Lattice Semiconductor Corporation (LSCC) Earnings Call Transcript & Summary

Great. Good morning, everybody. My name is John Vinh. I cover over semis here at KeyBanc. We're pleased to have Lattice Semi with us today, and we have Esam Elashmawi, Interim CEO and Chief Strategy and Marketing Officer; and also we have Sherri Luther.

Thank you.

Thanks for having us.

Maybe first question, I thought was really interesting from your recent earnings calls You talked about having new product revenue growth in the first half on a year-over-year basis. Obviously, that's a part of the bull case on you. I'm just curious, what are you expecting here in the second half? Are you expecting new products to also grow in the second half on a year-on-year basis? Or is there some potential pushouts just given the volatility that we're going through now?

Yes. I think if you look at Lattice product portfolio, if you go back to 2019, when we all joined -- I joined at the end of 2018 and Sherri shortly after. One of the things that we started off doing is really building a product portfolio that was very differentiated in the FPGA market around small FPGAs and most recently, mid-range FPGAs. And we've got a good cadence of now of introducing new device families, and most recently, we've even expanded device options within our families as well. And if you look at Lattice product portfolio today, never in the history of the company hasn't been as strong and robust as it is now, and it's both on the hardware and the software side, both of them. And one of the data points that we gave at the last earnings call that despite the inventory normalization that's happening in the market, if you look at our new products that we've introduced, they've actually grew in the first half of '24 versus the first half of '23. And that's a testament to the differentiated products, but something that we've always been talking about, which is investing in products that are very differentiated, that drive new revenue streams for the company. And we're pleased to see that in this market environment as well that these new products continue to ramp up. If you look at the second half of the year, we have new products that have yet to ramp that are going to ramp. We have the Nexus device family, the seventh device family we introduced that should ramp this quarter and that's on track to do that. But also we've got our Avant, which is our midrange FPGA. We have two device families that we introduced at the end of last year, Avant-G and Avant-X that are on track to start getting initial production revenue. It was very, very small, but the initial production revenue end of this year. But we also have the Avant-E that we introduced at the end of 2022. That achieved initial production revenue at the end of '23, and we're expecting that to continue to round throughout this year, and that's on track to do that as well. So we're pleased, and that's why we continue to invest in a product road map, product portfolio with new products that open up more opportunities for Lattice.

Great. Obviously, you're not alone in terms of seeing some of the headwinds related to just broad-based weakness out there. But it looks like you found a bottom year in 2Q, you're guiding for 3% sequential growth into the third quarter. I thought it was interesting that you're actually seeing signs of improvements in your bookings, but I just wanted to just better understand a little bit more in terms of what you're seeing, maybe just give us a little bit of color and why you're comfortable with what's seen in the bottom here in 2Q?

Yes. So if you look at Lattice, we've demonstrated over the past several years, strong double-digit growth. In fact, if you look at our long-term financial model, we said that in the long term, we expect the company to grow 15% to 20% a year. And if you look at the last 5 years, it was ending at 23%, our CAGR was 16% in the last 5 years. And we have the Avant product line that will layer on top of that additional revenue growth, which takes us to the 15% to 20%. Now we entered this cycle a bit later than everybody else. We started to see the first decline of inventory normalization back in Q4 of '23. And if you fast forward 3 quarters to Q2, we said in Q2 that we start to see signs of improvement. We knew inventory normalization was going to occur throughout '24. We said that in the very beginning of the year. But we said -- also said that most of it will happen in the first half of '24 to a lesser extent in the second half of '24. But we did see signs of improvement. What did we see? If you look at the second half of Q2, we start to see a good uptick in our bookings. And that's a good indication because we can track those bookings to customers that had inventory and that now the inventory is normalized. That's a really good indication. And we started Q3 with a higher backlog than we did Q2. That, in addition to the new product ramps that we talked about earlier on, we believe that Lattice is anticipating a return to growth now. It's a combination of those. But it's good to see that things are improving. Now if you look at it by end market, there's different characteristics by different end markets. Clearly, we've shown and demonstrated growth within our server market, and that continues. Our attach rate goes up. People are using more complex FPGAs. And we gave a data point at our last investor meeting that -- if you look at the dollar content per server on average, about 50% more-dollar content on the generation of servers that are ramping today versus the prior generation. That's, again, a combination of higher attach rate and the higher ASP FPGAs, because they are more complex challenges that we're solving in the server generation. So that, we believe, is normalized, and that is continuing to grow. We also see that if you look at the Communications segment, data center networking. This is a part of our business that we talked about at the last Investor Day, which think about us in data center like switches and routers. This was a new opportunity for Lattice and we're starting to grow. And we saw growth last quarter in data center network. And so clearly, that is normalized as well. Within the industrial market, we see pockets of normalization, but we also recognize that there's more normalization of inventory that's required. And pockets of normalization, if you go into industrial, you'll see like aerospace and defense as well as health care. We believe that's normalized now. And you go into deep industrial type applications with our customers that we talk to, we see areas of normalization, but we do see areas that still need to normalize. Some of our industrial accounts, when we sit with them, they'll tell us, hey, the areas around data center build-outs, think about cooling, HVAC, things that industrial companies do for [indiscernible] and that's healthy. They have normalization there. But there's other areas around factory automation and factory deployments that still need more normalization. So we see pockets of different normalizations depending on what end marketer segments we're looking at.

