Ladies and gentlemen, thank you for standing by. I would like to welcome everyone to the Lattice Semiconductor Third Quarter Fiscal Year 2019 Earnings Release Conference Call. Later, we will conduct a question A replay will be available approximately 2 hours after the call today. The replay dial in number is 4045373406. The conference ID number is 919-fifteen twenty nine.
The replay will also be accessible on Lattice website at latticesemi.com. I would now like to turn the call over to Rick Mieschey. Please go ahead.
Thank you, operator, and good afternoon, everyone. With me today are Jim Anderson, Lattice's President and CEO and Sherry Luther, Lattice's CFO. We'll provide a financial and business review of the third quarter of 2019 and the business outlook for the fourth quarter of 2019. 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. 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 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 2019. 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 presented by us 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 these non GAAP financial measures to GAAP financial measures that can be found on the Investor Relations section of our website at lattasemite.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. I'm pleased with the strong results Highlights for the third quarter of 2019 included revenue growth in line with our expectations, gross margin expansion of 2.40 basis points year over year 80 basis points sequentially to 59.8 percent on a non GAAP basis. Non GAAP operating profit for the company was 25 percent of revenue, a new 10 year high and non GAAP EPS increased 55% on a year over year basis. Let me now provide an overview of our business by end market. In the communications and computing market, revenue increased 5% sequentially in Q3 as we continue to experience strong sequential growth and year over year growth in this segment.
In computing, our revenue and servers for enterprise and cloud data centers increased sequentially with growth on increasing our content in next generation servers by adding security functionality with our new Mach X03D product family. In the communications market, we're benefiting from increased 5G infrastructure deployments. Our 5G revenue increased sequentially in Q3 as we continue to expect 5 Turning now to the industrial and automotive market, revenue declined 4.5% sequentially in Q3 as we experienced some demand softness towards the end of the quarter related to the macroeconomic climate and continued trade tensions. Despite some near term softness, we believe this segment will remain a long term growth factor for us given the breadth of applications that we serve. Long term growth drivers include the proliferation of robotics and industrial automation and the steady increase in electronic content in autos, Turning now to the consumer related to macroeconomic conditions.
We remain focused on serving the higher margin areas of the consumer market where our solutions are enabling customers to differentiate their products. As an example, support development of next generation human presence and gesture detection. I'll now provide an update on our product roadmap execution. First is SenseAI, our award winning low power AI solution stack. Last week, we released an update further extends our innovation in ultralowpowerai.
This new version introduces enhanced support capabilities enabling faster inference performance and human facial recognition. Moving to Mach X03D, our new Secure Control FPG we recently received the National Institute of Standards And Technologies cryptographic Program Certification. This security standard is extremely important for our enterprise customers and makes our solution even more compelling. We're pleased with the accelerated and broad customer traction we're seeing with this product on next generation server platforms. We also launched and sampled our new Crosslink Plus product in Q3.
Developers are using this product to enhance their user's experience by adding multiple image sensors or displays to embedded vision systems. And as a result, we expect to generate initial revenue for this product in Q4 of this year. Finally, at our Investor Day this past May, we committed to sampling our next generation FPGA platform in early 2020. I'm very pleased to say that we are executing ahead of schedule and we now expect to sample customers before the end of the year. This new product platform based on FDSOI Technology has been architected from the grounds up for low power operation, which enables a significant power reduction for our customers across many different applications.
We're looking forward to sharing more details about this innovative next generation platform at a special product launch event planned for this December. In summary, we're pleased with our strong financial results in Q3. However, we're even more excited about the solid execution of our product roadmap so specifically the accelerated product rollouts of both Crosslink Plus and our next generation FPGA platform. This execution fidelity is a direct result of the key strategic portfolio management and resource deployment decisions we made in late 2018. Those actions drove a sharp focus across the company on delivering high ROI products and accelerating the cadence and time to market for our new product roadmap.
