also another source of growth is in the markets that we serve. We believe we're gaining significant share in the part of the FPGA market that we serve versus our traditional FPGA competitors of Intel, Altera and Xilinx now part of AMD. So we're taking share from existing competitors. And then taking share from other types of silicon is another source, microcontrollers as an example. And what we're seeing there is in a number of different markets, if we use -- let's use industrial as an example, like in the industrial market, we're seeing customers that want to bring more intelligence, more decision-making capability to their platform. And what that means is they're trying to add some level of artificial intelligence processing into their industrial automation or robotic systems. And when they try to do that, those AI algorithms are inherently parallel algorithms. And when -- let's say, you're an industrial customer that's always used microcontrollers, now you're trying to add some artificial intelligence capabilities, you really hit a wall with the microcontroller because microcontrollers essentially a sequential process or it just doesn't run AI algorithm as well. But Lattice FPGA is a great fit for those AI algorithms. The FPGA can be programmed as a parallel processor customized to your AI algorithm. You know that share AI algorithm is going to change over the next few months, the next few years. So you want some level of future proofing. So you just as your AI algorithm changes, you just reprogram the FPGA. And so for the power performance benefits and FPGA from Lattice is just a much better solution. So that's why we're seeing a number of customers switch off of microcontrollers to FPGAs moving forward. We've also developed software that makes it really easy for those customers to make that switch. So a prebuilt software stack that they can use that makes it easy to convert from that microcontroller to FPGA.

Great. I know your traditional FPGA peers typically see more challenges on the ASIC front. I know you operate at a different segment of the market, but I'm just wondering, do you also bump up against ASICs and how are you faring there?