Lattice Semiconductor Corp (LSCC) Q3 2023 Earnings Call Transcript

Greetings, and welcome to the Lattice Semiconductor Third Quarter 2023 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rick Muscha, Senior Director of Investor Relations. Thank you, Rick. You may begin.

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'll provide a financial and business review of the third quarter of 2023 and the business outlook for the fourth quarter of 2023. 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 or 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 that 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 contained in our projections or forward-looking statements. This call includes and constitutes the company's official guidance for the fourth quarter of 2023. 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. We refer primarily to non-GAAP financial measures during this call. 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. 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 delivered solid results in Q3 with quarterly revenue growth of 11% year-over-year, while maintaining healthy gross margins and operating margins. Today, Lattice has the strongest product portfolio in our history in terms of both hardware and software solutions, and we continue to expand our product portfolio at a rapid rate. We're looking forward to the expected launch of the two newest members of our Avant mid-range FPGA family at the Lattice Developers Conference in December. Let me touch on a few Q3 highlights. In addition to the Q3 revenue growth, we achieved a record non-GAAP gross margin of 70.6%, which was an increase of 110 basis points year-over-year. We expanded non-GAAP operating margin by 60 basis points year-over-year to 40.3%, and we generated a 40% free cash flow margin. Let me now provide an overview of our business in the high-end market. In the communications and computing market, revenue was up 6% sequentially and down 6% on a year-over-year basis. We're pleased to see the sequential uptick in this segment given some of the macroeconomic challenges this end market has experienced over the past quarters. The sequential growth was driven in part by growth in data center servers for both general-purpose and AI-optimized applications. And we expect growth in servers to continue into the current quarter, offset by softer demand in 5G telecom infrastructure. Over the long term, we continue to believe we are well-positioned for growth in this segment given our growing content for server in both general-purpose and AI-optimized data center servers as well as long-term growth opportunities in data center networking and telecom infrastructure. Turning to the industrial and automotive market, revenue declined 5% sequentially and was up 28% year-over-year. While we're very pleased with the year-over-year growth, we did experience sequential softness in this market, consistent with broader industry trends, and we expect this market softness to continue into the current quarter. However, we continue to expect this market to be a strong long-term growth opportunity for Lattice as we address growing applications in industrial automation and robotics as well as automotive ADAS and infotainment systems. I'll now provide some product roadmap highlights. We're driving the largest product portfolio expansion in the company's history, which we believe continues to create new future revenue streams for Lattice. We recently introduced CrossLink-NX, the seventh device family built on the Lattice Nexus platform. This newest device family is the industry's first FPGA in its class with integrated USB functionality, which is applicable to many diverse use cases. We also continue to be pleased with the progress on our new Lattice Avant platform, which creates new greenfield revenue opportunities for Lattice. We look forward to further expanding the platform with the expected launch of two new Avant device families at our Lattice Developers Conference in early December. Software is a key component of our strategy, as our software accelerates customer adoption, enabling faster time to market for our customers while driving long-term multi-generational solutions. Avant will also leverage the same stack that our customers are already using today on our current Nexus products, which enables faster customer adoption of our new Avant platform. Overall, I'm pleased with our continued execution. While we're not immune to macroeconomic headwinds in our end markets, we're excited about the continued rapid expansion of our product portfolio. We believe that we continue to be well-positioned for long-term growth across our core markets. I'll now turn the call over to our CFO, Sherri Luther.

Thank you, Jim. We are pleased with our solid Q3 financial results. On a year-over-year basis, we drove double-digit revenue growth, continued gross margin expansion, and strong profitability. We generated a record level of cash from operations, continued to invest in our leading product portfolio, and returned capital to shareholders through our 12th consecutive quarter of share buybacks. Let me now provide a summary of our results. Third quarter revenue was a record $192.2 million, up 1% sequentially and up 11% year-over-year. Sequential growth in the quarter was driven by Communications and Computing. Year-over-year revenue growth was driven by Industrial and Automotive. Our non-GAAP gross margin increased 10 basis points in Q3 compared to the prior quarter to a record 70.6% and was up 110 basis points on a year-over-year basis. Both the sequential and year-over-year increases in gross margin continued to be driven by our gross margin expansion strategy, which is in its fifth year. Non-GAAP operating expenses were $58.2 million compared to $58 million in the prior quarter and $51.3 million in the year-ago quarter. R&D expenses increased both sequentially and on a year-over-year basis as we continue to make investments in our product roadmap. Our non-GAAP operating margin was 40.3% in Q3 and was up 60 basis points compared to the year-ago quarter. Q3 earnings per diluted share were $0.53 compared to $0.48 in the year-ago quarter, which represents 10% year-over-year growth. Driving strong cash flow generation continues to be a key focus area for the company. In Q3, we generated a free cash flow margin of 40% and returned capital to our shareholders by repurchasing $10 million in stock or approximately 110,000 shares in the 12th consecutive quarter of our share repurchase program. We ended the quarter with $114 million in cash. Let me now review our outlook for the fourth quarter. Revenue for the fourth quarter of 2023 is expected to be between $166 million and $186 million. Gross margin is expected to be 70.5%, plus or minus 1% on a non-GAAP basis. Total operating expenses for the fourth quarter are expected to be between $57 million and $59 million on a non-GAAP basis. In closing, I am pleased with our financial results and continued execution. While we are experiencing softness in some of our end markets, we remain focused on driving profitable long-term growth.

