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Executives

Darin G. Billerbeck – President and Chief Executive Officer

Joe Bedewi – Corporate Vice President and Chief Financial Officer

Analysts

Sanjay Devgan – Morgan Stanley

Lattice Semiconductor (LSCC) Morgan Stanley's 2012 Technology, Media & Telecom Conference Call February 27, 2012 7:15 PM ET

Sanjay Devgan – Morgan Stanley

Okay, thank you guys, I have to thank you everyone for coming today, for those of you that don’t know me, my name is Sanjay Devgan, I am a member of the Semiconductor Equity Research Team here at Morgan Stanley. It’s my pleasure to have the management team from Lattice Semiconductor with us today. To my left is Darin Billerbeck, the CEO and to his left is Joe Bedewi, the Chief Financial Officer. I think Darin is going to start this off with some high level overview of the company, and then we’ll jump into Q&A.

Darin G. Billerbeck

Okay, thanks, Sanjay, and thanks everybody for joining us here today. So the company has got a very interesting last year or so, that we’ve gone through a lot, I came in last November, November of 2010 and there was a lot to be done. So the company had suffered from about a decade where, let’s call it meandering and not necessarily having the right tools for the job, since, we come in, we’ve restructured most of the company, in fact, all of our restructuring would be substantially completed by the end of, well most of that was done by the end of last December, that’s about a quarter less of operations.

And you may say, so what have we accomplished? What are the end results? The results for the year speaks for themselves, we grew a little faster than our peers and the groups Xilinx and Altera where we grew about 7%, they grew somewhere between 5% and 6%, I think for Altera and Xilinx was probably flattish, but I think the key is, we did a lot, while we had a lot of balls in the air, and a lot of people will say, we try to change the tires of the company while it was still rolling.

R&D has been completely restructured, so the base of R&D is now out of San Jose, with a low cost geography in the Philippines, the Philippines didn’t exist and it was the group of people that we hired actually bought a group of R&D experts that we had hired and developed in the 1990, so they were part of an Intel organization that we essentially picked up after many years and when Intel closed down those factories, we potentially picked up that capability, that site now is about 70 or so head, gone from about zero to 70, if we’re just about 4:1 ratio of R&D resources compared to what we had. The good news is that is pretty done our latest project which was ECP4, which is our 6 gig SERDES product for the comps market capped out late last year and first of it comes out in another few weeks.

So we expect to have samples in the first half of this year on that product that’s really our highest performance, highest low-density products, so a lot of good things happened in R&D.

At the same time, we restructured operations – all of our operations out of the U.S. and into the Philippines or into our Subcon so we have, what we would call air traffic control for a logistics and planning in the U.S. over [New Oregon] and then everything else was in the Philippines or Subcon and a little bit in Singapore, so the operations has been also restructured, Joe and his team also outsourced IT, we were challenged pretty significantly in our manufacturing systems, our operational Systems, R&D systems.

We are probably five or six years behind in technology and when we finally came to grip someone who is going to take this shore of IT, it was probably more than we wanted to afford and was easier and cheaper to have an outsourced model, so that’s been done. And then finally, we restructured the executive team, we did that early on after we completed our strategic long range plan and that team essentially now has about 50% to 60% new people on it, all very aggressive with the capacity to change the culture and capacity to run very quickly.

So a lot has been done. Our strategy is done. Our product line business plan has been done. Our annual operating plan has been completed. Obviously it’s not the greatest environment in Q1. Q1 is going to be a challenge, but there are some good signs, I think from the comps market as opposed in Q4. In Q4 we saw a lot of the comps market push out some stuff, which just zeroed out. I think it took a lot of people by surprise, everybody in the FPGA market certainly by surprise. Q1 is right where I think a lot of people expected it, being a little uncertain, a little cloudy, but people are now starting to rebook at least in the comps market and we are feeling a lot more comfortable about how we are seeing things from an environment.

We still don’t know what the year is going to look like. I don’t think anybody really does with (inaudible) and everything else [going], I think there will be some uncertainty for some time. But all in all, that was a challenging year for sure. I moved up to Portland. I’m still cold that you guys can see that San Francisco hasn’t helped me get any warmer. But in a nutshell a very challenging year, very rewarding, a lot of great people, places, changes, have a long way to go on the culture, but we are making some good progress. So, and I am happy to be here by the way. Thank you for inviting us.

