Lattice Semiconductor Corporation (LSCC) Earnings Call Transcript & Summary

I guess it's still morning. Good morning, everybody. Thank you for -- and I'm sure some people will continue to trickle in because the sessions are fairly back to back here. But welcome to the semiconductor room, whatever lovely name they give it outside. My name is Matt Ramsay from the semi's research team at TD Cowen. This is day 2 of our 51st Annual TMT Conference and our first under the TD Bank umbrella, which is exciting. So really appreciate everybody participating, and we'll hope to make this an interactive session. Really, really pleased to have Jim and Sherri here from Lattice. It's been a remarkable story since you guys took over the management of the company, and you guys may be aware that they had an Analyst Day a few weeks ago here in New York and gave a bunch of longer-term updates. But thank you for being here, Jim. I don't know if you wanted to kick off and make a few remarks just to set the tone for the conversation. And then there's lots of topics to dive into.

Well, I think on the Investor Day that we just did, I think if you had to boil it down to one big theme, the thing that we're most excited about, about the company right now is we're in the middle of the biggest product portfolio expansion we've ever done in the company's history. We're certainly happy about the progress we've made to date. See, I'll be 5 years in September, you'll be 5 years in January with the company. So we're happy about the progress, but we're much more excited about where we're headed from here. And that's really based on that huge product portfolio expansion we're doing.

Yes, I think that that's been a lot of the feedback I've gotten from the Analyst Day as well in addition to the Analyst Day being short.

Yes, that was the most common feedback. Thank you for making it short and succinct.

So Jim, one of the things that I wanted to dig into a little bit is you have sort of 3 big buckets of products, right? So the pre-Nexus portfolio that was there at the company when yourself Sherri and Esam sort of took over the company and the road map. The Nexus portfolio of small FPGA that's very differentiated. It comes with its own low-power software stacks, et cetera. And then you're -- you've launched but not yet started to ship for revenue, a whole new platform, which basically doubles the TAM of the company for Avant. And maybe you could talk through the growth drivers of each of those segments because I get questions is growth of Avant, the future and maybe other growth is going to slow. I think we're still relatively early innings with Nexus and if you could just kind of lay that out for us, that would be helpful.

Yes, if we start with -- we kind of break the FPGA market into small, midsize and large FPGAs. And historically, Lattice has always innovated in the small FPGA segment. And Lattice is actually 40 years old this year. And so our innovation has always been around small devices, very power efficient, very easy to use. And those devices go into just all sorts of different applications, industrial, automotive applications, communications, computing, et cetera. And because we were in that segment that has kind of the broadest application across multiple markets, we're actually the highest volume FPGA maker. So the highest volume by kind of a long shot. And so step one, when we joined the company was to really rebuild and reinvigorate Lattice's business in small FPGAs. And so beginning as soon as we joined, we rebuilt the product road map for small FPGAs. And the newest product platform, like you said, is called Nexus, and that's for small FPGA. And since we launched Nexus at the end of 2019, we now have 5 different device families based on Nexus that are in production and ramping. In fact, the fifth just went into production this most recent quarter. And all 5 of those are ramping, and we expect Nexus to continue to ramp for many years to come. We just launched our sixth device family. We announced the seventh device family we'll launch later this year. So kind of a steady beat rate of new products. And so that's why we see many years of growth ahead of us in terms of Nexus. But actually, you mentioned the pre-Nexus devices. Pre-Nexus devices continue to grow as well. Now they're growing at a more modest rate than Nexus, Nexus is growing faster. But even the Pre-Nexus devices, we see that growing over the coming years. And we're certainly very -- make sure we're very happy, especially because the Pre-Nexus devices to have growth in those devices, there's really very little incremental investment. So FPGAs are a little bit different than like a processor business or a memory business in that our product lifetime cycles are very long. So we're yes, happy to see growth in Pre-Nexus as well as Nexus devices.