We remain focused on executing our business strategy and product roadmap for sustained long term revenue and profitability growth. I'll now turn the call over to our CFO, Sherry Luther.
Thank you, Jen. We are pleased to deliver revenue growth gross margin expansion, record profitability and a further de levering of our balance sheet. We are making substantial progress on our commitment from our Investor Day as we move closer toward our target model. Let me now provide a summary of our results. We achieved 3rd quarter revenue of $103,500,000, up 1.1% sequentially from the 2nd quarter.
Product revenue growth in communications and computing helped offset a sequential decline in industrial and automotive as well as consumer. Our key long term growth drivers remain intact. Gross margin on a GAAP basis was 59.4%, compared to 58.7% in the second quarter and up from 57.5% in the year ago third quarter. Our non GAAP gross margin expanded to 59.8 percent from 59% in the prior quarter and from 57.4 percent in the year ago third quarter. This was due primarily to product cost reductions, pricing optimization, and higher IP revenue.
We have now delivered 3 consecutive quarters of gross margin expansion. While we have made meaningful progress and as we work toward achieving our long term target model. Q3 GAAP operating expenses were 44,800,000 compared to $45,600,000 in were $35,900,000 compared to $35,500,000 in the second quarter. As a percentage of revenue, Operating expenses were R and D increased to 17.8 percent of revenue, while SG and A decreased to 16.9 percent of revenue. The mix of OpEx continues to gradually shift toward our target model of R&D at 20% of revenue and SG and A at 15% of revenue.
Our GAAP EPS for the 3rd quarter was up 67% sequentially and increased 100% from the year ago third quarter. On a non GAAP basis, EPS for the 3rd quarter was up sequentially 6 and 13% per diluted share and increased 55% from the year ago third quarter. Accelerating $85,000,000 in cash flow from operations, which is four times the cash generated over the same period in 2018, underscoring our focus on cash generation. Compared to $122,600,000 at the end of Q2. At our Investor Day, we detail our plan to actively delever the balance sheet Year to date, we have made 107,000,000 in total debt payments, including $33,400,000 in Q3.
As a result, our non GAAP debt leverage ratio as defined in the credit agreement is now below 1.5. To put this in perspective, we allowed us to reduce the interest rate by another 25 basis points for a total reduction of 300 basis points in 2019. Let me now review our outlook for the fourth quarter. Revenue for the fourth quarter of 2019 is expected to be between $97,000,000 $103,000,000. Gross margin is expected to be 59.5 percent plus or minus 1% on a non GAAP basis.
Total operating expenses for the 4th quarter are expected to be between $35,500,000 $36,500,000 on a non GAAP basis. As we look forward, Our priorities and focus are unchanged. We remain committed to expanding our profitability increasing our cash flow generation and de levering our balance sheet to build additional value
We have a question from Tristan Gerra from Baird. Your line is now open. Hi,
good afternoon. Given your increasing exposure in data center and also ongoing changes in mix, How should we look at typical seasonality going forward by quarter and including for Q1 terms of sequential changes in revenue?
Yes. Thanks, Tristan. In general, our business over the last year in particular, you've seen a shift in the makeup of our revenue towards higher percentage of comps in compute and industrial and automotive, versus, for instance, consumer segment. And so our revenue shifted to those segments. And would say that's made our business a little bit less susceptible to seasonality.
There is still some seasonality in our business with respect to specifically consumer, right? Normally, we would expect, for instance, consumer to be down from, say, Q4 to Q1 But it's really a consumer that's the only segment that exhibits significant seasonality now.
Okay, great. And then, as a follow-up, your DRAC sales increased nicely sequentially. Was there a particular end market that was the driver for that increase?
Tristan, could you repeat the width sales were you asking? Could you repeat?
Yes. So the non distribution revenue, the DUAC sales, which increased sequentially, was there a particular catalyst for that increase sequentially?
No, I, that can vary from quarter quarter distribution versus direct. So I don't think there was any particular catalyst for that, but we view that as within the normal sort of variance that we can see from quarter to quarter.
