Lattice Semiconductor Corp (LSCC) Q2 2021 Earnings Call Transcript

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 of the second quarter of 2021, and the business outlook for the third 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. I would like to remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events for the future financial performance of the company. We wish to caution you that such statements are predictions based on information that is currently available and actual results may differ materially. We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs and 8-Ks. These documents contain and identify important risk factors that could cause the actual results to differ materially from those that are contained in our projections or forward-looking statements. This call includes and constitutes the company’s official guidance for the third quarter of 2021. If at any time after this call we communicate any material changes to this guidance, we intend that such updates will be done using a public forum, such as a press release or publicly announced conference call. Some financial information that we present during the call will be provided on both a GAAP and a non-GAAP basis. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company’s performance and underlying trends. Management uses non-GAAP measures to better assess operating performance and to establish operational goals. For historical periods, we provided reconciliations of these non-GAAP financial measures to GAAP financial measures that can be found on the Investor Relations section of our website at latticesemi.com. Let me now turn the call over to Jim Anderson, our CEO.

Thank you, Rick, and thank you everyone for joining us on our call today. We are excited to be at the beginning of a new growth phase for Lattice, fueled by an expanded product portfolio and multiple growth vectors across our key end markets. Let me start by covering a few highlights from Q2 of 2021. We grew revenue 25% year-over-year and 9% sequentially, with double-digit year-over-year growth in each of our key market segments. We expanded non-GAAP gross margin by 80 basis points year-over-year to 62.1%, as we continue to execute on our gross margin expansion strategy. We achieved record non-GAAP operating profit of 29%, while non-GAAP net income increased 49% year-over-year. We also expanded our product leadership with the June launch of CertusPro-NX, our new advanced general-purpose FPGA. Let me now provide an overview of our business by end market. In the Communications and Computing market, revenue increased 7% sequentially and 15% on a year-over-year basis. As we discussed at a recent Investor Day, our key long-term growth drivers in this segment are data center servers, client computing, and 5G infrastructure. In servers, growth was driven by expansion of both attach rate and ASPs, as we continue to drive an increase in our dollar content per server with each new server generation. Client computing is a significant greenfield opportunity for us, with multiple programs ramping in innovative ways to bring new solutions to our customers. 5G infrastructure growth is driven by our higher content in 5G systems versus 4G systems and the continued worldwide build-out of 5G infrastructure. Communications and Computing continues to be a long-term growth opportunity for the company. Turning now to the Industrial and Automotive market, revenue increased 15% sequentially and was up 47% on a year-over-year basis. Our business grew across multiple applications such as industrial automation and robotics, where Lattice solutions provide significant competitive advantage and differentiation for our customers. We continue to deliver strong growth in the industrial segment and our product portfolio is well-positioned to drive sustained long-term growth. Turning now to Consumer, revenue was flat sequentially and was up 13% year-over-year. The quality of the revenue stream in Consumer has improved over the past two years as we’ve targeted higher value, multigenerational designs that better leverage our FPGA portfolio. We believe our Consumer revenue is stabilized and has the potential for modest growth over the long-term. I’ll now provide some product roadmap highlights. I continue to be very pleased with our team’s overall execution. With the June launch of CertusPro-NX, we have now launched four device families based on the Lattice Nexus platform since the platform was introduced in late 2019. We are excited about the CertusPro-NX family, which relative to the competition offers 4x lower power, best-in-class system bandwidth, and industry-leading reliability. Each of these advantages provides meaningful differentiation and value for our customers’ applications and systems. Our first two device families CrossLink-NX and Certus-NX are in production and ramping with customers. The third device family Mach-NX is on track to generate revenue by the end of this year. We continue to be very pleased with the broad adoption of our Nexus platform across our market segments. On our software roadmap, we continue to invest in tools, solutions, and software stacks to make it easy for our customers to adopt Lattice products and get to market quickly. During the quarter we launched Lattice Automate, our solution stack focused on factory automation and robotics applications. Automate is the fourth installment in our application-specific solutions stack portfolio and another proofpoint of our continued roadmap execution. Lastly, at our recent Investor Day, we announced our new Lattice Avant platform, which will double our addressable market and allow us to target mid-range FPGA applications. Execution is going well and we remain on track for launch in the second half of next year. We’ve engaged with over 100 customers on Avant and are pleased with customer reception and momentum. In summary, we continued to execute well in Q2 and we are excited to be at the start of a new growth phase for Lattice, driven by our leadership, product portfolio and multiple growth vectors across our key end markets. I’ll now turn the call over to our CFO, Sherri Luther.