Our first question comes from Mark Lipacis with Jefferies.

I had a question on geographic trends. Can you talk about what you saw in the quarter geographically and how things are playing out so far in Q4? Would you expect those trends to continue in Q4?

Yes. Thanks, Mark. And I'll also talk about it in the context of the end markets as well. So first of all, for Q3, we're pleased with the revenue results, the sequential growth and the year-over-year 11% growth. In the Comms and Computing segment, we did see a sequential uptick in revenue. We were pleased with that. That was one of the main drivers of that sequential growth from Q2 to Q3 as data center servers, both general purpose servers, as well as AI-optimized servers. From a geo perspective, it would be very much the geographical mix that you would expect for data center servers that go into both OEM server vendors and hyperscalers. Just as a reminder on that new generation of servers that's starting to ramp here in the second half of the year and into next year. We do have a significantly higher level of content in this new generation of servers. So that's a tailwind that we saw from Q2 to Q3, and we expect that to continue into Q4. Now we are seeing in Q4, although we see servers being sequentially up within that Communications and Computing segment, we do see some headwinds and softer demand in communication, specifically in 5G telecom infrastructure. And that's both wireless and wireline infrastructure; we're seeing lower demand. We view that as being driven by lower CapEx spending from telecom operators. That would be more pronounced in the European geography and parts of Asia as well. That's softness around telecom infrastructure. And then net-net, for the Comms and Computing segment, we expect as we go into Q4 from a sequential basis, we expect that segment to be flat to sequentially down with kind of server demand being up and 5G telecom infrastructure being down sequentially. And then if I move over to the industrial auto segment, in Q3, we're quite pleased with the year-over-year growth that we saw in Q3, 28% year-over-year. But towards the end of Q3, in the last kind of 4 to 6 weeks of Q3, we started to see demand soften from our industrial and automotive customers. I would say that it was really localized to the Asia geography. And we expect that softness that we started to see at the end of Q3 to extend into the current quarter, Q4. And that's both a comment relative to the Asia geography as well as in Q4. In the current quarter we're starting to see demand softness in the European geography as well. So we think that softening of demand that we saw towards the end of Q3 extends into Q4. And net-net, for our Industrial and Auto segment, we're expecting that to be sequentially down from Q3 to Q4. Hopefully, that gives you some insight both by segment and by geography.

That's very helpful. And if I may, on the follow-up, can you talk about Avant? It sounds like you're queuing up two more products or products in that family to launch. How should we think about Avant relative to Nexus? And what do you think you really hit your stride on Avant in terms of revenues?

Yes. Great. Thanks, Mark. Happy to talk about Avant; I'm always excited about Avant. So first of all, in general, we're really pleased with the continued progress on Avant overall. We launched that platform towards the end of last year. Just as a reminder, Avant is our new mid-range FPGA platform. It doubles our addressable market. What we're really excited about is it basically creates an entirely new greenfield revenue growth stream for the company. We feel really good about just the continued progress and execution on Avant. You asked relative to Nexus. When we look at the design win pipeline for Avant, it's very strong and continues to grow. Relative to Nexus, at the same relative point in time, the Avant pipeline is significantly larger, which we view as very positive. In terms of revenue, we continue to expect a small amount of initial revenue from Avant this quarter, Q4, as we've talked about in the past. It will be a small amount of initial revenue, but it's an important milestone for us because it marks the beginning of that revenue ramp for Avant into 2024, 2025, and beyond. We're also really excited about launching the next two device families in the Avant lineup. That's the Avant-G and X. We're expecting to launch that at the developers conference, Lattice Developers Conference in early December. By the time of the developers conference, with the addition of G and X, we'll have three Avant device families in the hands of our customers that address a wide range of applications across the mid-range FPGA market. I'm really excited about that and once we put all the samples in the hands of customers to drive that revenue ramp as we move forward. One other note, Avant leverages the same software as Nexus. So we leverage the same software investments that we've been making on the Nexus platform, and Avant takes advantage of those as well. Happy to share more about Avant, the new versions, G and X, at the Developers Conference in December.