Okay, great. Thank you.
Your next question comes from
Thank you very much. Good afternoon. Jim, I wanted to ask a question and you called it out in your script about some of the AI applications, facial recognition and a whole bunch of that you listed that some of your low power FPGAs are enabling. And I wondered if you might expand upon that a little bit. What are the customers that are driving that?
How, I guess, deep are the engagements and might they continue to expand on your new generation FPGA platform as you guys roll it out?
Yes, thanks for the question, Matt. So, first of all, a lot of that's related to our SenseAI software stack. So our Sensei software stack is a software stack that we introduced first about a year ago. We made refinements over the course of this year, introducing new versions that have improved the performance and, features and capability And what that software stack really allows our customers to do is to make it very easy to use our FPGA product in AI applications, particularly at the edge of the network. And, in particular for inference processing at the edge where you want to basic decision making, in edge computing applications.
And we've seen really good adoption of that and quite a bit of customer traction and interest. And it's across a number of different segments. We've certainly seen consumer related applications for that, whether it's facial detection or key phrase recognition, you know, we can also analyze an audio or video signal and, pick out different patterns in the audio or video So not just consumer applications, but also we've seen, applications in the industrial segment for as well, for instance, analyzing production line as, in a manufacturing line and, and detecting manufacturing excursions, for instance, and things like that. So We're quite pleased with the progress that we're making with, SenseAI and AI in general. And, yeah, it's been broad based across a number of different applications.
Got it. Thank you for that. As my follow-up, Sherry, the whole team laid out some pretty ambitious gross margin targets at the Analyst Day, 6 odd months ago. And, looks like you're coming in even better than those those expectations. And you mentioned in the script that you had a number of different levels levers to continue working on margins as you go forward.
Maybe you might expand on those and sort of remind us of what your long term ambitions are on the gross margin line? Thank you.
Yes, sure, Matt. Yes, so as we outlined at our Investor Day, we talked about some of the levers of gross margin expansion related to pricing optimization and product product cost reductions. And so the improvement that we have seen to date, Q3 over Q3 to 240 basis points, you can see is really delivering those levers that we mentioned at our Analyst Day. And the long term target that we laid out our Analyst Day of over 62% in near by years 3 4 out there, is really looking at those levers, including mix. And so the way we laid it out there in terms of the pricing optimization, we said roughly a 500 basis point increase from 2018 to get to our target model gross margin and We laid that out in terms of the, about 200 basis points improvement in pricing optimization, another 200 in product cost reductions.
And then another 100 in mix. And so that's kind of the way to think about the progress that we're making, moving forward with the 40 basis improvements that we've achieved so far and really the levers that we're looking at continuing to pull on, to achieve our target model.
Thanks very much.
Operator, did you want to bring her
Stefer Rolland from Susquehanna. Your line is now open.
Maybe you guys could talk about your outlook for next quarter by end market, how you see those trending? And then I know it's early, but some people have given thoughts on Q1 expectations versus typical seasonality given the difficult macro out there. I wonder if you guys had any thoughts there as well. Thanks.
Yes, thanks, Chris. So first on the Q4 guidance, if you take a look at the midpoint of our guidance, from a year over year perspective, it's up from a sequential perspective, it's down sequentially. If I speak about kind of what are the key drivers that we see sequentially a couple of things driving the expectation for a sequential decline. 1 would be, we're expecting our IP revenue to decline sequentially. We had a little bit higher than normal IP revenue in Q3 and we expect in Q4 for IP revenue to decline back to what is kind of considered by us to be the normal run rate.
So that's, you know, maybe a $1,000,000 to $2,000,000 sequential decline And then the other factor I would say is in the industrial automotive segment towards the end of Q3, we did see a little softening in at the end of Q3 related to, we think, macroeconomic conditions and continued conservatism around, trade negotiations and dynamic nature of trade negotiations. And we're expecting some of that softness to continue into, into Q4. So those are kind of the main factors for the the sequential movement from Q3 to Q4. And then, probably early, too early for us to give, any thoughts on Q1 and specific. But I will say, you know, if we go back to our investor day in May, you know, where we see over the long term, growth coming from for the company is in those 2 main sectors of ours in, 1st of all, in comms and compute.