Sherri, I wanted to kind of set a complete sort of the picture from the Investor Day from a few weeks ago. The gross margin and operating margin progress of the business since you guys took it over is remarkable. I mean the -- I think there was -- Jim and I talked about this before, in your first 2 days at the company as CEO, there was some low-hanging fruit that your predecessors left you on the tree. But also the -- I mean, we've added well over 1,000 basis points of gross margin, probably 2,000 basis points of operating margin in the last 4 or 5 years. And maybe you could talk about the drivers of that margin expansion, whether it's pricing optimization, cutting cost of -- input costs, obviously, revenue growth and then focusing on the operating expenses being targeted at the business that you're trying to grow rather than -- I mean, there were some things to consumer before, there were some stuff that was -- if you could just walk us through maybe where the margins have started, where they're going to go and how you've driven those targets.

Sure. Sure, Matt. So one of the things that we did when the time when Jim and I joined the company, was we took a look at the way that the company was pricing its products and really laid the foundation for our gross margin expansion strategy, which, as you say, we increased quite a bit. We're really proud of that. Since the end of 2018, we increased our gross margin by 1,360 basis points and so we're now in our fifth year of our gross margin expansion strategy. And so when we looked at the way the company was pricing its products, we saw a lot of opportunity to be able to add more value -- get value for our products for the value they provide to our customers. And so the elements of that gross margin expansion strategy is really 3 main areas: pricing optimization, product mix and product cost reductions. And so from a pricing optimization perspective, I think we put strategic analytics in place to make sure that we could price our products for the value they provide. Jim talked about our leadership product portfolio, our Nexus platform, certainly our Avant platform that we launched at the end of December. All of that adds value to our customers in terms of the functionality it provides and certainly contributes to our gross margin expansion. Product mix as well, you mentioned that the consumer, when we joined the company 5 years ago, consumer was a much larger part of our business. It was about 1/3 of our revenue. And now at the end of last year was sort of a net 6% revenue range. So a very small part of our business, a strategic and intentional shift toward multiyear revenue streams, really mix in product markets -- core strategic markets, segments of industrial and automotive and comms and compute that have higher capacity, greater functionality of products that our customers want. And so that's contributed to gross margin expansion as well. And then the third area, product cost reductions, that's an area where we work truly closely with our suppliers to get operational improvement in areas such as yield and cycle times, for example. And certainly, our strong relationships with our suppliers have also benefited us as well. So all of those together are really contribute to our gross margin expansion strategy. And for those reasons, we believe our gross margin is durable.

No, thank you for all that. And it's been remarkable, like I said, I under called your gross margin expansion at 1,000 basis points. So that hasn't happened to me too often. So it's interesting, though, to tie that margin conversation to sort of the strategy of the company. Jim, you and I had a few conversations over the last few weeks about whether the focus is on margin or the focus is on top line growth. And maybe you could speak to that as you're driving the team -- are we squeaking out the last points of margin? Or are we looking for -- to make sure that we're in the high teens in growth and maybe make that a bit conservative?

Yes. No, that's easy. Our top priority is always top line growth. Right. And we will -- so we're very focused on continuing to scale and grow the company. And I think with all the product, the new product cycles that we have, that's what we're focused on ramping those products as fast as possible and then those naturally drive growth. And I think the secondary priority is continuing to optimize and expand gross margins. But we would never want to get to the point where we felt like we were very focused on continuing to scale and grow the company. I think with all the product, the new product cycles that we have -- that's what we're focused on ramping those products as fast as possible and then those naturally drive growth. And I think the secondary priority is continuing to optimize and expand gross margins. But we would never want to get to the point where we felt like we were optimizing margins at the expense of revenue growth, right? Revenue growth is always our top priority.