Our next question comes from the line of Tristan Gerra with Baird.

So it sounds like the revenue shortfall relative to expectations for Q4 is all industrial and automotive related. So assuming that gives us about $95 million in Q4 for that segment, that's still above the run rate of '22. So the question, and I know you've mentioned weakness in China, how much further downside could there be in that segment that's been growing very meaningfully over the past two years? Where do you think your true demand quality revenue run rate baseline is in that market? And what was the significant growth in the past few quarters? Was it driven by inventory sales versus content gains? So just trying to see where we could land from a stable run rate, quarterly run rate in future quarters in that segment.

Yes, thanks, Tristan. On the back half of your question, we really see the growth that we've driven through the first three quarters of this year. And remember, that follows multiple years of double-digit growth, really as content gains. We've had significant design win growth over the past three to four years, and that's led to multiple years of double-digit growth. If you look at the midpoint of our guide for Q4, we would still expect the Industrial and Automotive segment to be up on a year-over-year basis for Q4. For the full year this year, we expect Industrial and Automotive to have, again, significant growth for the full year, for 2023. We believe that growth is driven by content gains and those content gains we believe are multiyear revenue streams. When we talk to our customers, they are seeing near-term demand softening based on their customers placing fewer orders with them. That softness is really driven by lower CapEx spending by their customers due to higher interest rates and higher cost of capital. So we remain pleased with the growth we've driven in this segment over the past year and continue to see Industrial and Automotive as a long-term growth opportunity for the company. We believe that industrial automation, robotics, automotive electronics, all present multiyear secular growth trends that will last for many years and that Lattice is well-positioned to take advantage of those trends, especially with the build-out of our Avant product line.

That's very useful. And then for my follow-up, you've mentioned in the past that you have very little in terms of LTSA. So what's your expectation for pricing next year? I know you're not providing guidance, but given the weakness, do you think that we get back to maybe a low single-digit decline in pricing? That's what a couple of analog companies have reported so far this earnings season. And where are your lead times currently relative to a quarter ago?

Yes, thanks, Tristan. On pricing, we see our pricing as generally stable and durable. As Sherri noted in her prepared remarks, we're in our fifth year of our gross margin improvement strategy, which included better pricing optimization. Over the past five years, we have found our pricing to be very durable, and we don't have any reason to think that would change. On lead times, I would say that our lead times are really back to normal, which we would define as kind of pre-COVID time. There can always be a particular silicon package combination that might be in tight supply. Overall, our lead times are generally back to normal, and more broadly, we view the semiconductor supply chain as being back to normal in terms of supply availability.

Our next question comes from the line of Blake Friedman with Bank of America Securities.

I just wanted to go back to Avant, and just relative to 90 days ago, have there been any changes related to your thoughts on how Avant is expected to ramp next year? And have any of the recent macro developments impacted the timing of any customer ramps?

Thanks, Blake. I would say no. In terms of changes in Avant, the only changes we've seen over the last 90 days are continued growth in the design win pipeline, which we expected, right, as we engage with customers and as new device families get closer to launch. We expect that overall pipeline to continue to grow. As for the timing of customer ramps, there are no changes relative to our thinking about how Avant would ramp next year. That's driven less by macro changes and more by the level of customer engagement and design win progress, and then the timing of when customers would enter production with those devices.

Got it, helpful. And then just as a quick follow-up on OpEx. If I look over the past few years, OpEx has kind of grown in this mid-teen range on an annual basis. Just curious how we should think about the trajectory of OpEx moving forward.

Yes, thanks, Blake. From an OpEx perspective, there can be fluctuations from quarter to quarter based on the timing of programs and things like that. You certainly have seen that over the past several years that we've been investing quite a bit in our long-term product portfolio and demand creation. Even in the current quarter, in Q3, sequentially, as well as year-over-year, you've seen that we've increased our R&D spend and the investments that we're making. Investing in our product portfolio for the long-term growth of the company continues to be a focus area for us. We want to make sure that we do it in a disciplined way. We want to ensure that we are investing the right amount in our product portfolio. The long-term model we put out at our Investor Day earlier this year, we talked about our OpEx being 30% of revenue and an R&D target at 18% to 20%. That long-term investment continues to be important for us.