Sanjay Devgan – Morgan Stanley

Thank you. So we are ready. Okay, good. Maybe I’ll thanks for the overview, Darin. To kick it off, you touched on Q1 being challenging and that was actually a very common theme we’ve heard from a number of companies that have presented today. But as you look, for example here, obviously wireless infrastructure is a big driver for yourselves as well larger competitors.

Can you talk about what are your thoughts on inventory levels within the channel? I guess, first off. And then secondly, are you seeing any signs of come back from that market to give you confidence that perhaps there will be a second half year loaded or a second quarter, I mean, any kind of color you can provide there, would really appreciate it?

Darin G. Billerbeck

So the inventory levels weren’t abnormal. Obviously we didn’t have a lot of inventory as seen from Q4. Our distributors don’t have a lot of inventory. We don’t sell as much through distribution in the heavy comps market as a lot of people want to go direct. We don’t have a lot of visibility into our end customer inventory and anyone would suspect that’s probably where the inventory is along what’s probably a demand shortfall as the year unfolded.

But I think this quarter, one of the big things is just the fact that people are booking and [saying], get ready, here is what is going. I believe Q2 and Q3 will be better than Q1. How much? I don’t know. But the indications from a few of our key comps guys today is they are still ramping up and they are still ready to go for 2012 obvious. I don’t know if it’s going to get back to the 2011 big ramp because we missed that also in Q4 right, Q4 of last year, same inventory correction itself.

And then Q1, everybody, said it was going to be [this long]. It came in better and then Q2 just went crazy and I think a lot of that could have been the Tsunami. It could have been a lot of things. So we see, at least I see that it looks like it’s better than it was. How good? We don’t know, but I don’t see it dropping of the (inaudible) Q2 like it did in 2008.

Sanjay Devgan – Morgan Stanley

On the programmable side, there is always a tradeoff of upfront cost for the ASIC versus the higher variable cost if you go FPGA. Two larger competitors have also powdered the fact that FPGAs are displacing ASPs and ASSPs and it actually looks like that on the consumer side, for you guys, you’ve some interesting design wins or products that you gear specifically for the consumer end market.

I was wondering as you look at kind of your growth opportunities going forward, can you give us any color as to how much are you guys depending upon ASIC or ASSP conversion to FPGAs versus just growth of the FPGA market that will drive result? I mean, have you guys ever done any work on that math in terms of splitting the market growth opportunities between the two?

Darin G. Billerbeck

Yeah. So the first comment I’ll say is we are not the big guy, right. So we are targeted much lower than they are. We don’t need to be on events [just targeting] because we are not driving those [blood] structures that they do and I’m actually glad that they are going off and doing some of the higher and either dual core or single core process integration because that’s a difficult thing to do and coming from Zylog and running Zylog microcontrollers and microprocessors are difficult.

And so, that’s going to be a challenge for them. Although, if you look at the architecture they are selling into, that’s one way that they can continue to grow and there is lots of opportunity. If you look at where we’re targeted, again we are the smaller company that looks at $50 million, $75 million opportunity in more segments and I joke with people about Moneyball. But if you’ve seen the movie, Moneyball, where the athletics, those guys with the Yankees, okay. So we can afford to play in this big investment market like they do, and we have to be really clear about who we are and what we can afford. We are buying basis, we’re buying on basis percentages, we are not buying home runs and we are not buying the best of technology. So for us that means, we target ourselves on these lower end market, one which we brought up, which is, you focus on the consumer market, where we think you can drive a lot of volume, 1 billion units of a lot of anything, it doesn’t take a lot of those at a buck has double our company size.

So and that’s tablets, smartphones, laptops, televisions, all of that stuffs. So for us, it doesn’t take a lot to make that significant inroads in a market that didn’t exist being SiliconBlue, right. So we acquired SiliconBlue, that’s the market we’re focused. As that evolved, one can argue more and more of low end basics could get displays by an FPGA, which isn’t the model, the big guys are planning, it’s a different model. If they are sitting on a 130-nanometer and they have to play all these in assets and we can provide 2k, 4k led devices then you’re going to absorb a lot of a lower end ASICs over time and one could potentially think about other things that could get integrated.