And then secondly, in industrial and automotive, we really see those 2 sectors as the long term growth drivers for the company.
Great. Well, I guess, great gross margin guidance, particularly given that IP declined sequentially there as well. As a second question, maybe you can just talk about FD SOI. How do you see this affecting top line? Is it a revenue accelerator for you guys?
And is it really about taking share here or these new kind of greenfield opportunities that FPGAs haven't been able to address before? How are you thinking about the FDSOI opportunity?
Yes, thanks. So first, the FDSOI is the technology that our sure that we're bringing to market with new features, new capabilities. And then that's built on top of the FTSOI Semiconductor technology. And, you know, what FDSI brings is at a transistor level a much more power efficient transistor level. And so for instance, you know, roughly 50% lower power than, for instance, regular or bulk CMOS technology.
And on top of that, then we add our own, low power architecture and other features and capabilities So we're really excited about that next generation platform. I, as I mentioned in the prepared remarks, we were actually executing a bit ahead of schedule. If you remember back in May of at our Investor Day, we talked about, 1st samples for this this platform being in the first half of twenty twenty. We're now expecting to provide first samples to our customers before the end of the year. I'm quite pleased with the engineering team's execution on this and we're excited to get this in the hands of customers.
We're also expecting special launch event in December to roll out the new product. And so we'll talk more about it at that time. But in terms of the business impact or revenue impact, from that product, we would expect that to be to begin to generate, revenue for us in probably the second half of year. That would And so that's when we would expect to see the business benefit. And then, of course, in the following years, we expect it to be a bigger, bigger revenue benefit.
I see. Thanks so much.
Your next question comes from the line of Richard Shannon from Craig Hallum. Your line is now open.
Well, Chris, guys.
Thanks for taking my questions. I apologize. I got in a little bit late, so I may have missed some of the prepared remarks, but let me ask you a question on the, the comms segment. It looks like it was up a few percentage points. I think you made some comments about 5G benefiting.
Maybe if you could kind of replay those comments and maybe unpack whether the comms business would have been up sequentially without 5G?
Yes. Thanks, Richard. So in comms and compute, we saw good sequential growth and also in that segment very, very good year over year growth think around 27% year over year growth in that segment. But in terms of sequential growth, we saw, growth in both the compute and communications parts of that segment. You know, a couple of the growth drivers are, 5G, you mentioned that.
So we saw sequential growth from Q2 to Q3 and 5G. But we also saw a nice growth in our server revenue from Q2 to Q3 as we continue to benefit from our higher attach rate and higher ASPs that we have in the current server platform generation versus the prior generation. So, Yes, the segment has been a good growth factor for us over the last couple of years and certainly in the most recent quarter.
Okay. Maybe I'll follow-up on the just looking at the comms part of that segment. Again, Is the business outside of 5G? Is that growing? Obviously, we have some trade tensions with a very large OEM out there sanctioned by the U.
S. Government maybe if you can kind of help us understand the dynamics in the third quarter and whether you have any worries about that going forward?
Yes, from a sequential standpoint, Q2 to Q3, I think it was relatively stable, across those two quarters. And you know, look, moving forward, the main driver for that segment will certainly be 5G wireless infrastructure deployments over the coming years. I mean, 2019 is really just the beginning of the 5G wireless infrastructure build out it's really only, happened in a couple of countries, a couple geographies, you know, moving into next year and the following years, we'll start to see greater build outs in North America eventually in Europe too. And so we think that, you know, in the 5G wireless infrastructure and our very healthy position in that will be nice long term growth factor for us.