Sherri, maybe you can just comment about what you're seeing in terms of inventory levels at your distributors and what your sense is in terms of inventories at your end customers? And how far are we away from getting to normalization?

Yes, sure, John. So when we think about inventory, just to kind of calibrate that there are 3 types of inventory. There's Lattice owned inventory that we have on our balance sheet. And we feel we've got healthy levels of that amount of inventory. We want to make sure we've got enough to satisfy any upticks in customer demand, but certainly to ensure we have enough of product design win ramps and revenue ramps. And so we feel we're in a good place there. We've been increasing that a little bit sequentially and may continue to do so, but we feel we've got a healthy amount of inventory there. Also, our inventory -- our product rather have very long-life cycles. And so the risk of obsolescence is really low. So that's Lattice inventory. When you look at inventory and the channel, our distribution inventory, that's inventory that is sitting at our distributors. And about 80-ish percent sort of in that range of our revenue goes through distributors. Many of our customers choose to use distributors as a means of fulfillment because we're very close with our strategic customers in terms of understanding what their needs are. But when you look at inventory in the channel, there's a range that we like to maintain. And that range, what we consider to be a normal range. We prefer not to have less than that, and we prefer not to have more than that. Where we are right now is we are in that range of what we consider normal. What we had talked about on the call is that we're just -- it's slightly towards the higher end of that range, but it's still within the range of what we consider to be normal. And so when you look at inventory distributors, what we've also seen is sequentially from Q1 to Q2, we saw that the dollar amount of inventory in the channel actually decreased, which is a good thing. Because we're also under-shipping that demand, what the true demand is. We were under-shipping true demand in Q1, and we did that in Q2 and at the midpoint of our guide for Q3, we will continue to undership that demand and customer demand because we want that normalization of inventory that Esam mentioned. We want that to continue to occur. So again, distribution inventory is within the normal range of what we like to see, albeit just slightly at the higher end of that. Than the other type of inventory that we have -- that there is inventory at end customers. While we are very close to our strategic customers have a really good feel for how much inventory they have in their inventory on their balance sheet, we have over 10,000 customers. So it's very difficult to know, or have a perfect picture of how much inventory is at these end customers. And so that's the part that's a little more difficult to see. But what we do know is there are some customers who have more than they need and some don't have enough, right? The -- It's a little mixed bag of that. But in terms of that normalization of inventory that we talked about that needs to occur, we need for end customers to that demand to uptick, right, so that they can consume that ending inventory that they have at end customers, and then pull from the channel, and that will pull that channel inventory down a little bit. But in the meantime, we want to continue under shipping so that we can have that normalization to occur through the rest of this year.

Questions? Maybe a follow-up to that is I've been asking all your semiconductor peers over the last couple of days, this question, is when you talk to your customers about how they view that new normal, right? Because obviously, we went through this pandemic cycle. Obviously, you had extended lead times, supply is really tied in your parts and customers kind of reacted and built buffer inventory. And then now that we're going through this destocking phase, how are they thinking about kind of the new normalized levels going forward? Are they compared to pre-pandemic levels? Or are they looking to hold more or less or the same levels based on the conversations that you guys are having?

Yes. When we talk to our customers, it varies, again, customer to customer end market to end market. I'll use an extreme just to prove the point. The automotive market paid a heavy price because they didn't hold enough inventory. When we talk to automotive customers today, they're not going to go back to that, but they're also not going to go to a year's worth of inventory. There going to be somewhere in between. If you look at server customers, that's a market that's very dynamic. You've got a new refresh cycle every 2.5 years. They do need to manage inventory. And they're sticking to probably the same model as what they had prior to the pandemic. There's no change there. Industrial, it's in between. We talk to some industrial customers. Some of them say, "Hey, our new models, we're going to hold a little bit more inventory." They would say, like our normal model used to be about a quarter's worth of inventory. Now we're just going to go a little bit more, and that varies from customer to customer. So I think that -- I think customers are not going to go less than what they were doing the supply chain. I think some will stay the same and some are actually correcting and say, "Hey, I'm going to go a little bit more now."

