Lattice Semiconductor Corporation (LSCC) Earnings Call Transcript & Summary

All right. I think we're ready to begin. So welcome, everyone. So again, I'm Chris Caso, semiconductor analyst here at Credit Suisse. So our next presentation is Lattice Semiconductor. With us from Lattice is Esam Elashmawi. I hope I got it right.

You got it right.

Chief Strategy and Marketing Officer; and Sherri Luther, the CFO. So thanks very much.

Thank you, Chris.

Thanks for having us. Chris.

Maybe a way to start, and I think folks understand Lattice in the FPGA space. But you occupy a special niche of the FPGA space, a little bit different than where I would always say, Altera and Xilinx, but now it's Intel and AMD. And it's a little bit different. So maybe you can speak to kind of what's different about you folks, and which areas are you targeting that give you a competitive advantage?

Yes. I think -- good question, Chris. So the best way to look at the FPGA market is to break it up into 3 simple buckets. And we break it up into: there's small FPGAs; there's a need for midrange FPGAs; and there's the large FPGAs that are out there. Think about the large FPGAs, that's really where the majority of the focus and investment of the Intel and AMD product lines are at. And that's about building the very large FPGAs, high performance, high power, for data center acceleration type of applications. Where Lattice has a leadership in is in the small portion of the FPGA market. And we've built that leadership. Starting back in 2018, we set out to rebuild our product road map and our product portfolio, and this is both from a hardware and the software side. And in the end of 2019, we launched what was our Nexus platform. And out of our Nexus platform, this is a platform that enables us to get out new FPGA device families to market at a much faster pace. In fact, if you look at the number of product lines that come out of the Nexus platform thus far, we've got about 5 different device families that come out of Nexus. And that's about a 3x faster cadence than what we've done before. And so that, in addition to investments we've done in our software tools as well, it's not just the hardware, it's also the software tools that we've invested in. And since that same time period, we've launched 5 different solution stacks. And solution stacks are software tools that Lattice provides our customers to help them get to market faster, helps make the sockets more stickier. And it's a win-win for the customers, and it's a win for us as well because it helps our incumbency as well. So if you think about it, we've got this -- the strongest portfolio that we've ever had, our product portfolio, both on the software and on the hardware side. And if you look at it from a customer perspective, there's a lot of customers that need these small FPGAs. And we introduced the Lattice Nexus platform. These same customers ask us, can you solve our challenges in the midrange? Because there is a void of development and innovation in the midrange portion of the FPGA market. And that, we went out and worked with our customers, about over 100 customers that we've been engaged with and we developed our next-generation platform, which is called the Avant platform, which we're actually going to launch this coming Monday on December 5. And that's really to address the needs and the void in innovation in the midrange portion of the FPGA market. So we focus on small and midrange FPGAs, of which the small is about a $3 billion market opportunity for us, and the midrange is about another $3 billion market opportunity. And that's really the biggest difference between us and the competition, is they're focusing on really much larger FPGAs for different sets of applications than what Lattice is focusing on.

And it's a little bit different than what we would hear from, again, the sort of leading-edge FPGA players. And maybe you could speak to the fact that, historically, their strategy has been to innovate on the leading edge and then let that kind of bleed down over time. So where do you guys fit in? How is it different? And how does that give you an advantage against, perhaps, product that's several years old from some of the larger guys?

Yes. I think you hit it right, several years old. In fact, it's a decades old in some cases. And so we're innovating for small- and mid-range FPGAs. We're not -- it's -- we had time to refer to that as a waterfall model. You innovate high and you kind of trickle down, we don't do that. We're really building products specific for the small portion of the FPGA market and the midrange portion of the FPGA market. And that needs innovation. But most of the systems that are being built out there actually require small FPGAs and midrange FPGAs. In fact, if you look at the volume of FPGAs, it starts with -- the most volume is on the small portion. Then it gets smaller and the customer base gets smaller for midrange, and then it gets even fewer units shipped and fewer customers in the large portion of the market.