Thank you, Jim. We are pleased with our strong Q2 financial results, as we continue to execute to our financial model. We drove sequential and year-over-year revenue growth, continued to expand gross margin, and delivered record profitability, while continuing to invest in our leadership product roadmap. We drove strong cash generation, increased our net cash positive position and continued to return cash to shareholders. Let me now provide a summary of our results. Second quarter revenue was $125.9 million, up 9% sequentially from the first quarter and up 25% year-over-year. Revenue grew double-digit year-over-year in our Communications and Computing and Industrial and Automotive market segments with strong sequential growth as well. Revenue from our Consumer market segment was also up double digits year-over-year and was flat sequentially. IT revenue was down both year-over-year and sequentially. Gross margin on a GAAP basis was up 30 basis points to 61.3% in Q2 compared to the prior quarter and was up 110 basis points compared to the year-ago quarter. Non-GAAP gross margin increased 40 basis points to 62.1% in Q2 compared to the prior quarter and was up 80 basis points compared to the year-ago quarter. Both the sequential and year-over-year increases in gross margin continue to be driven by our margin expansion strategy, as we benefit from pricing optimization and product cost reductions. Q2 GAAP operating expenses were $53.9 million, compared to $49.9 million in the prior quarter and $48.1 million in the year-ago quarter. On a non-GAAP basis, operating expenses were $41.5 million, compared to $38.9 million in the prior quarter and $36.6 million in the year-ago quarter. Our R&D expenses increased sequentially as we continue to invest in our product portfolio. SG&A expenses increased slightly on a sequential basis, while declining to 14.6% of revenue, which is below our target model. Q2 GAAP earnings per basic share was $0.16 per diluted share and $0.15 per diluted share, compared to $0.14 and $0.13 in the prior quarter and $0.08 in the year-ago quarter. Q2 non-GAAP earnings per basic share was $0.26 per diluted share and $0.25 per diluted share, which increased from $0.23 and $0.22 in the prior quarter and increased from $0.17 in the year-ago quarter. This represents 47% year-over-year growth for non-GAAP earnings per diluted share. Driving cash flow generation continues to be a key focus area for the company. We generated approximately $71 million in cash from operations in the first half of 2021. This is up over 90% compared to the cash generated from operations in the first half of 2020. In Q2, we repurchased approximately 525,000 shares or $25 million in stock under our buyback program. This brings our year-to-date total of stock repurchased to $40 million. Finally, our cash balance increased to $188 million as we further increased our positive net cash position. Let me now review our outlook for the third quarter. Revenue for the third quarter of 2021 is expected to be between $124 million and $132 million. Gross margin is expected to be 62% plus or minus 1% on a non-GAAP basis. Total operating expenses for the third quarter are expected to be between $42 million and $44 million on a non-GAAP basis. We are focused on continuing to drive revenue growth and profitability expansion through the strength and differentiation of our leadership product roadmap. Operator, that concludes my formal comments. We can now open the call for questions.

Yeah. Good afternoon. Thank you for taking my questions. I guess, Jim, it’s great to see the progress in the business, so congratulations. It’s been a couple of months now since you guys announced that at the Investor meeting the Avant program. And you mentioned a couple of things in your script. I wanted to revisit that and see what the initial engagements and customer receptions have been like. The second part of the question is, as you guys think about moving into mid-tier FPGA products over time, any thoughts as to the sensitivity or restriction on potentially shipping those into markets like China? I know some of your higher tier competitors have had some challenges there. You guys have been largely immune to some of those challenges in the lower tiers of the market. So any initial feedback from regulators as to how much flexibility you might have in those mid-tiers to go after some of those markets that your competitors can’t? Thank you.

