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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
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Good afternoon, my name is Gabriel and I will be your conference operator today. At this time, I would like to welcome everyone to the Third quarter 2018 Results Conference Call. [Operator Instructions] Mr. David Pasquale, you may begin your conference.
Thank you, operator. Welcome everyone to Lattice Semiconductor's third quarter 2018 results conference call. Joining us from the Company today are Mr. Jim Anderson, Lattice's President and CEO; and Mr. Max Downing, Lattice's Chief Financial Officer. Both executives will be available for Q&A after the prepared comments. If you have not yet received a copy of today's results release, please e-mail Global IR Partners using lscc@globalirpartners.com or you can get a copy of the release off of the Investor Relations section of Lattice Semiconductor's website.
Before we begin the formal remarks, I'll review the Safe Harbor statement. It is our intention that this call will comply with requirements of SEC Regulation FD. This call includes and constitutes the Company's official guidance for the fiscal fourth quarter of 2018. 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. The matters that we discuss today, other than historical information, include forward-looking statements relating to our future financial performance and other performance expectations. Investors are cautioned that forward-looking statements are neither promises nor guarantees. They involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. Some of those risks and uncertainties are detailed in our filings with the Securities and Exchange Commission, including our Form 10-K for the fiscal year ended December 30, 2017 and our quarterly reports on Form 10-Q. The Company disclaims any obligation to publicly update or revise any such forward-looking statements to reflect events or circumstances that occur after this call.
Our prepared remarks also will be presented within the requirements of SEC Regulation G regarding Generally Accepted Accounting Principles or GAAP. Some financial information presented by us during the call will be provided on both, a GAAP and on 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 for results and underlying trends. Management uses non-GAAP measures to better assess operating performance and to establish operational goals. Non-GAAP information should not be viewed by investors as a substitute for data prepared in accordance with GAAP. If we use any non-GAAP financial measures during this call, you will find the required presentation of and reconciliation to the most directly comparable GAAP financial measure in the Company's earnings press release.
At this time, I would like to now turn the call over to President & CEO, Mr. Jim Anderson. Please go ahead, sir.
Thank you, David, and thank you to everyone for joining us on our call today. We are pleased to report that results for the third quarter of 2018 meet or exceeded Lattice's guidance. We continue to execute well with our near-term business focus on driving profitable revenue growth, carefully managing our OpEx and paying down corporate debt. We again checked all of those boxes in Q3 with our highest non-GAAP EPS since the third quarter of 2014. We further reduced OpEx to $38.4 million, and we made an additional $15 million discretionary debt payment. Max will provide further detailed commentary on the results in just a few minutes.
Before I hand it over to Max, I thought it would be helpful to provide some background on why I joined Lattice and what near-term actions we're taking. As you get to know me over the coming quarters, you'll see that I'm focused on unlocking the full potential of Lattice. For over 20 years I've worked in the technology industry across many markets including consumer, enterprise, data center and telecom. I was most recently in-charge of A&D's computing and graphics business since Q2 of 2015. That was an exciting time as we were able to drive a strategic and operational transformation that brought disruptive new products to the markets and delivered market leading revenue growth and significant profitability expansion for A&D.
When the opportunity to lead Lattice was brought to my attention, I did my own extensive due diligence on the company. It quickly became clear to me that Lattice has a strong position with much greater potential. Lattice has a solid product portfolio with sought-after technology in market solutions, a Tier-1 global customer base, and a deeply talented team. Our secure low power programmable technology is in high demand and highly relevant to many growing end market and applications worldwide. Importantly, we're in a position to capitalize on inflection points in the market such as intelligence at the edge, increased industrial automation, continued growth in the electronic content in the automotive market, and the coming 5G wireless infrastructure rollout to name just a few examples. These inflection points create increased demand for programmability in small, secure, low-power applications where Lattice leads.