Right. And what about in terms of end market exposure? So your business is more skewed towards industrial sorts of markets as opposed to the consumer markets. Is that a function of the markets that you're targeting? Is it just how it played out? What -- how did you get to the end market exposures, where you are?

Yes, good question. So I talked about in the very beginning that back in 2018, we set out to build the strongest product portfolio within Lattice, its history. But also we set out to even focus on the right core markets. If you go back to that time period back in 2018, 1/3 of our revenue came from consumer. Today, 90% of our revenue is coming from comms and compute and industrial and automotive. These are our core strategic markets that we focus on. So 90% is coming from those markets. And within those markets now, we're very well positioned on good secular growth applications within each one of those markets. So if you think about the communications markets, we're well deployed across the top OEMs on 5G. So anything that's related to 5G, growth within 5G, we benefit from that. If you go into the compute portion of our end markets, we're strong in the server, as well as we're starting to ramp up in client devices. On the server market, if you go back to our first Investor Day in 2019 in May, we talked about an attach rate in servers of about 25%, driving that to 85%. And then our last Investor Day, we said we achieved 85%, now with the next generation of servers being launched, our attach rate is well above 1, which means basically, we're shipping more FPGAs into the server market than servers that are being built. So we've increased our attach rate significantly. But we've also increased the number of applications within a server that we're servicing as well. And that drives higher ASP for our units. So we have an attach rate increase in every generation as well as an ASP increase. So as the servers are deployed, we get benefit from both the attach rate and the higher ASP. And that's been helping us as far as the growth drivers within the server market. On the client side of it, think about notebooks and PCs. Although this isn't the sexiest market right now, everybody is talking about declines in the PC market. But from a Lattice perspective, this is a greenfield opportunity and a growth driver for us as well. A lot of what we did on the server market and finding applications in a server and driving the attach rate also applies to notebooks and client devices well. And so we started to engage with the top OEMs on the client side, and we started to ramp up new platforms, leveraging the Lattice FPGA and software tools. In fact, some of those OEMs talked about it publicly. Lenovo, as an example, talked about the ThinkPad leveraging Lattice FPGAs for a lot of its artificial intelligence and improving user use cases, and we can talk more about that if needed. But they've got it on their ThinkPad, they've got on their Chromebook. LG announced it as well, and we're working with other OEMs that you might hear more about in the future as well. But for us, it's a greenfield, independent if the total PC market starts to decline, whether it be the 15%, 20%, 12%. For us, these are new greenfield opportunities that are ramping up. So we benefit from that from a growth perspective. Our comms and compute, by the way, has grown double digits, and this is entering its fourth consecutive year of good double-digit growth for our comms and compute segments. And then you've got the industrial and automotive. And in our last quarter, we had a 45% growth year-over-year in our industrial and automotive, and it's on track for its third consecutive year of double-digit growth. And our FPGA is just a really, really good fit for factory automation, robotics and those types of applications in industrial. And in the automotive market, a lot of what we do, whether it be in industrial, communications, I mean, it applies to the automotive market as well. And we've qualified our FPGAs for automotive applications, and we're seeing good growth in the automotive market. In fact, the portion of the automotive market, although small in our industrial and automotive, is outgrowing that entire segment. So when we say that, that segment grew 45% year-over-year, assume that the automotive portion, although small, grew at a much higher rate than that. So we've got a lot of good drivers in good markets and secular growth markets as well.

I guess with that, maybe it's time to talk about some of the market conditions and what you're seeing and expecting. And everyone up on stage today has pretty much said the same thing, that those industrial auto markets still sound -- still seem very strong, which is different than we've seen in past cycles. The consumer markets that you're not exposed to are a bit weak. And I guess, servers a little bit in between. So maybe you could speak to some of that and kind of what your expectations are as you head into 2023.