And I guess expanding on that, you're now right in the middle of launching Avant and the first products of that portfolio, as you said, a beat rate of products, I'm sure, is to come in the Avant family. Maybe you could talk a little bit about how the company -- if I'm not mistaken, it was almost totally customer pulled that got you into Avant and so just maybe we could talk a little bit about the customers that you're servicing with your Nexus business and how those conversations evolved to bring you into the mid-tier FPGA market.

Yes. So this goes back to 2019, the first year that I was at the company. So we were introducing -- so we rebuilt the product road map, like I was talking about earlier, for small FPGAs since we're introducing that product road map to our customers. And then one of the common pieces of feedback that we got was, hey, your Nexus road map looks good. Your product is really power efficient, high-performance, small size, et cetera. But why don't you just take that same architecture and build a midrange device as well. And we have a number of big strategic customers ask us that so we took a look at it and realize that actually, the same customer base that uses our small FPGAs uses midrange as well. So it's largely the same industrial, automotive, communications customers and we can take that power-efficient architecture from small FPGA and apply it to midrange. And so we went back to those customers and said, yes, we go ahead and build this but we want you along for the ride, give us guidance along the way on what are the right features and capabilities. And so we launched that platform called Avant in December this past year along with the first device family. That doubles our addressable market, makes our customers happy because that's the product that they asked for. And actually there was, I think, 17 or 18 different customers at that event in December that provided testimonials. Anyway, so we've launched the first device family. We've announced that we'll launch 2 additional device families before the end of the year. First, revenue, we expect a little bit of revenue from Avant at the end of this year, but it will be more of a contributor next year and then ramp beyond that. And the great thing about Avant is it doesn't cannibalize our small FPGAs in any way. It's a totally additive revenue stream, but it's an additive revenue stream with our existing customers. It uses the same software as Nexus. So it's easy for the customer to adopt this product line. So yes, we're pretty excited about the expansion in the midrange.

That makes sense. By the way, if there's anyone who has questions, I'm going to be in this room all day listening to myself talk, so I'd appreciate it to anybody. If you have stuff by now, please flag me down. But we -- I'm kind of interested in -- as you guys think about Avant. I mean you talked about at the Investor Day, the TAM -- TAM, SAM I get -- anyway. Going from sort of $3 billion in small FPGA and towards sort of $6 billion and then $8 billion and then $10 billion. And it sounds like you've more than doubled the TAM of the company with going into Avant, but then you found another couple of billion dollars of opportunity as you explored this, that I don't know that the company was depending on, I always viewed Avant as you described, auto, industrial, communications probably not really serve a data center, maybe not really consumer devices. But it sounds like there's been some new opportunities that have come your way through customer discussions, and I'd be interested in hearing about those.

Yes. One of the examples is in the computing market, which is primarily servers for us today. Lattice has had just tremendously good growth in servers that go into data center. So I think we've had 4 consecutive years of double-digit growth in our Communications and Computing segment. A big driver of that has been in servers. When we initially started developing Avant, we didn't really see a need or a usage for Avant-E and server devices. We're generally used today in control management and security of the platform. But as we talked about the Avant product with our server -- with our big server customers, who had actually found applications for Avant there as well. So that's one area that we yes, we just weren't expecting. So as we've engaged with customers and shown them the capabilities of Avant, yes, the SAM has ended up to be bigger or TAM, as you would say, the TAM has ended up being bigger than what we originally thought.

So there's a couple of additional pieces. One, I want to get into competition for you guys for a minute. And you mentioned the 40th anniversary upcoming of Lattice and I think over that entire period of time, there's been 3 general purpose FPGA companies and there's still 3.

That's right. And actually, the Altera, Xilinx and Lattice where this is a weird fact is all -- we're all founded at around the same time with -- I think within about a year of each other, in the early '80s.

And so that's the...

40 years later, there's 3 general purpose company.