Sanjay Devgan - Morgan Stanley

Okay. So speaking off, I mean so speaking with the consumer business, SiliconBlue I think you guys mentioned you shipped around 10 million units.

Darin G. Billerbeck

They shipped.

Sanjay Devgan - Morgan Stanley

Or they shipped 10 million units, but now it’s been kind of brought in-house, and it’s really weird to see this kind of dynamic for programmable companies. I was wondering, as you look at this consumer opportunity, particularly in the handset space, can you talk to some of the functionality or the ASICs rate as these are specifics that are replacing? What that functionality that they are subsuming and other IP blocks, can you give us some example of other IP blocks, that you can bring to SiliconBlue to actually got a more of the [bomb] within the handset?

Darin G. Billerbeck

Sure, you know, first of all SiliconBlue and Lattice both were attacking the same market.

Sanjay Devgan - Morgan Stanley

Right.

Darin G. Billerbeck

And it made sense that we combine forces rather than beat each other in a true or false trying to win the opportunity. Both of those targeting similar applications some are out of power down and take offloading, half of graphics units. So the things that could be done in a graphics process that could also be done in FPGA. It was simple things like when you rotate cameras or you rotate some of the smartphones and the image keeps rotating with you.

They are simple applications and some of those get integrated over time, some of them are cheaper to doing FPGA. They are Sensor Hubs, which means you’ve got probably 15 sensors in your phone or tablet that tell you where it is in a orientation to where your head or in your pocket or those things.

And those Sensor Hubs have to be more flexible because the industry standards are changing, the sensors themselves are changing. And so we are able to provide a programmable solution, where they won’t have to be right, when they do this design. They can always design it later. And in both of the cases, we’ve had some customers that have designed in programmable logic, made a mistake the product has been out in the market. And they actually did a software patch over the wireline and reprogram the device to fix the consumer product that was already on the field.

So huge benefits not only for the fact that they would have probably had to bring some of products back, they fixed it in the field and the second thing it was a great cost structure. It provided the performance, and that’s what we are after. The problem that we have right now is teaching and training people how to use lower priced, lower features that programmable logic in areas where it’s never been used before. Because it’s easy on the high end, when you get sophisticated development, but on the low end since somebody just want a level shifter or a bridge or a latest interface that becomes more of a design win, but once you have that in the references whether it’s Sensor Hubs or a memory controllers or hard drive hot-swaps or all that stuffing go through distribution and you can sell it through a wider channels.

Sanjay Devgan - Morgan Stanley

I mean you kind of address this a little bit in your last response, when you go from kind of wireless infrastructure or kind of the traditional market you think about for TLB type products or [FOG] type products to more high volume consumer products. I was wondering if you can talk about some of challenges, and I think one of the benefits is what you mentioned the programmability in the fields, you can reprogram on the flights, so if there are issues with the products, that’s one benefit, but I was wondering on the flip side, what challenges if any you guys are encountering. One of the kind of warranty issues dealing with these kind of consumer markets or is that just – is that one level down and that's not something you guys have to worry about?

Darin G. Billerbeck

Yeah, I think the biggest issue that we come up against is lumpy, right, because you get a win that you don't know about. They don't want to tell you until the last minute because they are not sure, which product kicks off. So the inventory models are always challenging, so you have to carry more inventory, but because the cost of that inventory is much less, you can carry a lot more. And some of the mistakes that we've made and we've learned from is, we got into an eReader, we didn’t believe the demand, we weren’t getting a PO, we didn’t build the inventory and then the first containment with an order, and so we had to scrape up a 1 million units overnight to support that need. So that’s a part of the thing Joe has been working on with the team which is.

How much inventory do we position, where do you position it, how do you use your supply line for the benefit of both the customer, but then also take a risk out from us, so and then standardizing a product, so the products that are standardized and the inventory is really a lot less risk all of that. So keeping people of the custom products, having the right inventory level and then understanding some of that will be lumpy.

Sanjay Devgan - Morgan Stanley

Got it. One other issue, or it’s not issue, but one thing that has been talked about is, just the gross margin trajectory, you are doing a lot of 40-nanometer tapes that, tape out, I was wondering if you can give us an update on what’s going on with the 40-nanometer transitions and how we should think about that and margins longer term?