Okay, great. My last question, I'll jump out of line. Specifically in the automotive space here, we're seeing some some difficult numbers coming out of the, some of the major automakers worldwide, particularly in Europe. And I know historically Lattice has had a pretty good exposure in Europe. Maybe if you could help us understand the degree to which you've seen an impact from a units perspective and maybe offsetting as how much you've been gaining share to offset that?
Yes. In the Industrial Automotive segment, Automotive is still a relatively small part of our revenue in that segment. And Certainly, we are we have a number of different customers there and so we're subject to any macroeconomic slowdown affects automotive. But we do believe automotive electronics is a good long term growth engine for us we're seeing a very healthy design win funnel in automotive electronics. Obviously, there's increasing electronics and automotive moving forward.
And we're seeing, as I said, very healthy design win funnel with customers. And so we think this will be a nice, growth propellant for us for a number of years to come. Thanks Richard.
Your next question comes from the
Yes, thanks for taking my questions. I'll start with kind of a 2 parter on margins. I wonder as FDSO start to layer in back half of next year, as you mentioned, what is the impact on gross margins if you could speak to that? And then also on, on the OpEx side, we sort of flattened out here a little bit. I think SG and A on an absolute dollar standpoint sort of flattened out.
I know you guys want to get to 15% at some point. So is that more of a revenue growth that gets you there? Or is there still some opportunity determine the SG and A side? And then I've got a follow-up.
Thanks, Charlie. So on the FDSOI or next gen FPGA platform, we are planning that program or that set of products that will be based off of that platform, to be a margin benefit to us. We're trying to build into that, the design of those products and the marketing and the positioning of those products, a margin tailwind for us as those products, as those products ramp. You know, I would say in the second half of next year, we expect to see some initial revenue But I think the actual impact to our margin would be pretty muted in the 1st year just because the level of revenue would be pretty small in the 1st year. But moving toward the outer years as a program or is that generation of products continue or contributes to higher amount of revenue have more of an impact, positive impact to our margin.
And then on the second question on the OpEx, on SG And A, yeah, in terms of absolute dollars, it was roughly flat Q2 to Q3. But we are not done in SG and A yet. We still are looking at areas to continue to try to drive SG and A to that 15% target. And that is still, we still expect that to be a combination of absolute dollar declines as well as, just better, better scale as revenue ramps as well. So I would say we're still looking at additional absolute dollar declines in the SG and A bucket.
Great. And then there was some commentary in the script about the the press release to in the quarter about the NIST standard and securities, a source of content gain for you. So I wonder if you can just speak to the ramifications of that standard and some of the content opportunities that are out there, end markets that want to adopt the security? Thanks.
Thanks, Charlie. Yeah, that's on our mock X03D product and that one we launched in Q2 and what that is is that that product is an FPGA that we've added specific security technology to, and it allows that product to provide platform root of trust and essentially allows that product to ensure that the hardware or firmware in system has not been tampered with, whether it's tampered with in production or in transit or when it's been deployed. And so we're really excited about that product. We've seen very good, traction with, for instance, server OEMs for next generation server platforms. The reason that that, that particular standard is important, the NIST standard is that's basically a good stamp of approval that this meets the right security requirements.
And so it's an important it's an important stamp for our customers progress. And beyond the server customers, we see this product as potentially applicable in a number of different markets to basically provides security in all sorts of endpoint devices, whether those should be client computing platforms or other endpoint devices in the network.
Great. Thanks so much.
Thanks, Charlie.
Your next question comes from the line of David Duley from Steelhead. Your line is now open.
Thank you very much. I was wondering it seems like your new product introductions have been accelerated versus previous conference calls on your Analyst Day. I'm just wondering, with the acceleration of new products, does that mean that you'll achieve higher levels will hit your accelerated levels of revenue growth sooner than you had before. And could you just remind us what the long term revenue growth goal is?
Yes, let me start with the last part of your question, Dave. And that's at our Analyst Day in, in May of the earlier this year. What we provided is that over this year and next year, our revenue growth would be expected to be kind of in the mid single digits in terms of year over year percentage. And then in the 3 to 4 year timeframe, we would accelerate revenue growth into the low double digits is what we expected. And And yeah, certainly to the extent that we can accelerate the product roadmap or get things to market quicker in the hands of our customers quicker, that certainly helps, help solidify our long term growth objectives.