Yes. I think we see what everybody else sees. I mean we're not immune to macroeconomic things that are happening globally. We talked about the fact that even in China, we see a slowdown in the server market in China. But again, go back to our higher attach rate in every server generation, we're processor agnostic, a higher ASP. Even if the growth rate of servers declines a bit, we still outgrow the overall server market because the attach rates are going up. On the PC side, again we talked about that. I think it's all greenfield opportunities for us on the PC and notebook side. On the industrial and automotive, we see what everybody else sees. But we also look at our position in these markets and say, even if there is a downturn to come, and everybody's got a different view what they see today, what they're going to see a few quarters from now, I think we're just well positioned in those markets. That even if there is a downturn, we will weather it better than the market itself. I mean with 45% growth year-over-year, 3 years of consistent double-digit growth, we've been gaining a lot of traction in these markets, both industrial and automotive, and we expect to continue to do that. Not just because of how we're being used, but because of the new product cycles that we're bringing to market as well.

Okay. One of the things you mentioned earlier is the new Avant program platform that launches on Monday. Two questions on that. One is, is that fully incremental revenue for you? Are you attacking fully incremental markets? And if so, what's the size? How much do you expand your TAM by launching Avant?

Yes. So if you look at the small portion of the FPGA market, our addressable market today, if you go back to our investor pitch in May of 2021, talked about a $3 billion opportunity for us. And with Avant, we're actually doubling that to $6 billion. So we're doubling our addressable market. And the beauty about Avant in moving from small to the midrange portion of the market is that it's all greenfield opportunity for us. It's all additive revenue. Another way to put that is every dollar we get of Avant is a share gain for us. It doesn't take away from the existing products that we have. So although I just went through, we've got a lot of good growth drivers, consistent growth with our comms and compute and industrial and automotive, we expect that to continue. We're going to continue to invest in the small portion of the FPGA market. But now you've got this additive product line that's coming on to address the midrange, which is the Avant platform, which will have a set of device families coming out from that as well, that's all incremental revenue. The other good thing about it is if you look at the customer base for Avant. So if I take the mid-range FPGA mark and I say, who are the customers that buy mid-range FPGAs, 90% of those customers are existing customers of ours today that buy small FPGAs. So we've got good customer traction. In fact, a lot of those customers helped us define what Avant should be in order to help them innovate in the market and differentiate their products. Did somebody throw that at us?

I think Chris did.

For those online, he just dropped the ball.

I just dropped the ball.

So we've got good -- the customer base, our software tools, designing FPGAs, the solution stacks that I talked about are also leverageable for Avant as well. So we're really excited about launching the Avant platform. And one more plug on December 5, we will be launching the event. And anyone welcome can register and watch the event.

What's the design cycle for those products? So you'll launch it on Monday. There's probably been some sampling to some large customers already. What's the cycle time to kind of get those into revenue? And so what should we expect about layering that in over time?

Yes, good point you made. Our definition of a launch, it's not a paper launch. It's -- we actually ship samples to customers. We've been engaging with customers through this journey. And so when we have the launch event, expect customers that have had softwares to look in any evaluation boards. But if you look at the time to revenue, how long does it take customers to adopt the product and start to see meaningful revenue from it, we take the similar model as what we've done with our Nexus product lines, and that's about 4 quarters to start seeing initial production revenue. It's not significant, it's initial production revenue. But every quarter after that, the expectation is that it will grow and become more meaningful. So if we launch on December 5, which we're planning to, expect some initial revenue on the end of 2023. And as you get into '24, it becomes more meaningful.

Okay. And it's safe to assume Avant uses the similar software stacks as the existing product line, such that if you have customers that are under the last 10 that you're using similar tools in that, which would, I guess, would be your first -- the first adopters of the product.

Correct. That's correct.

Okay. And what's the level of stickiness that's involved there? That obviously, the hardware is important. But as a former engineer a long, long time ago, having the good software tools to be able to program those and being familiar with it has got to be a big competitive advantage. Maybe you could speak to that.