Our next question comes from the line of Christopher Rolland with Susquehanna.

So there have been a number of companies that have reset revenue guidance recently. And it's spurred a reevaluation of customer inventory and channel inventory out there. Have you guys begun this process? Are you really comfortable with understanding the level of inventory out there, particularly after this downtick in demand at least evident for Q4? And are there any patterns geographically, in end markets, or actually by distributors themselves that you've noticed?

Yes, thanks, Chris. In terms of inventory, let me start with distribution or channel inventory. Most of our revenue flows through distribution, so that's really important to us. We have very good visibility on distributor inventory. When we look at distributor inventory where it ended in Q3, I would say it is very much within the normal historical range for us or Lattice in terms of levels of distribution inventory. We see that as healthy. There are one or two distributors that are on the relatively lean side in terms of inventory. But overall, in aggregate, our inventory level in the channel I would view as healthy and within the normal range. If we move to end customer inventory, we have thousands of end customers. We don't have perfect visibility on end customer inventory, but with some of our large strategic customers, we don't see obvious signs of excess inventory with those customers.

Great. And perhaps another one for you. So Altera came out with some kind of an interesting update on kind of pre-IPO track. First of all, they talked about a decline in revenue. It looks like maybe one-third of their revenue peak to trough. Is there an expectation for a decline? I just wanted your take on refocusing on the low end with new products they have coming in the first quarter of next year. And also refocusing on the channel and Industrial and Auto, an area where you've taken some considerable share over the past few years.

Yes. I can only speak to our business and what we see. We expect overall growth for the full year, despite the sequential guide down for Q4. If you look at where we're tracking for the full year, we are pleased with the progress, especially given some of the macroeconomic conditions in some of the end markets. Regarding competition, we will always assume there's robust competition in every market that we serve and every product that we build. Since I joined the company, we've planned our products to compete accordingly and feel good about the competitive positioning of our products. Our small FPGA portfolio and the Nexus product line are very competitive on power efficiency and feature set. We just launched our seventh device family based on the Nexus platform. We expect the sixth and seventh to go into production next year. On Avant, we feel good about its competitive positioning as well. We will always presume robust competition; our goal is to ensure our products are leadership in the markets and segments that they target.

Our next question comes from the line of Srini Pajjuri with Raymond James.

Jim, given the macro weakness, are you seeing any change in your customers' adoption of some of the new products? I understand you have a lot of them coming up and a lot of design activity out there. But given the macro, do you see any impact at all on the Avant ramps in the next few quarters?

Yes, thanks, Srini. Let me look broadly across all of our products, which includes Avant but also Nexus and even pre-Nexus products. In the first three quarters of this year, we're seeing another very healthy year of growth in our design wins, as we have over multiple years of significant growth. So we're pleased with the continued expansion of the design win pipeline. This benefits not just Avant but Nexus and pre-Nexus devices. Important to that design win growth is our software strategy which has positively impacted the rate and pace of our design wins. Our software portfolio is geared towards specific end-use cases that make it easier for customers to adopt our products and get to market quickly. We are pleased with the rate and pace of Avant design win growth, and we're looking forward to the revenue ramp starting as we expect at the very end of this year, benefiting 2024 and beyond.

Got it. And as a follow-up, Jim, you discussed auto and industrial weakening in Asia, potentially spreading to Europe as well. Nobody has perfect visibility, but any insights into how long these macro headwinds may continue?

Yes, thank you, Srini. Our customers are struggling to determine the timeline. They attribute demand softness to lower CapEx related to higher interest rates and the resulting cost of capital. While we saw this initially in Asia towards the end of Q3, we expect it to continue into Q4 and spread into Europe. We will provide more thoughts on Q1 and next year at the next earnings call.

Our next question comes from the line of Matt Ramsay with TD Cowen.

Jim, I wanted to dig into the trends in Industrial and Auto in that segment. So a few questions there. Could you help us break down that segment between Industrial and Auto business? Are you seeing any drastic differences in lead time trends between the two? And finally, any visibility into specific customers or applications where you're seeing weakness?