Thanks, Matt. Yeah. So, on Avant, first of all, we are really pleased with the progress on Avant. I know you asked about customer momentum, but let me give a shout out to our engineering team for continuing to do a great job executing on that program. We are really pleased with the progress on execution and we remain on track for sampling and launching the device in the second half of next year. Then on customer momentum as well, I am really pleased with the progress on that. As we shared at the Investor Day, we had engaged with over 100 customers on Avant. We continue to have very strong engagement and growing customer momentum. Also, if you recall from the Investor Day, I shared that it was the customers that encouraged us to build Avant. When we introduced Nexus to our customers, we got great reception on Nexus, but the customers also asked us, 'Can you do more? Can you expand the portfolio? Can you bring your power-efficient architecture to mid-range?' And so it was really at the customer’s behest that we went ahead and started working on Avant back in 2019. And so, yeah, customer momentum continues to be good. Our sales team is very happy right now having all sorts of discussions with Avant with our customers. On the second part of your question on export controls, so of course, we always adhere to all U.S. regulations on export controls and we would of course do that for any new products whether those are Nexus or Avant. Now, we’ve done extensive market research. We believe that there’s a tremendous market opportunity for Avant. We believe it’ll be a very competitive product, and as we shared at Investor Day, we believe that will open up about $3 billion of additional SAM for us additional addressable market, which will roughly double our addressable market when Avant launches. So, yeah, once again, really pleased with progress on Avant and just really excited to launch it next year.

Thanks for the color there, Jim. As my follow-up question, there’s no secret that most companies in the semiconductor industry right now have a lot more demand than they have supply. I would assume that you guys are in that position to some extent. Maybe you could talk a bit about what the supply-demand gap is? And are you maybe in a better position to supply more of that demand, given you are sourcing from SOI-based platforms versus some of the bulk CMOS that is a lot more tight at foundry? Thanks.

Thank you, Matt. I believe our supply chain team has done an excellent job this past year in managing the challenges within the semiconductor supply chain that the industry is facing. They have proactively addressed these issues by collaborating closely with our customers to understand their needs and long-term forecasts. This ensures that we can align with our key strategic suppliers to secure the necessary supply. Additionally, we have strategically built up inventory on high-volume products that will last for years, starting this initiative in the second quarter of last year. We have continued to increase inventory in the following quarters, ending the year in a strong inventory position. In the most recent quarter, we maintained that inventory growth, which I believe has been effective in supporting our customers. I appreciate the efforts of our supply chain team in executing this strategy. Overall, I think we are successfully meeting our customers' demand. While there may be some localized issues with specific silicon and packaging, I feel we are doing a commendable job in supporting our customers, who recognize our efforts. This will ultimately benefit us as customers take this into account for new designs, and we are already seeing some advantages in terms of new designs thanks to our effective supply chain execution. I hope that answers your question, Matt.

No. Thanks very much, Jim, and congrats, guys. I’ll jump back in the queue. Appreciate it.

Thanks everyone and I also extend the congratulations on another great quarter and for helping make us all look good. Just on the revenue by end market breakout. Maybe Jim, if you can just talk to us a little bit more about how those segments tracked versus your internal expectations going into the quarter? And then maybe a little more granular on the industrial side. Obviously, there’s been an acceleration on robotics and automation coming out of COVID. But can you maybe hone in a little bit on how much of it really is market growth versus share gain versus some of the incumbents that maybe have neglected the industrial customers in particular?