Interesting. Maybe if we think about your industrial end markets. Obviously, you're seeing some headwinds there. But I think more broadly, I think some of the commentary is a little bit more constructive on industrials versus automotive. Are you seeing pockets of industrials that are maybe further through the bottoming process than others? And what are those?

Yes. Within Industrial, I think we talked about aerospace and defense, health care, industrial is very fragmented, very large, even within particular customers. If I look at their portfolio and they share that with us. Within their portfolio, there's pockets that are normalized, pockets that are not normalized, depending on that industrial company's portfolio, what end markets are they serving? Are they serving a data center market, then it's more normalized. If they're serving factory automation, and we know that factory deployments have slowed down a bit, CapEx is more expensive cost of capital is more expensive, they may still have pockets of normalization that they still have to go through. So it varies within customers, and it varies customer-to-customer based on the markets they service.

Great. Maybe moving to servers. I think you mentioned recently that with Intel's next-generation server CPU Granite Rapids, you would expect your content to go up. I'm wondering if you could just talk about what's driving that? And also, would you expect that your attach rates would continue to trend up?

Yes. I think for those that aren't familiar with Lattice, one of the things that the team does very well is each one of our end markets, we drive Lattice specific growth drivers that go beyond the end market growth itself. And we do that within industrial, around robotics. We had more attach rate, automotive. We're adding more attach rate. And so your question on servers. If you go back, what Lattice talked about in our 2019 Investor Day, we said that our attach rate in servers is about 25%. That means you take all the servers that are out there. We shipped about 1/4 of the units compared to number of servers. We had an attach rate of 25%. Then at the next Investor Day, we grew that to 80%. So we almost had an attach rate of 1. And we said it was greater than 80%. And then at our last Investor Day, we said that the attach rate is now well above 1, which means that for every server that's out there, if you open it up, you're going to see 1, if not multiple lattice devices within that server. So we continue to grow that attach rate. We do things in server from Board management, control and security, and this is physical board management and security of those systems. And the complexity of architectures is changing now on servers as well. Servers are becoming more modularized. What do I mean by more modularized? If you go back a few generations, you had one board, one motherboard that had everything on it. Now those motherboards are actually smaller, but they put control functions in another board, security functions in another board and you have network cards that are all separate. So it's becoming more modular. As it becomes more modular, that's opening up more opportunities for Lattice. Each one of those boards we're adding more opportunities now for Lattice. So we drive an attach rate that's higher. Now we work very closely with our end customers. Hyperscalers, OEMs, even the ODMs, we participate at OCP Summit, and we're leading with these companies. Even CPU vendors. We partner with CPU vendors, and we're presenting next-generation architectures and how do we solve that? So we have really good visibility of where we're at in each of the architectures, not just today. But if you look at the next-generation architectures that are being deployed, we have very good insight into what those architectures look like. by hyperscaler, by OEM, even by ODM, and we know where we're being leveraged. So we have good insight to say that our attach rate is continuing to increase. And we know that they're ordering now even more complex FPGAs, which drive a higher ASP. And then we have visibility over the next generation after that. We're actually working on next generation although early, we can see also, again, more opportunities for Lattice from that perspective. So we're encouraged that the team is doing a really good job of driving higher attach rates in every generation of server that's being deployed. And that's not talking about AI servers. Now If you look at AI servers, our attach rate on average is even higher in general-purpose servers. AI servers have more configuration, more network cards, more modularization on those AI servers. So on average, our AI server attach rate is higher than the general purpose servers.

Speaking of AI, investors are really focused on NVIDIA's next-generation platform Blackwell. They also have a configuration, GB200, which is a full stack server system. How does your attach rate or content on GB200 compared to AI servers today, in terms of attach rates content?

Yes. It's a healthy attach rate working -- NVIDIA is partner of Lattice, and we worked with NVIDIA for a long time. Not just on AI solutions in the data center, but AI solutions on the Edge there. We've partnered together on providing solutions for Edge AI applications as well. And with NVIDIA, we don't look at it as just a server and you kind of hinted to it. We look at it by the whole entire rack now. Because when you look at the rack and you need switches and you need network interface cards, we kind of look at it as a whole system as far as our attach rate. That's really important for us. And that's part of the partnership that we have working with the NVIDIA team.

Great. Sherri, maybe we can touch on gross margins. You're sitting at 69% today with all the volatility and headwinds in the marketplace. Is low 70s still the right long-term growth rate? And if that's the case, can you just walk us through the bridge and how do we get back to low 70s from where we are today?

