Lattice Semiconductor Corp Q1 FY2021 Earnings Call

Thank you, operator, and good afternoon everyone. With me today are Jim Anderson, Lattice’s President and CEO; and Sherri Luther, Lattice’s CFO. We will provide a financial and business review for the first quarter of 2021 and the business outlook for the second quarter of 2021. If you have not obtained a copy of our earnings press release, it can be found at our company website in the investor relations section at latticesemi.com.

Thank you, Rick, and thank you everyone for joining us on our call today. I'm very pleased with our strong results in Q1 as we continue to execute our strategy, drive product leadership, and deliver shareholder value. Let me start by covering a few highlights from Q1 of 2021. We grew revenue 19% year-over-year with continued double-digit year-over-year growth in our two largest segments, Communications and Computing and Industrial and Automotive, which represent over 80% of our total revenue. We also grew revenues sequentially by 8% with sequential growth in each of our key market segments. In particular, we're pleased to see a second quarter of sequential growth in our Consumer segment. We expanded non-GAAP gross margin by 190 basis points year-over-year as we continue to execute on our gross margin expansion strategy. We achieved record non-GAAP operating profit of 28%, while non-GAAP net income increased 52% year-over-year. And we delivered sequential growth from our latest Lattice Nexus with our second device family Certus-NX entering production in the quarter.

Thank you, Jim. We are pleased with our strong Q1 financial results as we continue to execute to our financial model. We drove sequential revenue growth, gross margin expansion, and record profitability while continuing to invest in our leadership product roadmap. Through strong cash generation and a focus on working capital, we have a healthy balance sheet and continue to grow our net cash positive position. Let me now provide a summary of our results. First quarter revenue was $115.7 million, up 8% sequentially from the fourth quarter and up 19% year-over-year. Revenue grew double digits year-over-year in our communications, computing, and industrial and automotive market segments and was also strong sequentially. Revenue from our consumer market segment grew for the second consecutive quarter, and IP was down slightly sequentially. Gross margin on a GAAP basis was up 50 basis points to 61% in Q1 compared to the prior quarter and was up 190 basis points compared to the year-ago quarter. Our non-GAAP gross margin increased 10 basis points to 61.7% in Q1 compared to the prior quarter and was up 190 basis points compared to the year-ago quarter. Gross margin improvement continues to be driven by our margin expansion strategy, primarily in pricing optimization and product cost reductions. Q1 GAAP operating expenses were $49.9 million compared to $47.5 million in the prior quarter and $47.8 million in the year-ago quarter. On a non-GAAP basis, operating expenses were $38.9 million compared to $37.5 million in the prior quarter and $36.1 million in the year-ago quarter. Our R&D expenses increased sequentially as we continue to invest in the expansion of our product portfolio, while SG&A expenses were roughly flat sequentially as we continue to drive SG&A efficiencies. Q1 GAAP earnings per basic share was $0.14 and $0.13 per diluted share compared to $0.12 and $0.11 in the prior quarter and $0.06 in the year-ago quarter. Q1 non-GAAP earnings per basic share was $0.23 and $0.22 per diluted share, which increased from $0.20 and $0.19 in the prior quarter and increased from $0.15 in the year-ago quarter. We remain focused on cash generation and generated $29 million in cash from operations in Q1. We also repurchased approximately 300,000 shares or $15 million in stock under our stock buyback program. Our cash balance increased to $185 million, growing our positive net cash position.

Our first question in queue comes from the line of Alessandra Vecchi from William Blair. Alessandra, your line is now open.

Thanks, everyone. Congratulations on the stellar results, especially in such a dynamic quarter with supply constraints. Can you maybe, Jim, update us on how we should be thinking about your exposure to supply constraints? I know you did a tremendous job starting in Q2 and in building up inventories, but those now appear to have come down a little bit. If you could just give us a little bit of a framework on that front and then a follow on?