Yes, thanks, Matt. On the breakdown of Industrial and Auto, within that segment, we are definitely more weighted towards Industrial than Automotive, which is a smaller percentage. Automotive has been the faster-growing part of that segment, but overall our revenue comes more from Industrial. Regarding lead time differences, we don’t see significant differences between the two. The demand softness we’re experiencing is broad-based across many customers and applications in industrial automation and robotics. We expect to see this weakness continue.

Got it. I appreciate you answering all parts of my question. A quick one for Sherri. We’ve spoken about the performance of the company on a free cash flow margin basis. Is there a certain trend in end markets that would lead you to dial back spending? Or will you keep investing through this cyclical environment because of new products?

Yes, Matt. From an OpEx front, investing for long-term growth continues to be our focus. The long-term model we set at Investor Day for an OpEx of 30% of revenue remains intact. We want to invest in a disciplined manner and have made significant progress in the investments we've made with new products launched to date. We'll continue to ensure that we're investing the right amount in our product portfolio.

Our next question comes from David Williams with Benchmark.

So I guess, Jim, first. Just kind of understanding how small the Auto is relative to the Industrial segment. It is a greenfield opportunity for you. I'm just wondering if you could talk about the growth opportunities there and the mix optimization between the two segments.

Yes, thanks, David. So while auto is smaller within Industrial and Auto, it has been a faster-growing area. The applications we address include ADAS and infotainment systems. A recent win was with Mazda, where our device preprocesses video streams for their ADAS system. We see automotive electronics as a strong growth area for the semiconductor industry overall, presenting an obvious secular growth trend for Lattice as well.

And then secondly, Sherri, we've talked about the gross margin, and it's been surprisingly robust here. Does that give you greater confidence just in that trajectory and the sustainability of it? And does this potentially signal a rebound?

Yes, thanks, David. Gross margin at 70.6% is a record. We’re thrilled with the sequential improvement as well. Gross margin is an area we continue to focus on. At the midpoint of our guide, it is a range, right? 70.5%, plus or minus 1%. We believe our gross margin is durable, and we will continue to execute toward the long-term model we discussed earlier this year.

One of the benefits we’ve seen on gross margin is a higher software attach rate. As more designs utilize our software solution stacks, they generally achieve higher ASPs and gross margins. This is a tailwind over time.

Our next question comes from the line of Ruben Roy with Stifel.

Jim, you said you like to talk about Avant. So I was going to ask another question about Avant and specifically about the pipeline. The Avant SKU seemed to target Edge processing initially. Is that the area where you see most design activity or has that expanded?

Yes, thanks, Ruben. I'm always happy to talk about Avant. We're seeing great growth in the pipeline, particularly with Edge AI applications. The first product family we launched was Avant-E, optimized for Edge applications. This family is what will start to deliver revenue. The follow-on devices, Avant-G and X, expected to launch soon, will address a broader range of applications. We’ll share more details at the developers conference in December.

Got it. Great. If I could ask a quick follow-up. Any updates on client-side PCs? Are you seeing any design activity around that front at this point?

Yes, we continue to see client as a large TAM opportunity. Lattice devices are already engaged with several OEMs, including Lenovo and LG. While it's early to discuss specifics, we're excited about the collaborations and the potential for driving battery savings and improving security in client devices. We see this as a good growth area moving forward.

Our next question comes from Quinn Bolton with Needham.

First for Sherri and then an Avant question for Jim. Sherri, on gross margin as revenue pulls back, is there any sort of significant under-absorption or operational costs that could start to be a factor for gross margin? And then regarding OpEx, is there an upper threshold where you would start to cut absolute OpEx?

From a gross margin perspective, we've contemplated all these factors in our guidance for Q4. We believe our gross margin is durable and will continue to drive toward the long-term target model we set out at our Investor Day. For OpEx, we remain focused on investing wisely for long-term growth. Our target of 30% remains.

For Jim, can you clarify if the larger Avant pipeline translates into a faster revenue ramp, or is the larger pipeline more reflective of the TAM being much bigger?

The larger Avant pipeline being positive is encouraging, but the revenue ramp will depend on the pace at which customers can bring that product to market based on their natural timelines and platform refresh rates. The ramp of the Avant product line will evolve accordingly across the next few years.

Ladies and gentlemen, that was our final question. I would now like to turn the floor back over to Lattice's President and CEO, Jim Anderson, for closing comments.

Thank you, operator, and thanks again, everybody, for joining us on the call today. We're pleased with the solid results in Q3. We're really excited to continue executing on what we see as the biggest product portfolio expansion in the company's history and are excited to share more about that at our developers conference in December. Thank you for your time and operator, that concludes today's call.

Thank you. This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.