And I would say, asked a little bit about the products and why they were accelerated. If you recall, at the end of last year, and we've talked about this previously, we did a pretty extensive portfolio, optimization where we looked at every single product and project that the R and D team was working on and really justified that each project according to it's ROI and strategic value. And we pruned out a lot of projects that we believed were low ROI or just didn't have the right value for the company. What we did then is we took the resources that we saved out of pruning out some of those projects and we doubled down on the high ROI projects and really focus the R and D team on driving the high ROI programs to market quicker to increase the cadence of our roadmap and to increase the time to market. And so a couple of the programs that I mentioned that have had some schedule acceleration I really view that as a direct result of that portfolio optimization and R and D focusing that we did last year.
And so our Crosslink Plus product which launched in Q3. That's, that sampled a little earlier to customers than expected. We're actually expecting to generate initial revenue from that product this quarter. And then I mentioned our next generation FPGA platform as well. Originally, we thought samples early next year now, samples before the end of the year.
So yeah, I'm pleased with the progress on the product roadmap and R and D team has done a good job to execute the schedules and actually pull in a bit.
Okay. Next question is, As far as your server business goes in the with the cloud computing guys, you've talked about increasing content there with the with the next generation platforms that are being rolled out. Could you just help us understand where are we on the next generation of server platforms being rolled out by the big customers, whoever they might be, the intel's of the world, I guess. And, what we should expect going forward from this segment with that progression of the customers adopting the new platform.
Sure. In the current generation that's really ramping today, sometimes it's called by its code name that per generation. And that current generation that started ramping last year has been ramping this year. One of the reasons out that's a big growth opportunity for us or has been a good growth performer for us is that versus the prior generation of servers, we increased both our attach rate and our ASP. So our attach rate roughly tripled from prior generation to this generation and our ASP went up as well.
And so that helped to drive a significant amount of growth for us. That's, for instance, part of the reason that our comps and compute sector this quarter in Q3 was up 27% year over year. And if we look forward to the future generations of the server, which aren't, haven't started ramping yet, What we're focused on there is, of course, maintaining our high attach rate, but also continuing to bring more value to the customers and higher ASP along with that value as well. So we're trying to bring more content, more value to the server customers And then that mock XO3 product that I mentioned earlier is part of that. That product brings new security functionality We're working with the server customers to get that designed into future server generations to again bring more value and continue to drive growth in that segment a long period.
And just as a follow on, about what you just talked about, did your server unit volumes grow this quarter or was more of an ASP increase. And then just as a final clarification, could you just talk about any revenue into China and are you recognizing revenue that you sell to Huawei?
Yes. So in the 1st unit in ASP on the sequential increase from Q2 to Q3, it was a combination of both. And both unit and ASP relative to certainly the prior generation. And then in terms of, China or Huawei revenue specifically, So we are shipping to Huawei. We are shipping only those products that we've deemed, compliant with export restrictions.
And so near the end of Q2 of this year. We did a very extensive legal analysis of which products are compliant with export restrictions, using both internal counsel as well as leveraging multiple external legal firms as well. So we did very extensive analysis and we're shipping those products that we've deemed, deemed compliant at this point.
Thank you.
There are no further questions at this time. I would like to turn the call back to Lattice CEO, Mr. Jim Anderson for closing comments.
All right. Thank you, operator, and thanks everybody for joining us on our call today. So in summary, we achieved a new 10 year high in our non GAAP operating profit as a percentage of revenue. On the product side, our solid execution has enabled us to launch and sample crosslink plus ahead of plan and to pull in sampling of our next operation FPGA platform, which is based on FD SOI Technology. And overall, we remain focused on executing to our business strategy and our product roadmap.
We appreciate your support and, look forward to updating you on our progress moving forward.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.