Sure. Thanks, Alex. Regarding your first question about revenue by end market, our Q2 results exceeded our expectations for the topline, which we are very pleased with. We particularly noticed strength in Communications and Computing, which were up 7% sequentially and 15% year-over-year. Additionally, Industrial and Automotive showed impressive growth, up 16% sequentially and 47% year-over-year, which surpassed our expectations. Consumer performance aligned with our forecasts for the quarter. The segments of Comms and Compute, along with Industrial and Auto, have been pivotal for our strategic growth. Last year, both segments experienced double-digit growth, and we rely on them to drive most of the company's future growth. We see multiple growth avenues within each market. In Comms and Compute, there's growth in servers, client computing, and 5G infrastructure. In Industrial and Auto, growth is centered on new design wins and programs related to industrial automation, robotics, and automotive electronics, even though automotive still represents a smaller part of that segment. We are witnessing solid growth in industrial automation and robotics applications, with our industrial customers accelerating their automation and robotics plans, leading to new design wins and increased demand for our products. Our offerings align well with these needs, providing power efficiency, flexibility, and extensive software content. We just introduced our Lattice Automated software stack tailored for industrial automation and robotics, which assists customers in quickly bringing products to market and efficiently integrating our solutions, making this a significant area of strength for us. Regarding the proportion from end market growth versus share gain opportunities, I would say a part of it is due to end market growth. The Industrial and Automotive sector has made a considerable recovery since last year's Q2, but a notable amount is also attributed to share gain, which plays a significant role. We are very optimistic about the Industrial and Auto segment and view it as a long-term growth area for us.

Great. That was extremely helpful on the color front. Just as my one follow-up, as we think about R&D spend going forward, I believe you guys have an internal target of about 20% of revenue. It’s been tracking a little bit below that for the last few quarters. Is that just a function of the timing of tape-outs or how should we think about that? It’s just a little bit surprising given all the new product launches and Avant coming up?

Yeah. Thank you, Alex, for the question. You are right; our target that we put out at our Investor Day back in May of this year was 20% as our R&D spend target. During the quarter, we came in at about 18.4% of revenues. So, it is below our target, but I will point out that in terms of absolute dollar perspective, we did increase our R&D spend to really enhance our investments in our products portfolio over the long-term growth of the company, and we’ll continue to focus on that. If you look at our guide and the midpoint of our guidance for Q3, you’ll see that that’s up and that’s also a reflection of the continuing investments that we want to make in our product portfolio. At our Investor Day, we mentioned our Avant platform as well as the CertusPro-NX product that we launched. We will continue investing for the long-term growth and you’ll see that reflected in our financials.

And the one thing I would add, Alex, is certainly, as Sherri said, we are continuing to invest in the product portfolio, to continue to expand the portfolio and to get great products to market. We also want to invest in a controlled and disciplined way to ensure we get a return on that investment. So we’ll continue to invest, but we’ll do that at the right rate and pace and in a disciplined manner.

Hi. Can you hear me?

Yeah. We can hear you, Tristan.

Oh! Okay. Sorry. Just a quick follow-up on the earlier question about shortages. You mentioned that it’s actually helping you as some customers know that you are managing the supply chain well in terms of new design win qualification. Given the notable extension of lead times in microcontrollers, and that’s the type of architecture that you are really targeting going forward in terms of share gain. Are you seeing designs or an acceleration of design shift away from microcontrollers to your product because of the improved availability? Or is it not really the case yet because obviously it takes time for customers, they have to redesign the product to qualify. But in terms of that supply shortage, are you seeing an acceleration in terms of your TAM expansion against the MCUs?

Thanks, Tristan. I would say we are definitely seeing new and accelerated opportunities against microcontrollers. There’s no secret that there’s a supply shortage on microcontrollers, and we’ve been quite clear that we are targeting parts of the microcontroller market. We are competing with our traditional FPGA competitors in the FPGA market, but we are also going after portions of the microcontroller market as well. We are already in a good position to displace microcontrollers because of the nature of our products, the power efficiency, and the ability to do parallel processing for artificial intelligence algorithms at a much higher performance. So we are already seeing conversions of microcontrollers to FPGAs. The supply shortage has allowed our customers to notice our effective support, and we do have examples of customers accelerating their plans to switch to a Lattice device. We see that across several market segments, with industrial being one that is particularly notable. Customers are actively motivated to redesign systems as quickly as possible. So, yes, we are certainly benefiting from that.