I think that speaks to -- I had the task of doing some FPGA work in my industry career. And the software barriers to entry are significant. And so I guess the question is, as your company pushes into the mid-tier with Avant, what changes in the competitive landscape? Is this you're expecting this growth to sort of pack man up share from what Altera and Xilinx are doing in those markets? Is it new TAM? And what is the -- so far, what have you observed to be the competitive response as you guys not hinted that you were going to launch Avant and then launched and then now we're going to start into revenue.

So first of all, if we just start from the customers. If you look at the customers of Avant, the target customers. Actually, 90% of those customers are already customers of Lattice today. So a lot of industrial automotive customers. They primarily just use midrange and small FPGAs. They really don't use a lot of large FPGAs. So we're really talking about basically the same customer base that we already have been supporting for many times -- decades. And then when we built the product road map either for Nexus or Avant, we always built it under the assumption that there would be robust competition from our traditional -- our 2 traditional competitors. We just naturally from the very beginning, always build our road maps, assuming that. And so I'm going to say that from a competitive standpoint, there's really -- there's nothing that we've seen that wasn't expected or anticipated from us. We've assumed that there's robust competition. But as we shared at the Avant launch in December, we shared measured data of Avant versus comparable FPGAs that our customers would be choosing from. And we showed that the power advantage of Avant bond is 2x to 3x better, it's higher performance. It's up to 6x smaller physical device side. So we feel like we have a really good competitive position for the product.

I get this question, and it's been -- the frequency of this question has gone down a bit in the last couple of months, thankfully. But I still get it. And during the period of market tightness there were certainly some wins that you got at the expense of traditional MCUs. There -- many of those companies, I think, were planning on taking designs to small FPGA from MCU anyway and maybe the accelerated time line happened. But any change in the competitive dynamic relative to the MCU space? Or is this just sort of a short-term phenomenon that happened, and we'll go back to sort of the traditional landscape?

Yes. I think you're replying -- you're talking about some of the supply chain strengths that the industry saw. Yes. So we -- there were a number of customers that were planning to move from, say, a microcontroller to one of our small FPGAs. The reason that they were doing that was for primarily for technical reasons. Common example would be if they're trying to add some level of inference processing, which is a form of artificial intelligence processing. And if they were trying to add intelligence and inference processing to their system, if they tried running that workload on a microcontroller, it doesn't naturally map very well but on a Lattice FPGA, it maps really well. They get a much better performance per watt. And so they were already planning to switch from a microcontroller to a lattice FPGA. And the only thing in the supply chain -- the constrained environment did is maybe accelerate that transition. There were some customers that just made that move faster, but that's the only effect that we saw.

Got it. One more sort of -- you and I have had this conversation a number of times, but I think it's helpful in this forum. You guys continue to say that Lattice is not going to be immune from the macro, but the financials continue to be relatively immune from the macro. So that brings questions. And the question that I've been kind of consistently getting -- and Jim, you and I have addressed it a couple of times, but distributor inventory and at customer inventory levels. Maybe you could just kind of walk us through where we're at right now.

Sure. I'll start by repeating that we're not immune to the macro. No I mean we're -- Lattice is affected by the end market fluctuations, just like anybody else. I think the only difference is, I think what you're referring to is we've been able to outperform the underlying market and do that pretty consistently. And that goes back to why is that? First of all, we've just got a lot of new product cycles that we're going through, as I shared. I mean we're in the middle of -- we've been around for 40 years. We're in the middle of the biggest product portfolio expansion we've ever done, right? And so those new product cycles drive new design wins with customers. They drive -- they naturally drive top line growth. And so I think that's helped us outperform the underlying market. And then yes, in terms of inventory that we see what we shared in the most recent earnings call was at the end of Q1, our inventory sitting in distribution and most of our revenue goes through distribution was relatively flat quarter-on-quarter. And then relative to kind of the historic normal level, the normal range that us and our distributors would consider the normal range to hold. We're still lean relative to that normal range. So our channel is a little bit lean. I think last year, you saw some other semiconductor companies ended up with too much product in their channel, and they had to bleed that down. That didn't happen with us, right? We're actually a little lean and still need to replenish our channel a little bit. And so we don't see any excess inventory in distributors. And then end customers, we have 9,000 -- over 9,000 customers. So we don't have perfect visibility of every end customer. But for -- some of our large strategic customers, they're pretty transparent about their forecast and their inventory levels. We don't see anything obvious in terms of big inventory pockets at our end customers.