Joe Bedewi

Sure. So, SiliconBlue is on 65-nanometer right now, we’re actually shipping 40-nanometer product, as we convert customers, that’s where we start to seeing them move towards our corporate average gross margin. So that should be not happening now, we should see a substantial movement by Q3, we have also got our ops that got to this point. But as Darin mentioned earlier, moving to Manila, so when that happens, we all have freed up cost in Oregon that will be gone, so there is some upside potential there for ops, so we will see an absorption issue related to [ops].

We see gross margins hovering in our model range, between high 50s, low 60s and the 40-nanometer with SiliconBlue is mission critical, movement of the ops was critical for us, we are also doing stuff shifting from gold to copper. That transition is ongoing now, we have customers in transition for that, so that all will happen by mid year. We should see more stable gross margin model in the second half of this year.

Sanjay Devgan - Morgan Stanley

So speaking of the gold to copper transition, is that more a case of getting the products qualified on the customer side or is there, what’s that you need to do on your side, so i.e. is this engineering or that needs to be done or is it just matter of qualifying it with the customers and getting them comfortable with that transition?

Darin G. Billerbeck

It’s a little above. There is an element of the technology people are worried about. Obviously, a tax spend of copper in the particular bond wires that we have. From an external standpoint, there is no difference. From an internal standpoint, it’s more difficult. So first, we have to overcome the hurdles and in fact that there is a lack of capacity, because everybody is trying to get the copper as quickly as they possibly can. And then for us, it’s also managing the inventory between gold and copper. And the only way we can do that is, pick up the highest volume runners that we have, so we get the biggest things for the benefits, and you are going to have cross shift for sometime. Some customers and some of the more sophisticated markets that needs very high reliability may not convert 100%, may take them over time, that they’ll run their own series of test other people just say, give me what you’ve got, so you are going to have a mix between the very detailed, specific, more rugged applications versus the consumer and everyone else, which is and they are okay with the PC and the product changes and that they are off to the races. But we are doing the 18-20, it’s like 20% of that volume is 80% of the benefit, so we are going to convert that as fast as possible, okay.

Sanjay Devgan - Morgan Stanley

One thing that was interesting is, consumer market naturally implies higher volume from a foundry perspective, as you kind of look to your foundry partners, what are the thoughts or have you watched those discussions with the foundry partners on like back to the ASPs may be much lower, but the foundries, they are kind of blind to that it’s more a cost of the units going on, I mean, is there potential to get better pricing from the foundry partners as the volumes go up?

Darin G. Billerbeck

When you are talking tens of thousands of diaper wafers, that doesn’t drive a lot of wafers.

Sanjay Devgan - Morgan Stanley

Okay.

Darin G. Billerbeck

So the good news is, I think holistically we look at it, as we have to make those business model work, at the same wafer cost that we do our standard product, and so it really comes down to the die size that they were, the featured sets that we offer, the test plan, the packaging plan, all the things that are important to the cost structure, we focus on, so we don’t have a deal with any suppliers or consumer we have a different wafer cost. We are trying to have the unique base that we use today and then we have to be able to hit the cost target, and we feel comfortable today that with SiliconBlue acquisition in our XO2 product lines, I don’t think there is anybody in the world that can do what we are doing.

Sanjay Devgan - Morgan Stanley

Okay. Perhaps, I will open it up to the audience, if we have any questions from the audience, now I can continue. Doesn’t look like and so, if we move to wireless infrastructure, we talk a lot about the consumer opportunity. On the wireless infrastructure side, you have your ECP3, ECP4 is coming. I guess, first off, can you talk to the LTE opportunity [granted] majority of your business from my understanding is largely 3G focused. When do you anticipate having kind of an LTE-enabled solution and when do you think that actually manifest something material?

Darin G. Billerbeck

So a lot of people mistake our product line as being wireless or wired comms being ECP2, ECP3, ECP4 and the hidden secret is XO out ships those. So our XO product line, which fits in the wireline or wireless, is our most popular and most, actually it’s the best product that we have in the line and we follow that with XO2, which is a 65 nanometer version of the same product just with a more features that’s in a much lower cost structure.

So in all of them, we can sell XO, we can sell XO2, and possibly overtime even some SiliconBlue offering. For the ECP3 family, ECP2 on the 2G, I think that will fell off over time. We got some upside last year from some of the 2G infrastructures that we’ve built out in Africa. ECP3 is still growing and we expect to do quite well with ECP3 this year. In fact we expect to grow ECP3 significantly as we go through the year.