Sure, sure. So we're really pleased with our gross margin at 69%. I mean, as you mentioned, with a lot of headwinds out there, and a lower revenue base that we saw in Q2 and certainly Q1 as well as the Q3 guide, 69%, is what we're guiding at the midpoint for Q3. And if you actually go back to similar top line revenue figures, in the past, our gross margin was in the low 60s at that time. So that really speaks to the durability of our gross margin. And why is that the case? Well, we've been executing now for a long time. I think it's our sixth year which is a long time, but it really speaks to the various levers if you go within that strategy, the elements of that strategy. And that gross margin expansion strategy includes Mix. Mix is a big driver there. To your question, how do we get to -- back to our long-term model of the low 70s, which is still our long-term model. We're still committed and focused on getting there. But Mix is a driver. It's improved gross margin since we started this strategy, which increased it by 1,200 basis points since we started it, but it's also going to help us as we move forward because industrial and automotive, for example, which is the market that we saw the most softening in our most recent quarter, that gross margin in that market segment tends to be higher than the corporate average. And so as that market comes back, Mix will benefit us at the gross margin level. We had seen benefits from new products. Esam talked about our new products being year-over-year growth in new products and certainly record design win activity there. New products add value to gross margin, whether it's our Nexus products or it's our Avant products, we expect for Avant to continue to ramp as we get to the second half of the year and certainly into our long-term model that will add value also software attached. More than 50% of our design wins have software attached, and we can charge more for our products with software attached. And so that's also beneficial to gross margin. And of course, post COVID, as we're hearing about foundries. It's in the news or having more capacity freeing up. We certainly want to take the benefit there of continuing to negotiate with our suppliers to get better costs for our wafers from our foundry suppliers as well as our OSAT suppliers. So we want to continue on executing on all of those levers within our gross margin expansion strategy, and we're really good about our long-term model of the low 70s.

Great. Speaking of software attach, I think it's over 50% today. Where do you think that could go over time?

Yes, it's a good question. We do see the attach rate increasing, but to a lower rate than what we've seen before. We know that there are customers that will use their own software. Just the way they do things, the way they are with eternally. They want to leverage their own Software. So it will never get to 100. That's another way I think it will never get to 100. But we do see improvements in the attach rate. Today, we're still above 50. But at some point, it will saturate a number below 100, how much that is, we don't know, but we do know that theoretically, it cannot reach to 100.

Okay. That's fair. Maybe, Esam, maybe just give us an update on just how the ramp of Avant's going. Maybe talk about kind of the design win traction that you're seeing out there. How much of those new sockets are coming from existing FPGA sockets versus kind of new applications?

Yes. So for those who aren't familiar, we introduced our first mid-range FPGA, which was Avant and we launched that in December of 2022. And this opens up -- it more than doubles our market opportunity for us. It has a market opportunity that's greater than our small FPGAs. And when we built this midrange FPGA, the platform is called Avant, we had over 100 customers that helped participate in the definition of it. And if you look at the target customers for mid-range FPGAs is, 90% of them are already customers of Lattice, and they're very familiar with our software tools and the same software tools that they've been leveraging for small FPGAs are the same tools they will leverage for mid-range, whether it be our software solution stacks or our design tools. So we launched a product in December of 2022. The first product was Avant-E, and I talked about initial revenue of that product in end of '23, and we launched two additional devices in end of '23 G and X which we expect to get initial revenue as well by the end of this year, and we're on track for that. A good way to say how are we doing on the design momentum of that. If you compare the Avant platform versus our successful Nexus platform, the design funnel is much larger for Avant than it was for Nexus at the same point of time since the launch. And in fact, we gave the team a bogey on internal goals of what to achieve last year and they exceeded it. So it exceeded our own internal model. So we're really excited about the adoption of Avant, the customer momentum around Avant. And we gave a financial target related to Avant at our last Investor Day that we expected 3 to 4 years out, and this was in May of '23, that the Avant would contribute somewhere between 15% to 20% of our FPGA revenue. And we're on track for that, and we're making good progress.

That's great. That's great. Maybe the last topic is, obviously, maybe kind of tough for investors to envision right now, but is 15% to 20% still kind of the right long-term target for you? And why do you feel convicted that, that's still the right number?

Starting from a growth perspective?

From revenue growth.

Well, I think our CAGR of small FPGAs over the past 5 years has been 16%. And then with a CAGR of 16%, if you layer on top of that now mid-range FPGA that are additive to the growth rate. That's an acceleration of our growth rate, we feel that the company targets could be around 15% to 20%.

Great. Okay. Looks like we're out of time. Thank you, guys.

Thank you.

Thank you John.