From a customer standpoint, Lattice has an impressive Tier-1 customer relationships already in place, including an existing solid footprint across many large global customers across multiple geographies. We have the opportunity to do much more with these customers. To extend and expand these relationships, we have to be more closely aligned to our customers long-term application needs. The key focus for our team will be increasing the alignment between our customers' needs and our product roadmap and ensuring that our customers can count on us for a steady cadence of new innovations over multiple product generations. This will allow us to build deeper multi-generational partnerships with our customers and is central to our ability to drive steady revenue growth and sustained profitability.
To help with these efforts, we recently hired two new key executives; Steve Douglass, our new Corporate Vice President of R&D; and Esam Elashmawi, new Chief Marketing & Strategy Officer. Steve was most recently at SightLinks [ph] and joined Lattice to lead our global engineering team. He will help ensure that we have a world-class R&D execution machine. And Esam, who was most recently on Microsemi will help ensure we are focused on the right markets and applications, and we are bringing the right products to our customers. Together Steve and Esam have nearly 70 years combined FPGA business and engineering experience. I'm confident their experience and in-depth understanding of the FPGA market will help us make Lattice the defacto standard in small, secure, low-power FPGAs.
As I spend time with the global Lattice team over the past couple of months, I've been impressed with Lattice's highly talented team. The company has a scrappy fast-moving culture that gives us a real competitive advantage. The team has built a strong product portfolio with more new products on the way. For example, during Q3 our team expanded the Lattice sensAI software stack with features to help speed time to market for developers of low power artificial intelligence applications across all our segments. We also engaged top server manufacturers with our new security solution for platform for more resilience. As the industry moves to more secure systems, we are well positioned to provide more value to our customers. Overall, we are committed to driving profitable revenue growth and bottom-line results that build greater value for the company and our shareholders.
Let me now turn the call over to Max for additional details on our financial results. Max?
Thank you, Jim. The key takeaway that you have today is that we continue delivering profitability and leverage improvements as we focus on our core business, market expansion and fundamentally improving our cost structure.
Our revenue for the third quarter was within our expectations at $101.5 million, compared to our expected range of $100 million to $103 million, and down by 1% from the second quarter revenue of $102.7 million. On an end-market basis, communications in computing was up 11% sequentially and 19% year-over-year, primarily on continued growth in the server business. Mobile and consumer was up 11% sequentially, and 4% year-over-year with the third quarter inclined driven by strengthening consumer. Following five consecutive quarters of growth, industrial and auto was down 14% sequentially, and up 12% year-over-year. The quarter-over-quarter decline is driven largely by late third quarter softness, primarily localized in Asia, due to conservatism related to the macroeconomic conditions and tariffs. Licensing and services was down 19% sequentially and down 22% year-over-year, primarily due to prior royalty audit settlements.
Gross margin on a GAAP basis was 57.5%, compared to 48.9% in the second quarter. The prior quarter GAAP gross margin included approximately $8.3 million or roughly 800 basis points of inventory write-off directly related to the shutdown of our Millimeter Wave business. Our non-GAAP gross margin improved to 57.4% just above the middle of our expected range of 55% to 59%. This is up from 57.2% in the prior quarter as improved product mix and other efficiencies more than offset the effects of slightly lower licensing and services revenue. Third quarter GAAP operating expenses was $45.4 million compared to $63.8 million in the second quarter. The prior quarter included $4 million in restructuring charges, and $11.9 million in impairment charges related to the shutdown of our Millimeter Wave business. On a non-GAAP basis, operating expenses were $38.4 million, down about 4% from $39.9 million in the second quarter, and better than our third quarter guidance range of $39 million to $41 million.
Our GAAP net income for the third quarter was approximately $7 million or $0.05 per basic and diluted share. This represents the first quarterly GAAP basis net income since the fourth quarter of 2014, and compares to a net loss of $20.2 million or a loss of $0.16 per basic and diluted share in the prior quarter. The second quarter included $24 million or $0.19 per share in restructuring and impairment charges associated with the shutdown of our Millimeter Wave business. On a non-GAAP basis, third quarter net income was $13.8 million or $0.11 per basic and diluted share, as compared to $12.4 million or $0.10 per basic and diluted share in the second quarter.