Yes. Software tools are really important. We want to help our customers get to market faster. And by providing these solution stacks in key areas of focus, we actually so far have delivered 5 unique solution stacks. One is around artificial intelligence, helping get your artificial -- your AI applications to market, one around security, around computer vision, factory automation as well as around communications, 5G ORAN. And these -- the customers that leverage these tools, these are prebuilt applications that they actually run in their systems. So their stickiness as well, because of the software usage of the solution stacks within their system as well. And so that helps the stickiness of it. It helps them get to market much faster. They don't have to deploy as many resources. I mean, we save them person years of development effort by leveraging our solution stacks. That makes it really, really sticky and helps our incumbency. The other thing that I'll add on to that is we took a look at our attach rate of our software solution stacks. And what we found is that attach rate is increasing over time. In fact, if you look at the attach rate today with a -- you look at the last 12 months of sockets and design wins, you can see the attach rate is slightly above 50%. The other thing we did is we took a look at the ASP uplift with leveraging the software solution stacks. Although today, we don't monetize these softwares that add value to our customers, the way we get the return on that or the monetization of it is in the price of the actual FPGA. So when we take a look at the FPGAs that have software attached to it versus those that do not, we see an ASP lift on the -- the ASP of the FPGAs that we sell them.

Okay. Maybe we'll pivot a bit to margins. And since the company made its transition, the gross margin level is up pretty considerably over that period. Maybe you spoke to what drove that. I know there's a different end market focus now. There's less consumer, there's more industrial and such, I'm sure that helps. What are the factors that got you here, and what is the plan going forward?

Yes, sure, Chris. So when you look at our gross margin expansion to our most recent quarter, Q3, we've increased our gross margin by nearly 1,300 basis points. So certainly very significant since we started our gross margin expansion strategy. We're entering our fourth year now, so we're really pleased with the progress there. And there have been many multiple elements to that strategy, including pricing optimization, which includes really getting the value for our product, making sure that we're pricing our products for the value that they provide to our customers. Our products have a lot of additional functionality that our customers really appreciate, some of which Esam talked about a little bit ago. So pricing optimization is certainly a key part of it. Our new products have also added value. Our Nexus platform, we have 5 devices on that platform. And then Avant, which we're launching on Monday, just to give another plug for that. That -- those new products are designed to be gross margin accretive. And so that has added value and will continue to be a key area of gross margin value add. We've also have product cost efficiencies that have contributed. We provide the recipe, if you will, to our vendors to make our products. And so we ensure that we get yield efficiencies, for example, things like that, that help improve our gross margin. The other thing that you mentioned, Chris, as well, is our mix improvement. In 2018, in that time frame, our consumer was about 1/3 of our business. And that part of the business was really a low margin, high volatile part of the business. And so we intentionally brought that down to what is in our most recent quarter, 6% of our revenue. So much lesser reliance on that. But the type of revenue that, that is, even though it's a lower percentage of the total, is really higher quality, higher-margin multiyear revenue streams that we prefer to certainly focus on for the business. So those have been some of the key elements of our gross margin expansion strategy. And if you look over these past 4 years, that 1,300 basis point improvement, it's been -- some of those initiatives have kicked in, in the near term. Some have kicked in more in the longer term just for each of those initiatives kick in at different points in time. And so we'll continue to focus on that as we move forward. Gross margin continues to be a key part of the business for sure. The other thing I'll mention is that -- sometimes we're asked the question about why is our -- why isn't your gross margin as higher, perhaps, as maybe Xilinx. We often get that question pre-AMD acquisition in the low 70 percentage range. And our response to that is really, it's just that Xilinx is a much larger company, or pre-AMD was a much larger company. And so that really has helped them achieve the higher gross margins. Other than that, we don't see any reason why our gross margin couldn't be higher. So we'll certainly continue to focus on that as we move forward.