Yeah. Thanks, Alex. Appreciate it. So in terms of supply chain, if you look across the semiconductor industry, certainly the supply chain is tight as everyone knows. I would say that from our perspective, from the Lattice perspective, I think the team is doing a really good job managing the supply chain and making sure that we're delivering to our customer needs. In fact, I'd like to take an opportunity to just say thanks to my supply chain operations team for the great job that they're doing. A few things that we’re doing to make sure that we manage the situation and meet our customer needs is one which you already mentioned – about a year ago we started to build inventory, Lattice inventory. And we did that proactively and strategically to make sure that we’re in a good inventory position because we anticipated some supply chain tightness. So we built inventory in Q2 and Q3 and Q4, and we're glad that we did that. And even if you look at where we ended inventory in Q1, our most recent quarter has more inventory than we were carrying a year ago, so we're in a very good inventory position. Beyond that, we've been working very carefully and closely with our customers, especially our big strategic customers, to fully understand their demand and ensure that we've got a demand picture for the coming quarters. We're also working closely with our supply chain partners to ensure that we're matching that demand with the right capacity in the supply chain. We're pleased with the level of inventory that we have and with our ability to support our customers. I think we’ve been doing a good job at that.

Just, I was looking for a little more color. I mean the upside to the quarter was quite strong. You highlighted industrial, but the 20% sequential growth in industrial off of what were already some very strong comps in the back half. Can you maybe tell us how much of that upside or how much of the upside in Q1 in general was from the full quarter of Nexus CrossLink, and how we should think about the contribution there and potentially going forward?

Yeah, definitely. Let me start with the first part of your question around what’s driving the upside for Q1. We saw strength across all of our market segments which we’re quite pleased to see. For example, communications and computing has been a strong growth driver for us the last two years in a row that's grown double digits. We saw 28% year-over-year growth in comms and compute. As you mentioned, industrial and auto grew 20% year-over-year. And then consumer, which was a headwind for us the last couple of years, really started to stabilize at the end of last year. We've seen two quarters of sequential growth in consumer as well, which we're pleased to see. All three of those segments contributed to the upside in Q1. Regarding Nexus, certainly it was a contributor to that growth as we just started shipping Nexus into production revenue at the end of last year. The Nexus revenue from the CrossLink-NX device grew sequentially in Q1 versus Q4, and we're really pleased with that growth. Additionally, we began production of our second Nexus device family, the Certus-NX, in Q1. Our third device, Mach-NX, which we launched at the end of last year is expected to ramp in the second half of this year. So we're quite pleased with Q1 results.

Great. That was tremendously helpful. With that, I'll go back in the queue.

Thanks, Alex.

Your next question comes from the line of Mark Lipacis from Jefferies. Your line is now open, Mark.

Hi. Thanks for taking my questions. Maybe for Jim, the gross margins were the highest I think in 20 years, and you're guiding them to be 62%, which I believe was the target you said at your Analyst Day. Now that you've hit that target, where do you go from here with the gross margins? And as part of that, maybe you can remind us what has driven the gross margins 500 basis points since you took the helm, and which of those drivers are still in play?

Thanks, Mark. So, on gross margin just kind of the progress, let me start with some of the progress that we've made over the last few years. The gross margin progress, which you mentioned, is almost 500 basis points since 2018, and it's about 450 basis points to the most recent quarter. What drove that gross margin expansion were two main drivers. Number one was our pricing optimization strategy which we built out at the end of 2018 and started putting in place at the beginning of 2019. We continue to execute on that strategy, and that's certainly been a big part of the gross margin improvement. The other big contributor was our product cost reduction strategy, which was a multi-year roadmap that we worked with our key suppliers to drive product cost reductions over a multi-year period. The other factor has been a little mix benefit as well, but the two primary factors were the pricing optimization and product cost reduction strategies. The target we had put out a couple of years ago at our Investor Day in May of 2019 was to get gross margins to 62% or higher. We're very close to that target in the most recent quarter, and our midpoint of our gross margin guidance is at 62%. In terms of targets moving forward, we have an Investor Day next week, so we'll talk more about what might be the right business targets for the business moving forward. But we're certainly pleased with the gross margin expansion over the last couple of years.

Excellent. A follow-up, if I may. Can you talk about the software stacks you've introduced for your products? Can you talk about how that’s being bundled together with your products? To what extent do you charge for the software separately versus as part of a larger bundle or license fees? Can you separate out for us what the software component of your revenue mix is versus that chip side? Is there an ability to do that? And that’s all I had. Thank you.