In alignment with our goals to delever our balance sheet, we made debt principal payments of approximately $16 million during the quarter including a $15 million discretionary principal payment; this is in addition to the $10 million discretionary principal payment we made last quarter. And we ended the quarter with healthy cash and short-term investments in approximately $117.5 million allowing us flexibility for future discretionary debt payments and the ability to support our customer's long-term roadmaps.
This concludes my portion of the call, and I'll turn it to Jim for our outlook.
Thank you, Max. Revenue for the fourth quarter of 2018 is expected to be between approximately $93 million and $97 million. This reflects an expected inventory reduction at some distributors, in addition, we are seeing softness in the industrial and consumer markets, particularly in Asia. We expect this to be partially offset by strength in the communications and computing markets.
For gross margin in Q4, we expect approximately 57%, plus or minus 2%, on both a GAAP and non-GAAP basis. Total operating expenses for the fourth quarter are expected to be between $52 million and $55 million on a GAAP basis, and between $37 million and $39 million on a non-GAAP basis.
Operator, we can now open the call for questions.
[Operator Instructions] Your first question comes from the line of Charlie Anderson from Dougherty & Company.
I wonder maybe if you could just drilldown a little bit more on some of the weakness that you're seeing, are there any particular used cases in -- is it something that we should think about as a longer term associated with trade wars or is it short-term in nature? And any elaboration there would be helpful, and then I've got a couple of follow-ups.
Maybe I'll start and then Max will add a little bit of commentary as well. If you look at the Q3 to Q4 sequential guidance that we're giving, what I would say is the downward guidance is really kind of two parts; the first part is, we're expecting an inventory adjustment at our distributors, so about half of the downward adjustment or downward guidance from Q3 to Q4 is due to anticipated inventory reductions out of the distributors. And then the other half is due to some softness that we're seeing in industrial and consumer; we're really starting to see that at the very end of Q3, sort of in the last month of Q3 and we're expecting that to roll into Q4, and that's partially offset by some strength that we're seeing in the communications and computing segments, sets a little additional color on Q3 to Q4. Max, do you want to add anything to that?
No, I think that was pretty comprehensive Charlie, unless you have any follow-up questions to that.
And then on the comms on competing upside, that's certainly interesting. I think we've heard some of your peers talk about 5G starting to get pull-forward. I wonder if you're seeing it yourself and maybe if you could just elaborate on Lattice's position for 5G, does that rolls out over the next few years? That would be helpful.
I'll comment on the near-term piece. We're seeing -- in the near-term what we're seeing with respect to the comms and compute is, it's -- for us it's really driven by the compute and the server ramps at multiple customers there and we see the comms component of that really being more of a 2019 aspect, and Jim probably has something to add with respect to our position there as well.
Yes, I'll just add a little bit of additional color. On the compute segments, that's really -- servers going to the data center and called [ph] applications, and the functionality that we're providing to those servers is manageability and security functionality. We've got a nice footprint across the number of different server vendors today and so that's -- we're seeing good growth there, we expect that to kind of continue moving forward. And then on the comp segment, like Max said, when we look to the 4G to 5G wireless infrastructure transition, we have a bit more content on the 5G infrastructure than on 4G, so we'll see an expansion in content, so that's 5G ramp; we expect that to be a growth factor for us. But that will -- that's more of a 2019 and beyond impact for our revenue.
I wonder if you could just reconcile what you're seeing in gross margin; we sell industrial down but then consumer up and then stable margin. It sounds like there are some cost initiatives that are hitting and just wondering how much head room you see to improve gross margin even beyond what you're doing right now? Thanks.
Yes, you're exactly right. In the third quarter, we saw industrial down with typically and historically would suggest a margin degradation in the quarter but a lot of -- as you know, we've been focused pretty strongly on margin expansion initiatives and we're seeing those things provide a little bit more stability. As we go forward, we're going to continue to focus on margins as an area of opportunity through, both better pricing, as well as better cost structure and targeting our market focus to those higher ASP markets as we move forward. So, I'm not going to necessarily comment on the long-term future but we feel like we've got a good solid foundation providing stability to the margin.