Yes. And I guess with Xilinx and the XN Intel's business. It's a different business model where you're innovating at the leading edge and there's higher upfront costs there that's taping out at leading-edge nodes as opposed to what you're doing. But how does that play out over a cycle, for example? And in the event that things do slow down next year, what sort of levers do you have to pull to be able to kind of soften that if we should see a broader slowdown?

Yes. And I believe you're speaking of gross margin in particular?

Gross margin, in particular, yes.

Yes. So the beauty of having so many levers as part of the strategy that we've put in place and so many factors is that you have those various levers that can kick in at various points in time, depending on what is going on in the environment, with our products, with our customers. And so that actually is the beauty of it, having so many different levers that we can put into place. I mean, if you -- even during all of the supply chain constraints during COVID, we actually continue to increase our gross margin even during that time frame. And so it's really multi factors within that strategy that help us manage that to weather whatever storm may be ahead.

It's 1,300 basis points since 2018, I believe, yes?

Yes, yes.

And if you look at every year since then, it's about 200 to 300 basis points improvement in a typical year, like '19 and a pandemic here like '20, in a supply constraint year in '21 and now this year. There's different types of scenarios we've encountered, But the team has done a really good job in showing that independent of the type of year that we had in the industry, we've had improvement in our gross margins. And as Sherri said, it's going to continue to be a focus.

Yes. And it's really, frankly amongst ourselves, we talked about it and we say it's really part of our DNA. This is just the way that we think about things that we operate. We always want to have multiple levers to be able to activate. And so this is just -- this is the way that we do business now.

Maybe you could speak to pricing and the extent to which pricing has been a benefit over the last year. And we've heard from a lot of the companies. One is pricing is higher just because of shortage of supply. The other is foundries have also been raising price as well. And it sounds like that pricing is still going higher as you go into next year. One is, what benefit have you had in the past? And then how have you been passing along the input cost increases?

Yes, sure. So I'll just respond to the last part of your question first. As far as when higher input costs are passed along to us, it's our intention to pass those along to our customers. Having said that, when you look back at that 1,300 basis point improvement over 4 years, really about half of that was before COVID. So half of it was before it even became fashionable for semiconductor companies to increase prices. And again, it goes back to our strategy and the factors that are involved in that strategy. So -- that's the way I would think about that in terms of the pricing aspect. The other thing is that year 2022 -- 2021 versus 2020, our volumes increased year-over-year. So it's really a function not just of pricing, right? It's increases in volume that have really driven revenue growth as well.

Right. And I mean, does it -- do you still see -- and we've spoken others today who still see pricing, a favorable pricing environment going into 2023. Is that your view as well?

I think the best thing for us to do is just to keep executing on our strategy from a pricing perspective. I think the other thing, it's not just increasing prices, it's getting value for our products. And when you have so many new products -- the product cycles that we have, it's very exciting. I mean it's never happened before in the history of the company to have as many new products as we have now, 5 devices on the Nexus platform and more to come, and then on the Avant platform and launching that on Monday. So when you have so many new product cycles like that, that are providing so much different functionality to allow our customers to differentiate their products, that helps you get value for your product because we're providing our customers what they want.

And then the software attach rate as well, we talked about. I mean this is all part of the pricing optimization that we put in place early in 2019 that we're continuing with even to today, and it becomes something that we continue with in the future as well.

Okay. I'll just pause if there's any questions in the audience. I don't see any, so we'll just continue. Just from an R&D perspective, using the Avant program as an example. With your R&D spend right now, what's your capacity to continue to layer on new products? Is this situation where I guess it's been about a 2-year cadence from Nexus? Is that right? Is that about what we would expect in terms of new product families? And then I guess that R&D spend is what's ultimately going to drive the revenue growth.

Yes. So from an R&D spend perspective, I mean, even in our most recent quarter, we increased our R&D spend 19% year-over-year. You've seen recently sequentially increases in our R&D spend, and that is to really support the long-term product portfolio and make those investments. At our Investor Day last year, we talked about our R&D sort of target, if you will, of 20% of revenue. But we don't want to just throw money at it to achieve a target. We want to make sure we do it in a disciplined way to support the growth of the business. And so we intend to launch more products on the Nexus platform and certainly more on Avant. And so you'll continue to see that in our investment spend.