Thanks, Mark. So let me first start with software. Back a couple of years ago at our Investor Day, we discussed how software is a very key part of our strategy. We've certainly invested more in software over the last couple of years and built out our software portfolio. One particular area we've focused on is application-specific software solution stacks. These software solution stacks are built for specific applications and make it easy for our customers to adopt our products into their systems and get to market quickly. The side benefit for us is it helps us get to revenue quicker and also helps us stick with customers on a multi-generational basis. We built out three application stacks to date, the sensAI software stack around artificial intelligence, an embedded vision processing stack, and a security software stack, with more to come. In terms of how we monetize that today, it’s bundled with our hardware sales, enabling that silicon or total solution sale. For existing customers, this really helps us expand our share of wallet at a number of large customers. It has also accelerated new customer acquisition. Over the last 6 to 12 months, we've had some of the highest rates of new customer additions we've ever seen in the company's history. While in the future there may be opportunities to monetize the software independently of the hardware, for today, we're focused on a solution sale, the combination of software and hardware sold together.

Your next question comes from the line of Tristan Gerra from Baird. Please go ahead. Tristan, your line is now open.

Hi, good afternoon. Could you give us an idea of where you think Nexus might stand as a percentage of revenue by the end of the year and when you anticipate reaching crossover to 28-millimeter compared to acquire notes?

Yeah. I think it's probably a little early to give guidance on that, Tristan. What I will say is we believe the company started to move into a higher growth phase this year in 2021, and Nexus is certainly a contributor to that. Nexus started revenue at the very end of last year, and we’re ramping that into full production this year, with more Nexus devices entering production at the end of this year with Mach-NX. Nexus is certainly a contributor to the top line growth both this year and in the years to come. That said, we're still driving growth on pre-Nexus products as well, so the products that preceded Nexus continue to drive growth.

Okay, that's great color. And then on the consumer side, it's now the second quarter of consumer stabilizing. Any color in terms of segments driving that growth? Is it smart speakers? Do you still have some presence in China smartphones? What’s the level of confidence that the difficult comps are behind in consumer?

Yeah. Good question, Tristan. Thank you. We're pleased to see two quarters in a row of sequential growth in consumer. Consumer had been a headwind for us in the past, and we don't anticipate it being a headwind for instance this year in 2021. One thing that's changed over the last couple of years in consumer—and we had talked about this at our Investor Analyst Day back in 2019—was that we were going to rebuild the revenue base of consumer and shift towards more multi-year revenue streams, higher-margin revenue streams, applications that are less volatile and are more multi-year. We don't have any handset business within consumer, so the revenue is based on longer-term revenue streams such as prosumer applications and home automation applications that last more than just 12 months. We feel we've rebuilt that foundation so it's much more stable, and we don’t expect consumer to be a headwind moving forward. We expect the primary growth drivers for the company to be Communications and Computing, and Industrial and Automotive—those segments are our largest contributors, representing over 80% of our revenue.

Great, thanks for the color.

Thanks, Tristan.

Your next question comes from the line of Christopher Rolland from Susquehanna. Your line is now open.

Thanks, guys, and congrats on the quarter here. I guess the first one is probably for Sherri but Jim, if you want to chime in. In terms of typical seasonality, I think there are some anomalies in here but I got a really two and four Q, traditionally. You guys are clearly on a strong growth projection for this year. Maybe if you could just give us some broad strokes on how we should feel about the third and fourth quarters of this year? Are my seasonality numbers right or is there a slowdown traditionally in the back half? Are you guys really growing through this? Thanks.

Yeah. Thanks, Chris. I think on seasonality historically, the part of our business that had the strongest seasonality was our consumer segment. Now that consumers become a smaller percentage of our overall revenue, our business has been less affected by seasonality since the other segments have less seasonality patterns. I think that's one thing to factor in. There are also some Lattice-specific growth drivers that have been kicking in and kind of superseding the seasonality. Just as one example, in communications and computing in client computing, we had a couple of new client computing platforms begin production last year and those continue to ramp up, providing a full year's benefit this year. So, that's helping drive above what is normal seasonality. For the first half, we feel like we're off to a really good start, and we're seeing strong demand. We don't provide annual guidance, but we see good demand continuing through the remainder of the year as well.