Your next question comes from the line of Christen [ph] from Baird.
You mentioned some debt payments for Q3, could you please update us on your debt deleveraging in terms of a debt ratio target and the timing expectations?
As you know, our stated goal for a while now has been to paydown about 20% of our outstanding debt by the second quarter of 2019, and that -- when we establish that 20% line, our debt balance was right around $300 million. And along with that goal was to get our leverage ratio down to right around 3x, and that's our gross debt leverage ratio. And we've been making discretionary payments the last two quarters and in fact, increased it here in the third quarter and with those payments in our current $275 million debt balance using our Q3 EBITDA run rate we're under that 3x ratio. We still have a little ways to go to get to that 20% target but our financial priority is to continue to delever and paydown the debt as we go forward.
Could you please give us an update on the 28 nanometer ramp?
So our next major platform update is on the 28 nanometer node, our next tape-out [ph] is coming very shortly with the engineering team very focused on that, we're making good progress on that, we're really excited about that new platform generation, that will bring a lot of new key capabilities to our product line, it's a brand new platform for us and we're just really excited to get it to market and pleased with the progress that it's making the tape-out [ph] is soon, and then the product launch -- we'll talk more about the product launch once we get closer to the actual launch date.
[Operator Instructions] Your next question comes from Christopher Roland [ph] from Susquehanna International Group.
I guess to start out Jim, as you look over the business, your first couple of months there; what do you think are the biggest opportunities where you can add value based on your past relationships in customers? And then I'd be curious to get kind of your take on the bigger picture opportunities like AI at the edge as well.
So on the first part, on where I can add value. One of the nice things as -- just over the couple of months that I've been on board, as I've had a chance to meet a number of our key customers, one of the nice things is; with many of those customers I have existing relationships and one of the pleasant surprises as I joined Lattice was -- as I got to know the footprint that Lattice has at our customers really is a pretty extensive footprint across what I would call global Tier-1 really marquee customers. And so Lattice has a really nice footprint today but I do see a lot of opportunity for expanding that footprint, both in terms of breadth and depth and one of the nice -- well, as I mentioned, one of the nice things is I have a lot of existing relationships there already. So hopefully, it will help us expand our footprint quickly.
And then in terms of some of the new growth areas that I see, certainly artificial intelligence is a good potential growth opportunity for us. Our sensAI software stack is something that we're really excited about, we actually expanded that software offering in Q3, we're really excited about the -- we look at the edge of the network, especially new applications for artificial intelligence processing at the edge of the network across the variety of markets, industrial, automotive, consumer markets. Now I do think that artificial intelligence, how the processing is happening is still evolving and so we do see that as a longer term growth factor but a good important growth factor for us moving forward.
So yes, maybe one other place that I'm excited about is on the compute side; and we mentioned this a little bit already but the manageability and security processing [indiscernible] and the servers that go into our data center and cloud; really some nice features, we've got a new product coming out soon that brings some new capabilities in terms of firmware protection. And so I think that will be a nice growth factor for the company as well.
I guess, just in general on the macro picture; and maybe inventory levels at your distributors -- you guys are certainly not alone in saying kind of thoughtness in the marketplace right now. But what kind of ability do you guys have to inventory levels through your distribution channel? I guess, can you see how bookings were through the quarter, when did some of the softness kind of start to appear? And then, how big might an inventory should be -- like, how long could it last?
Maybe I'll start and see if Max wants to add. We do have very good visibility of the levels of inventory that are held at our distributors, and as I mentioned, we are anticipating that there is some inventory draw down this quarter at our distributors. We would attribute that to more sort of end of year, tightening up of inventory levels, sort of normal end of year tightening. And then, it's going to be a little bit of that attributed to some of the conservatism that we're seeing in the market right now around the macroeconomic climate, especially in the Asia geography. And then in terms of -- just when did we first start to see a little bit of softness in terms of the softness in demand that we saw in industrial and consumer. As I mentioned, that kind of started to happen at the very end of Q3, say the last month of Q3 and we're anticipating that rolling into Q4. Max, did you wanted to add any additional comments?