And it's the platform strategy that allows us to efficiently develop new product families tuned for specific applications within the market.

Right. And I guess the -- even for Avant, that the core of that product is shared with prior products, therefore, you're not reinventing the wheel entirely as you go forward.

Yes. I mean we've taken a lot of our power-efficient architectures that we've built in the past and scaled it to the midrange, added more innovation into our midrange FPGA, which people will hear about on December 5 as well. But the whole platform strategy allows us just to increase our cadence of new product introductions.

Okay. As we're getting to the end, I wanted to ask about just supply and capacity, and that's been a constraining factor for most of the semiconductor industry this year. With some of the slowdown that we're seeing in some of the consumer-related markets, does that provide more capacity for you? And I guess is the thesis from a number of companies, they're hoping that we get some supply freed up on the foundries, because of the slowdown of handset in consumer, and that could be redirected towards some of the industrial markets. Is that a likelihood for 2023?

Yes, it has been. Actually, we talked about supply easing up, I think, about 2 or 3 quarters ago, we started to see that. And clearly, it makes sense as other end markets start to slow down, it frees up capacity for everyone else. But if you've been watching Lattice and tracking us since 2020, you'll notice that even when during the year of the pandemic, we started to raise our own internal inventory and get prepared for the fact that there will be a turnaround. We've been through these before. And so we put ourselves in a much better position from an inventory perspective to deal with the supply constraints that came about. So although there's always a few product package combinations that are constrained, overall we've done a really good job. And that's reflected in the growth of the company as well. And as Sherri talked even in 2021, a lot of our growth, which was 26% year-over-year, a good portion of that, the majority of that, was volume driven. In fact, I think we talked about in our earnings call, our volume in Q2 compared to Q1 and Q3 compared to Q2 has also gone up.

Absolutely.

So we've been doing overall, I would say, a much better job than some of our peers in the industry as far as having supply and being able to satisfy our customer base. But we are seeing easing in supply right now.

Right. And I suppose once you bring people into the tent and they start using the platform if you have a product, and the other guy doesn't, then you've got a customer, there's some stickiness to the business, I would suppose.

That's right, that's right.

Yes. The other thing I'll just add in terms of inventory is that, as Esam mentioned over -- throughout COVID 2020, 2021, we've increased our inventory. And even in our most recent quarter, we increased inventory intentionally because we wanted to make sure that we could support the growth of the business. So growth in terms of design win ramps, growth in terms of new product ramps that we've talked about here, whether it be Nexus or Avant. And so really to support that type of growth and the general growth of the company. So we want to make sure we have the products that our customers want. And the other thing I'll just point out is FPGA is a very, very long life cycle. And so risk of obsolescence is very, very low. And so we're feeling really good about the amount of inventory that we have on hand.

And this is Lattice inventory. Our channel inventory is still very lean, and eventually that needs to be replenished. But the channel inventory itself, we've been keeping it lean.

Okay. It looks like we're just about out of time, unless you have anything closing, you'd like to.

No, I just want to say, if you look at the company over the last several years, we've done -- I mean, kudos to the Lattice team, rebuilt the product portfolio as the strongest portfolio of products we've had in our history, both hardware and software. We've repositioned the company into really good growth markets, secular growth applications and markets. The competitive environment from our perspective, has never been as favorable as it is today, with our customer intimacy as never as strong as it has been today. And that's evident in what we've been doing in the small portion of the FPGA market, but also their contributions in helping us define the midrange or the Avant platform that we had talked about. And then lastly, just kudos to the Lattice team, just consistent execution across the board.

Great. Well, that's -- we're out of time. But both of you, thank you for attending. Thank you.

Thank you, Chris.

Thank you, Chris.

I appreciate it. Thank you.

Thanks, everyone.