Okay. That’s great feedback. And then a question for Sherri. Obviously, we know your gross margin longer-term target. In the near-term, next few quarters, should we expect the 62% gross margin tabulation? Is that something we should expect for the next few quarters as well? If you could comment on what you think are the key pillars for gross margin to step up from current levels?

Yeah. Thank you, Tristan, for the question. So, I’ll point out that our gross margin has improved nearly 500 basis points from 2018 to date. We are really pleased with our progress that we’ve made on improving our gross margin as part of our gross margin expansion strategy. Pricing optimization and product cost reductions are two key elements of that strategy. When you look at the current quarter, the 40 basis points improvement shows our strategy kicking in there. We exceeded our 2019 target announced at our Investor Day in 2019 of greater than 62%. The Q2 results exceeded that target. As we pointed out at Investor Day this past May, we raised our target to 65%. The elements of our gross margin expansion strategy will continue to focus on pricing optimization and product cost reductions. We have several initiatives that we continue to work on, some are near-term and some are longer-term, but we expect to continue executing on that strategy to reach our long-term target of 65%.

Hey, guys. Thanks for the question. Given that supply doesn’t seem to be a huge constraint for you guys, would that mean typical seasonality is a bigger driver in the back half? Traditionally, you guys have been more flat sequentially in the back half, but given your strong product ramps here, would you expect to grow through that?

Yeah. Chris, I think, other than the Consumer segment, we haven’t seen strong seasonality patterns over the last couple of years. The Consumer segment still exhibits normal consumer cycle patterns. But that segment remains a relatively small part of our overall revenue. Certainly, we provided guidance for Q3. We look forward to a strong second half, just as we had a strong first half as well.

Okay. Great color there. Thank you. One thing I noticed in your report is DIST as a percent of total was up. I know a lot of vendors have actually been shorting DIST given their supply constraints, but that may not be the case for you. Any updates there on the channel? Why was DIST going up as a percent? And then inventories that you have there, how robust do you think those are and would you expect these trends to continue?

Yeah. Thanks, Chris. I wouldn’t read too much into that sequential increase. Our percentage of DIST versus direct can fluctuate quarter-to-quarter. A number of our large strategic customers prefer to go through distribution, which makes it operationally easier, although we are happy to support our large customers in either direct or through distribution modes. We do have visibility into our level of DIST distribution inventory, and we finished Q2 on the leaner side of what we’ve historically seen. I would call DIST inventory lean. We have good visibility into what ships out of DIST to our end customers as well. Again, to your first question, I wouldn’t read too much into the sequential fluctuation in percent of DIST.

Great. Thanks, Jim, and nice quarter.

Thanks, guys. Congratulations. Hey, Jim. Just a question on some customer activity in the design cycle. Are you seeing the design cycles accelerating or shortening?

What I would say is, it’s a little bit market-dependent. I would say that we are certainly seeing a high level of customer activity in general in terms of customer engagement, new design wins, and design-ins. We are experiencing a tremendous amount of activity. I would say the level of customer engagement and activity is the highest since I’ve been at Lattice. Several of our sales employees, who have been at Lattice for many years, would agree that it’s the highest they’ve seen in their many years at Lattice. I think that’s a testament to the strength of the product portfolio. The Nexus platform, we’ve now launched in June our fourth family of devices based on the Nexus family. So that’s four device families in our customers’ hands now. The first two are already in production and ramping. The third, which is Mach-NX, we expect to ramp into production at the end of this year. And the fourth, which we just launched, is expected to start generating revenue next year. We are seeing tremendous activity around Nexus. There’s also tremendous activity surrounding Avant, the new platform announced at our Investor Day in May, which is expected to launch in the second half of next year. In terms of design cycle acceleration, there are instances where we’ve seen customers accelerating their design cycles. This is generally driven by customer-specific needs. In some cases, particularly in industrial applications, customers are facing supply issues with existing microcontroller providers and are thus driving a faster transition to Lattice products. In general, we are seeing great customer momentum.

Great. Just a quick follow-up to ensure I understood correctly. Your lead times have not changed, correct?