Got it. No, that's helpful. Sherri, I wanted to -- all this goodness that Jim is talking about, you put out a financial model that sits to approximate that for all of us. And you talked about sort of high teens revenue growth and getting into the low 70s on gross margin. But what I'm really interested in is how you're giving these guys the dollars to invest to continue to grow the business and what that means for the operating margin over time. Are we expecting leverage on G&A and still robust R&D growth? Just how are you thinking about governing the investments that the team is making.

Yes. So the other target that we put out was for OpEx at 30% of revenue. And within that, R&D 18% to 20% range and SG&A in the 10% to 12% range. And so you definitely want to continue making investments for the long term. Certainly, Jim talked about the rapid pace of innovation and product expansion that we've made. We want to continue to make those investments for the long-term growth of the company. We also want to continue to invest in demand creation, customer support. All those areas are very important. And so we definitely want to continue to do that. And then when you look at our capital allocation perspective, number one, there is investing in the organic part of the business, as I just mentioned. So that continues to be our #1 priority. The other areas that we focus on from a capital allocation perspective are -- we've been able to return capital to our shareholders through our share repurchase program, which were in our tenth consecutive quarter of executing on that. And to date, we've repurchased about 3.7 million shares of stock, and that has reduced our dilution by a little over 2.5%. So we're pleased with the progress there. We do have an additional $120 million left on our board authorized share repurchase program. So we'll continue to look at that on a quarterly basis. And the other area we've made a lot of progress on is in our debt paydowns. Our leverage ratio is -- it's almost next to nothing. It's well below a leverage ratio of 1. And in our last quarter, we made some significant pay downs, $25 million during the quarter and then subsequent to quarter end, we made another $60 million pay down. So have very little debt on the balance sheet. We're pleased with the progress there. And so we look at all of those areas on a quarterly basis to make sure that we allocate capital in the right place.

I think you raised every one of our targets.

We did raise that. [indiscernible]

No pressure.

We put out a new free cash flow margin target.

Yes, I was going to ask you about that is maybe how are you thinking about the cash flow generation and uses of cash? Is it still the same uses that you had and just laid out in terms of the buyback? Or are there other things you're thinking about?

Well, maybe I'll speak from a business perspective. And Jim, you might want to speak from M&A perspective. But -- so I mean all the elements that I mentioned of capital allocation that we continue to look at every quarter, our free cash flow margin target of greater than 30% is a new target that we put out there. We're focused on cash. We've been focused on cash. We've had record cash generation, really pleased with the results there. A really good working capital focus. And so let's put a target on it. We're focusing on it so much, and it's so important. And so I'm excited about that target as we continue to drive significant cash generation for the company. So I'm really excited that we put that target out there.

Just to switch gears and we have, I think, 4 or 5 minutes left in the conversation. Jim, we all spent a few days together post your Analyst Day and had some longer conversations about things that have changed in the business. And one thing that struck me, as Esam and yourself talked about getting -- with large customers getting pulled into strategic road map conversations that might not have happened. Certainly wouldn't have happened when you guys took over the company and maybe not even a couple of years ago. And I think when we last saw each other, you guys were heading to Europe to meet with some of you -- the largest industry [indiscernible]. Yes, some of the largest industrial customers that on the continent there. How those conversations go?

They were good.

No, I mean, obviously, not to the specifics, but I'd be interested in the tone in the conversations what kind of folks you're meeting with, what's different about 4, 5 years ago than today. I think those are helpful for the audience.