Okay. Fair enough. Thanks for the answer there. And Jim, I'm going to get you back on this one for a second time. We’re obviously in some interesting times; people can't build cars because they can't get a $2 microcontroller. One of the great things about FPGA is their flexibility. I'm wondering if you're seeing anything today? Are you seeing any of these shortages in any other areas of the market? Are you finding people that are coming over, whether they're replacing ASSPs as you mentioned or even some microcontrollers or small kind of ASIC? Are they finding they can use FPGAs instead? If so, are you guys near-term beneficiaries of this change? If not, do you expect to be if this persists? Thanks.

It’s a great question, Chris. I would say that we are doing a good job supporting our customers, and they see that and appreciate it, factoring that into their decisions moving forward in terms of what parts and companies they’re going to rely on. We will see some benefit further out in time. There are advantages that FPGAs have given their power efficiency, flexibility, and the complete software content we've built. They are compelling for a customer who's used an ASSP or microcontroller in the past to switch over to our FPGA. We can usually offer them better power efficiency and performance, as well as software stacks. We're having discussions with customers about switching from their $2 microcontrollers over to the Lattice FPGA. However, I think that’s not a near-term benefit, as it takes time for customers to switch from one device to another. Yet, this is something that we can see a benefit from in the future quarters.

Thanks, Jim, and congrats to you and your team again.

Yeah. Thanks again, Chris.

Your next question comes from the line of Hans Mosesmann from Rosenblatt Securities. Your line is now open.

Great. Thank you. Congrats, guys, fantastic execution. Sherri or Jim, in terms of the outlook, are you constrained? Are there sales that you are leaving on the table?

We think, Hans, that we're doing a good job supporting our customers. The supply chain team did a good job supporting them in Q1, and I anticipate they do the same great job in Q2 as well. It helped, as I mentioned earlier, that we built inventory last year and got ahead of the curve regarding supply chain tightness. We exited last year in a good inventory position, and entering Q1, we had higher levels of inventory than we did a year ago. Combined with our work with customers to plan demand and our suppliers to match that demand, I think we feel good about supporting our customers moving forward.

Okay. So does that mean that your lead times have not changed?

Our lead times have been relatively stable for the vast majority of our parts. There may be some particular parts with a specific silicon package combination where we're seeing a little bit longer lead time than normal. But the vast majority of our parts are within the normal lead times. More importantly, we're working carefully with our strategic customers to understand their demand needs moving forward and ensuring we have the capacity to match that supply.

Okay. And then one last one, maybe for Sherri. Your expenses are growing a bit faster than top line in Q2. Is that a function of costs that are maybe going up? Some players have been talking about costs increasing for supplies of certain products or packaging.

Yeah. Thanks, Hans. From an OpEx perspective, our OpEx was up sequentially versus Q4, as we expected towards the higher end of our guide. The areas where it's higher are in R&D. Our R&D spend increased 7% sequentially as we continue to invest in our product portfolio. You’ll continue to see more of that as you see our guide for Q2, which is up at the midpoint versus Q1. This increase reflects our growth mode and long-term investment in the company. Our target from the 2019 Investor Day was 35%, and for Q1, we were still below that. While investing in the business, we manage our SG&A to our target of 15%. We're just slightly above that but managing towards that target. With respect to costs, in general, our costs are relatively stable, but we have seen some increases, like in shipping costs. Where we're managing that is through our pricing optimization programs, helping us achieve increased gross margins, which we increased by 10 basis points in Q1 and 190 basis points year-over-year.

Fantastic. Thank you.

Your next question comes from the line of Matt Ramsay from Cowen. Your line is now open.

Thank you very much. Good afternoon. I think this question is probably for both of you. Different companies in the semiconductor supply chain right now are obviously facing demand outstripping supply. Some have chosen to keep more inventory on books versus the channel. Some, I guess, chose to support the channel versus draining their own books of inventory. If you look across both of those metrics, Sherri, how are you guys thinking about the inventory levels both that you have and that you have in the channel versus target levels and what that might mean for visibility of revenue as you look forward into the back half? Thanks.

Thanks, Matt. Let me take that one and I can ask Sherri to add if she has something to add. We talked a little about the Lattice inventory and the fact that we proactively built Lattice inventory last year, so we're in a good inventory position at the end of Q1 versus a year ago. In terms of distributor inventory, where we ended Q1 is within the range we've seen over the last few years, so it's on the lower end. We made sure to maintain higher inventory levels on the Lattice side to provide us flexibility in allocating supply where we see demand. I hope that answers your question, Matt.