When you look at the overall set of Lattice products, our lead times have been quite stable. There may be some specific combinations of silicon packages that could experience tighter supply and longer than usual lead times, but overall, across our wide range of products, our lead times have remained stable.

Hi, Jim. Hi, Sherri. This is Sam on for Richard. Thanks for taking my question. I want to follow up on your distributors and channel inventory. Could you talk about how those channel inventories compare to levels you saw in the first quarter? You mentioned they were lean. Is that kind of across segments or are there certain spots that are more lean than others?

Yeah. In our channel inventory, Q2 was sequentially down versus Q1. Comparing Q2 to the past three to four years, it’s at the lowest level we’ve seen. We see very lean levels of inventory with our distributors. We have been maintaining a healthy level of inventory at Lattice. Our inventory is at a very healthy level, and we’ve strategically built inventory to allow us to allocate parts to the right markets and support our customers effectively. Regarding differences in inventory levels across segments, I would say we are not seeing any significant variance across the different market segments.

Okay. Thanks for the color. That’s helpful. Then one more quickly, just curious on the Industrial Auto segment, obviously, the last four quarters have been pretty strong as that starts to tick up. Q2 last year I think had growth rates of about 8% or higher quarter-over-quarter. Just wondering as you head into the back half, do you think we should expect the rate of change or the rate of growth there to slow a little bit?

Yeah. For Q3, if you look at our guidance and the midpoint, we expect Q3 to be sequentially up from Q2. We would expect our two big growth segments of Comms and Computing and Industrial and Auto to reflect that midpoint and expect both of those to be sequentially up as well. So, yes, we are expecting Industrial Auto to be sequentially up in Q3.

Hey, everyone. Thanks for taking my questions. Jim, I was curious about the various end markets, what you are seeing on the progression from Q2 to Q3, just unpacking third quarter guidance from a revenue perspective, if you could provide any directional commentary on that.

Certainly, Derek. So from Q2 to Q3, we expect Q3 to be sequentially up. We expect Comms and Computing to be sequentially up as well. In Comms and Computing, we have three growth drivers: data center servers, where we continue to expand our dollars of content per server, and we are expanding that through a combination of higher ASPs as delivering more value to each server platform and higher attach rates. We’ve shared that with the new generation of servers that’s ramping, we expect a significant increase in our dollars of content per server, driven by attach rates that are expected to exceed one, meaning we are shipping more than one Lattice device per server. Client computing, 5G infrastructure are also growth areas for us in Comms and Compute. In Industrial Auto, we saw a very strong quarter in Q2 and are seeing good strength in new programs ramping in industrial automation and robotics. Therefore, we expect to see sequential growth there as well. For Consumer, we would expect to be flat to slightly up from Q2 to Q3. Hopefully, this provides some additional context for you, Derek.

Yeah. That’s great. And as my follow-up, just curious about any incremental competition in low power. I believe there are some new FPGA players hitting the market. Are you seeing anything incremental in terms of competition and are there any interesting companies out there for you guys to acquire to maybe build on your hardware or software platforms? Thanks.

Yeah. Thanks, Derek. Regarding the competitive landscape for the market we are addressing with our products, it has remained quite stable. We haven’t seen any dramatic changes. We believe we are leading the market in terms of our product portfolio for small FPGAs that are power efficient and flexible. We definitely think we are in a strong position, especially with our Nexus devices. We presented several competitive comparisons at our Investor Day back in May, demonstrating our leading position in the market. Regarding potential M&A opportunities, we focus first on driving organic growth. While we consistently scan the landscape for possible inorganic options that are adjacent and complementary to our existing portfolio, they would need to be additive in a manner that supports our organic strategy. Thanks, Derek.

Operator, that concludes my formal comments. We can now open the call for questions.

Thank you, Operator. And thanks again for everybody for joining us on the call today. We are really excited to be at the start of a new growth phase for Lattice, driven by our leadership product portfolio and multiple growth vectors across our key end markets. We look forward to updating you on our continued progress on our next earnings call. Thanks, Operator. That concludes today’s call.

Ladies and gentlemen, this does conclude today’s conference call. Thank you for your participation and have a great day.