Well, it's totally different when myself and Esam -- Esam is Head of our marketing and strategy kind of runs our product definition. But Yes, it's completely different than 5 years ago. I mean 5 years ago, none of those customers would talk to us, right? They'd send us to the procurement guy. But no, and now we're having very strategic high-level discussions that are focused on multiple generations, long-term road maps, et cetera. And so yes, that's a great change versus 5 years ago. And that's what some of -- last week, we were in Europe with some of our largest European industrial and automotive customers and very high-level long-term strategic discussions. I think the reason -- primary reason for that is, look, at the end of the day, Lattice is a product company. and they see us investing in the kind of products that they need for their business. And so when we bring out a steady beat rate of Nexus devices, and we don't just bring on a lot of products, but these are incredibly competitive products and we bring them out when we tell them we're going to, right? We execute, we do what we say we're going to do and -- which seems to be more and more rare nowadays, right? But they get the product when we say -- when we promised it, right? And when they see us doubling our portfolio now midrange devices, and there's things on the road map that we, of course, share with our strategic customers that aren't public. And so they see our future investment and where we're headed, and we're pretty excited about that. And so yes, I would say the engagement with customers, not just in Europe, but North America, our Asia customers as well is fantastic. It's certainly the best it's been since I joined the company.

[ Erica ], go ahead.

I was curious, and I know you get some variation on this question in the meetings, but when you talked about Avant being very customer-driven from the same customer base by NEXUS. I was wondering if you get approached by -- by large FPGAs and ask you whether you would consider moving into large FPGA market. And I know you've talked about technologically, there's no reason why you couldn't. [indiscernible].

Yes. I think for today -- so I think maybe should I repeat the question, yes. So the question was, hey, do you get customers asking you to build even bigger FPGA, a mid-range large FPGAs and I think that, technically, there's -- I don't think there's anything that prevents us from building larger capacity FPGAs. We know how to do that. It's just a matter of -- to be a matter of time and whether Sherri would give us the investment. I guess we have to ask Sherri for the investment. But it's something the company could do. For today, now we're very focused on small FPGA, mid-range FPGA. If you look at an industrial customer, most of what they use is that small and mid-range FPGAs. That's what we're focused on today. That's -- as we shared at the Investor Day, that's a -- we estimate that's a $10 billion SAM 5 years from now. So we've got -- relative to our revenue today, we've got a lot of headroom to grow within our existing TAM, right? But -- so we're excited about the road map that we have today and where we're headed.

I think we got a minute or 2 left here. I wanted to ask Jim about software. You -- what I've observed anyway is that in the high-end large FPGA market, there's been a ton of investment over the last 10 years to make those larger FPGAs easier to program and easier to interact with servers, the cloud market, the wireless infrastructure market. So interact with classical computing, and that's added a lot of user-friendliness, but also fluff to those software stacks, which is kind of the opposite of what you would want to do if you were designing low-power software. And so as you move into the mid-tier, are you seeing from the competition new software investments that would be similar to yours? Or are there -- or is it still a -- we're going to take a large FPGA product and I don't know, despec some and try to sell it into the mid-tier.

Yes. We think what we're -- our software strategy is pretty unique to us. We think what we're doing is kind of special. And maybe just for the benefit of the audience, just to describe our software strategy, this really is a key part of our investment strategy. What we're doing is building a portfolio of application-specific solution stacks that help our customers design our products into their systems, help the customer switch from a competitor's device to our device or design into totally new applications. And we can see the adoption rates have continued to go up on that software. Over half of our design wins now include that software, the ASPs on the design wins that include software are higher than when we don't have software attached. And we know that, that creates long-term stickiness with our customers as well. So it's definitely a key part of our strategy, and we're continuing to invest in.

Well, our little red light friend is telling us that the time is up. But thank you, everybody, in the audience for your attention. Thank you, Jim, Sherri, for your partnership and a great conversation.

All right. Thanks, Matt.

Thanks, everybody.