ECP4, we expect to start sampling in the second half of this year. So that’s really the primary 6 gig SERDES product that hands the LTE performance and that should be a good product, albeit, that’s going to be a product that competes more directly with Xilinx and Altera. And so, that will be more challenging for us, but I think it’s a good place for us to stick the wedge and then drive some of the cost structures off of that. But I wouldn’t anticipate. Just because LTE grows, doesn’t mean we won’t play with XO or XO2 and other things. We may not win every socket on ECP4, but we are still going to win a lot of business with all other targets.

Sanjay Devgan – Morgan Stanley

Speaking of competing against the big guys, the Alteras and Xilinxs of the world, typically have you gone head-to-head against them in certain markets? So I’m wondering the times when you actually have won design, what has been kind of differentiators, been easy of programmability of device, incumbency? I’m just wondering what has been if you track what’s been the differentiating factor, and then you try to bottle that magic, so to speak and kind of replicate that process? I was just wondering…

Darin G. Billerbeck

Well, this is the beauty of being laid, which we were laid on many of our products is that not that that’s a program for success in the future, but the beauty of being a little bit laid on those is we could add features that Xilinx and Altera didn’t had, right, for instance the latest standard interface. So the latest thing that maybe they didn’t have time because they were leading for it.

So the ECP3, the success of ECP3 had head into with a lot of things. One was it was very low power. In fact it was the lowest power at the time in the industry. It had DDR3 interfaces on it. It had 3 gig SERDES and it was really at the right price point, right. To duplicate that means you really going to target another product kind of right in this mid-range performance, but also meet the customers' needs for big enough to supply those.

Our software isn’t good as our competitors, although we are working better. We spend a lot of time on ease of use. The ease of use is a little bit subjective, but we still have a long way to go on software. I think as time goes on the eases of use of software and the ability for customers to be able to translate from our competitors’ software to ours, we can make it easier for them to do that. We’ll do a lot better than we have done in the past.

I wouldn’t point to any one thing, but I can tell you we don’t want to be late in the future. So we want to be at the right time with the right cost structure with the right performance and have software that supports them.

Sanjay Devgan – Morgan Stanley

Okay. Maybe kind of switching gears to the higher level, you talked about the restructuring [larger] being completed. You consolidated the number of design centers. You have a new team in the Philippines, R&D team there, new IT, outsourcer the IT teams. As you look at the company kind of go-forward and you look at kind of where you want to go and what you want to do from an operational standpoint, do you think there are any other kind of I wouldn’t say big, heavy listing, but kind of low-hanging fruit that you guys can kind of pick off to continue to drive operational efficiencies go forward or I mean, I’m sure there’s always something that is always being…?

Darin G. Billerbeck

Yeah, I mean the biggest challenge that we had coming into the company and this is really all the new ELT number of course. We need to be get down to nuts and bolts of finance, right because we need to understand every element of margin structures, the cost structures to how we match different things to different products to that overall plan that enables us to hold that margin model. And that’s really what Joe came in to do with his expertise.

If you look at the rest of it, it comes out of execution from R&D. So R&D need to be able to execute at a faster pace, than we did before. And then be able to use our low cost geographies, and do all the derivatives, and proliferation. And even with this year with all the challenges that we had, we still turned out three different proliferations, we didn’t have on the roadmap in addition to take (inaudible).

So we’ve made good progress, but our goal is really to double and triple the number of price to time. Just back to the Moneyball statement, we are playing the game with basis on base percentages not with home run, so for us it is all those $50 million market that the big guys ignore, and having enough products to fill in from the mid range, all the way through the bottom. And then we will each and we will do it again.

So we’re not going to play with them on 22-nanometer development. We have to focus on the things that we do well. And there is tons of opportunity from an execution standpoint. And there is tons of opportunities for architect lower cost that will make it difficult for them to keep compete with us in the spaces that we play.

Sanjay Devgan – Morgan Stanley

Okay, great. Let me just check and see if there is any questions or actually follow up questions if not perhaps we will just end it there. And thank you so much for the time. We really appreciate it. Thank you.

Darin G. Billerbeck

Okay, thanks everybody for joining us. Thank you.

Question-and-Answer Session

[No Q&A session for this event]

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