David, I think the only additional thing that I would add to what Jim had there was that, we do some fairly granular analysis of our distributor inventory including terms and expected sell-through and those types of things; and while it is up a bit, we are within the historical range of distributor inventory levels, so we're not alarmed at all in that regard.
[Operator Instructions] Your next question comes from the line of Richard Shannon from Craig-Hallum.
I guess maybe I'll ask a question on the industrial weakness here. Jim, you talked about it being in Asia. Is there any specific geographies within Asia you're seeing it more so than others or is it broad based?
I would describe it as more broad based and it's across the number of different product lines as well; so it's not localized any particular product line; so in general, the Asia geography.
Max, I asked this question last quarter about OpEx; I think you talked about a goal of getting down towards $37 million per quarter on a pro forma basis, your guide here is $37 million, $39 million, so we're getting fairly close, certainly you did better than my estimates. Curious as whether your $37 million goal is something you'd like to update or do you think you can beat that? Any thoughts about where you're going there.
I think going forward on OpEx and we're not guiding beyond the fourth quarter at this point but not different than the past, we're going to continue to focus on improving the operating leverage in the company, right, and we're going to continue to focus on operating expenses in our overall cost structure. With respect to R&D, I think what you'll see our focus there really is on increasing the efficiency and the effectiveness of the R&D machine that Jim was talking about a little bit earlier, a little bit ago. Within the existing R&D investment envelope, with SG&A, I think you'll see us focus on that with respect to trying to identify any cost structure improvements so that we can make there.
Jim, obviously you've been on board here for a couple of months; curious when should we expect to hear about your kind of full strategic plan with financial goals, is that something we should expect next quarter or how do you anticipate communicating that fully?
We're expecting to do a financial Analyst Day next year, we haven't nailed down the specific date but certainly next year. And I'm looking forward to sharing the long-term strategy, our long-term business model and some of our product plans and market plans as well, so it's something we're looking forward to.
Well, I'll look forward to that as well, that's all my questions. And I look forward to working with you Jim. Thanks.
[Operator Instructions] Your next question comes from the line of [indiscernible].
I was wondering, you mentioned a couple of these opportunities and inflection points on the side -- I'm thinking audio and industrial is what you mentioned in your prepared comments. I was wondering if you might be able to frame how big of an increase in tame [ph] opportunity that is for Lattice or any sort of revenue objectives that you might be able to get from those markets?
Probably at this point we're really only talking about Q4 guidance, so I'll provide any specifics beyond that. But -- yes, there are couple of things I talked about was -- in the 4G to 5G transition, we do see an increase in our content and with that 5G ramp, we're expecting that to be a growth factor, we talked about compute. And then the only other thing I would mention is, in the industrial, it was an auto segment, we are seeing increased demand for automation in the industrial segment, and in a number of cases and a number of applications that the requirements are really to have a small, low-power, very flexible device that Lattice's solutions are just sort of a perfect fit for. So we're seeing a lot of activity interactions in an industrial automation space, so that's something that we see as a long-term potential growth factor for the company overtime as well.
There are no further questions at this time. I will now turn the call back over to CEO, Jim Anderson, for closing remarks.
Thank you, operator, and thank you everyone for joining us on the call today. So in summary, the key takeaways from our call today are that we have a solid product portfolio. We've got an extensive footprint with Tier-1 customers and a deep talent base that puts us in a strong position moving forward. We've added new marketing and engineering leadership with really broad industry experience, and we are very focused on growing Lattice's core FPGA business, and that's by delivering profitable revenue growth, expanding our gross margins, carefully managing our operating expenses and paying down our corporate debt; all of these will increase value for our shareholders.
We appreciate your continued support and encourage you to reach out with any follow-up questions. Operator, that concludes today's call.
Thank you very much. Recording of today's conference will be available in approximately two hours at toll-free 1-800-585-8367, or internationally at 404-537-3406. Thank you very much.