Yeah, Jim, that’s great. Thanks. Obviously, there will be a lot of questions that will get answered next week at the Analyst Day, but I wanted to ask about a recent partnership announcement you guys made with Rambus regarding sharing technology around security in various end markets. Jim, could you give us a bit more detail on what that partnership entails? What IP you might be supplying and what you might be getting? What that partnership may do to enhance the security features of your portfolio moving forward? Thanks.

Thanks, Matt. We were really happy with that announcement and our partnership with Rambus. We view Rambus as an IP partner, both an IP supplier to us and to our customers. This partnership is specifically around IP related to security. We have been investing in our products' security capabilities from both hardware and software perspectives. We've launched two devices to date that are security optimized: our MachXO3 3D product and our Mach-NX product. We’re also developing software stacks on top of that. There’s additional IP from Rambus that we want to run on Lattice devices, ensuring that if our customers choose to use that security IP from Rambus, it runs seamlessly on Lattice products. This enables our customers to build secure systems, and we'll probably talk a bit more about this at the Investor Analyst Day as well.

Your next question comes from the line of Sam Peterman from Craig-Hallum Capital. Your line is now open.

Hi guys, Sam on for Richard here. I want to ask quickly about your industrial and auto segment. You had another quarter where industrial automation drove a lot of strength, and obviously you’ve seen that over the last year the pandemic accelerated digital transformation across the board. I'm curious now that we've lapped a year of strong growth in that area, what's your read on demand and industrial automation going forward? Is it still growing, but maybe we should expect the rate of growth to slow to a more normalized rate beyond this quarter? How should we think about that?

We view industrial and automotive as one of our key growth drivers for the long term as well. Last year, our Industrial and Automotive growth was approximately 11% year-over-year, which contributed positively, and most recent quarter, Q1, grew 20% year-over-year. Within that segment, industrial automation and robotics are significant drivers. Lattice devices, along with the software on top, fit perfectly in industrial automation and safety. The power efficiency, flexibility, and performance make us a great fit, and we have a strong pipeline of design wins. Pre-pandemic, we saw high engagement levels around industrial automation and robotics, but COVID has accelerated our end customers’ plans for faster automation of their facilities. We’re well positioned to benefit from what appears to be a long-term secular growth trend. Thus, we see Industrial and Automotive as long-term growth drivers for the company.

Okay, that's great. And one more quick one for me. You said before you have a healthy design win pipeline in automotive. You haven't given a lot of color on that. Is there any way you can characterize where those design wins are and when auto might become a more material portion of the Industrial and Auto segment?

We’re pleased with our Automotive segment in Q1; it did grow sequentially and year-over-year. However, it remains a relatively small portion of the Industrial and Automotive segment. That said, we have a very healthy design win pipeline. We will talk more next week at our Analyst Day about specific automotive applications we are designed into that are growing and some of those in the pipeline.

Your next question comes from the line of Derek Soderberg from Collier Securities. Your line is now open.

Hi, everyone. Congrats on the results. Just one question for me. Jim, I’m curious sort of high-level, to what degree are some of the product enhancements you bring to market helping expand the unit opportunity out there in the industry? Clearly, there are opportunities with higher ASPs, bundling software. But what sort of what – to what degree should some of that growth start to come from unit volume? Just trying to get a sense for how the industry is growing. Thanks.

We see significant unit volume opportunities. One example to note is client computing, which is a large market—about 300 million units a year, including laptops, tablets, and desktop computers. We had several platforms in that segment starting to ramp last year and achieving healthy volume this year. This will contribute to our growth. We see even more opportunities in that segment for Lattice products to provide interesting functionalities, such as human presence detection and gesture recognition. We also see good unit opportunity growth in parts of industrial, including robotics. Beyond unit volume growth, we have been driving ASP growth. Our ASPs have steadily increased over the last couple of years. We are focused on driving both higher ASPs and unit growth.

There are no further questions in queue. I will turn back the call to Lattice CEO, Jim Anderson, for closing remarks.

Thank you, operator, and thanks everybody for joining us on today's call. As you can tell, we're really excited about the progress that we've made, but even more excited about where we're headed from here in the future of Lattice and the opportunities ahead of us. We look forward to talking to all of you next week at the Investor Day. And thanks again for your time.

Thank you so much. This concludes today's conference call. Thank you for participating. You may now disconnect. Presenters, please stay.