Good day. My name is Jerica, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter and full year 2018 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star then one on your telephone keypad. If you'd like to withdraw your question, please press the pound key. It is now my pleasure to turn today's program over to David Pasquale of Global IR Partners. Sir, the floor is yours.
Thank you, operator. Welcome everyone to Lattice Semiconductor's fourth quarter and full year 2018 results conference call. Joining us from the company are Mr. Jim Anderson, Lattice's President and Chief Executive Officer, and Ms. Sherri Luther, 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 email 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. In addition to today's results, we would ask that you please note on your calendars that Lattice's management will be hosting investor meetings at Morgan Stanley's Technology, Media, and Telecom conference in San Francisco on February 25th and at Susquehanna's Annual Technology Conference in New York City on March 12th.
Please also note, Lattice will be hosting our Analyst and Investor Day in New York City at Nasdaq's market site in Times Square on May 20th. If you would like to attend the May 20th Analyst and Investor Day, please RSVP by emailing your contact information to lscc@globalirpartners.com. Before we begin the formal remarks, I'll review the safe harbor statement. It is our intention that this call will comply with the requirements of SEC Regulation FD. This call includes and constitutes the company's official guidance for the fiscal first 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.
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 30th, 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 will also 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 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. Non-GAAP information should not be viewed by investors as a substitute for data prepared in accordance with GAAP. I would like to now turn the call over to Lattice's President and Chief Executive Officer, Mr. Jim Anderson. Please go ahead, sir.
Thank you, David, and thank you everyone for joining us on our call today. I've been on board for about five months now, and I continue to be very excited about the potential of Lattice. We're well-positioned in large, growing markets. We have a solid footprint across many of the world's leading OEMs, and we have a differentiated product portfolio with new products coming to market later this year. We now have a new management team in place to lead the company forward. Despite the uncertainty in the current macroeconomic climate, I'm pleased to report that Q4 of 2018 developed as planned with revenue, gross margin, and operating expenses in line with our expectations. In Q4, we also expanded cash flow from operations by roughly $20 million sequentially, and we made another $15 million discretionary debt payment as we continued to de-lever our balance sheet.
In terms of the full year, 2018 was an important transition year for us. We shut down non-performing businesses to focus on our profitable and growing programmable logic business, and we made solid financial progress in 2018 across a number of key areas. We improved our profitability and raised our Non-GAAP operating income from 9% of sales in 2017 to 17% of sales in 2018. We tripled our Non-GAAP EPS year-over-year as we continue to focus on driving profitability expansion. We also significantly improved our cash flow in 2018 and used our cash to de-lever the balance sheet. In 2019 and beyond, we will continue our focus on driving profitable revenue growth and bottom-line results that build greater value for our shareholders. Let me now provide an overview of our business by end market.
In the communications and compute market, revenue was roughly flat sequentially in Q4 and up about 9% for the full year of 2018. We benefited in 2018 from growth in our products that are used for manageability and security in servers. We have a strong position across a number of different server vendors, and we saw good growth in 2018 as the current server platform generation began to ramp in data center and cloud applications. We're also seeing strong customer interest in our early access program for our next-generation security solution. We believe our next-gen solution has a solid competitive advantage, and that server and client security can be an important growth vector for us moving forward. In the communications market, we are starting to see early demand related to the 5G wireless infrastructure build-out.
We expect the 5G build-out to be a growth driver for us since we are well-positioned across many OEM 5G platforms. However, although we are seeing initial demand from 5G, it's still in the early stages of the ramp, and we continue to expect 5G to be a material contributor to our revenue in the second half of 2019 and into 2020. Turning now to the industrial and automotive market. Revenue was down sequentially in Q4 by 8% and up 17% for the full year 2018. As expected, we experienced softness in Q4 in this segment, particularly in Asia, which we believe is related to the uncertain macroeconomic climate and trade tensions. For the full year, the strong growth in the industrial and auto market was driven by increased automation in factories and increased electronic content in autos.
In automotive, we are gaining traction with our CrossLink solution for video bridging for ADAS and infotainment systems. We are also seeing strong design win momentum in a wide range of industrial automation applications, such as autonomous robots and motor control. Turning now to the consumer market. Revenue was down sequentially in Q4 by 21% and down 9% for the full year 2018. The Q3- Q4 decline was due primarily to macroeconomic weakness, particularly in Asia, as well as product life cycle transitions. Moving forward, we are focused on serving the high-margin areas of the consumer market, where our solutions can help designers competitively differentiate their products with high value-add features such as voice recognition and face detection.
Our business has already moved away from the more volatile and low-margin handset market. We intend to be more selective in this market segment as we focus on profitable revenue growth moving forward. In summary, despite some uncertainty in our end markets due to the current macroeconomic climate and trade tensions, we are positioned to benefit over the long term from multiple catalysts in our business, including growth in servers used in data centers, growth in industrial and automotive applications, and the global 5G build-out. We're excited about 2019 as we unlock additional value for the company and its shareholders. Let me now transition from talking about our end markets to providing a couple of other recent product highlights. We are very pleased that our Lattice sensAI solution stack was just named a Hot 100 Product of 2018 by "EDN" magazine.
Lattice sensAI combines programmable hardware, neural network IP, software tools, and reference designs to accelerate customer development of AI inferencing in a wide variety of edge computing applications. In 2018, we also launched Lattice Radiant, which is our next-generation FPGA design software. Ease of use is a key feature of Radiant because that helps accelerate customer adoption as we expand our reach across the broad market with our low-power solutions. Finally, over the past months, we've also simplified the company's operating structure and added experienced, proven leaders to all critical business functions. In addition to the new R&D and marketing leaders that I discussed on our Q3 call, we recently added three new important leaders to our team. Glenn O'Rourke joined Lattice in December from Xilinx to lead our global operations and supply chain team.
Sherri Luther joined Lattice in January from Coherent as our Chief Financial Officer, and Mark Nelson joined Lattice in January from Intel's Programmable Solutions Group as our Head of Worldwide Sales. Our new leadership team is excited about the opportunities ahead of us to unlock the full potential of the company. With that, I would now like to welcome our new Chief Financial Officer, Sherri Luther, to the call. We are very pleased to have Sherri on our team. Sherri is a CPA with nearly 30 years of financial and operations expertise. Most recently, she served as Corporate Vice President of Finance at Coherent. Sherri is a great addition to the Lattice team, given her extensive financial and operational experience. Let me now turn the call over to Sherri.
Thank you, Jim. I'm excited to join Lattice given the company's position in a high-value segment of the semiconductor industry and the impressive leadership team Jim has assembled. I look forward to working closely with all of our investors and analysts as we execute on our strategy. Let me now give you a summary of our results. Results for the fourth quarter met our expectations. Revenue was $96 million, which was within our expectations and down by 5.4% from the third quarter revenue. For the full year, revenue was up 3.3% to $398.8 million from $385.9 million in 2017. Gross margin on a GAAP basis was 56.6% compared to 57.5% in the third quarter. Our Non-GAAP gross margin was 56.7%, which is down from 57.4% in the prior quarter, primarily due to product mix.
We are working to return to sequential gross margin improvements in Q1 as we remain committed to expanding gross margin over the longer term. For the full year 2018, gross margin was 55% on a GAAP basis and 57.2% on a Non-GAAP basis, compared to 56.1% and 56.3%, respectively, in 2017. Fourth quarter GAAP operating expenses were $56 million, compared to $45.4 million in the third quarter. On a Non-GAAP basis, operating expenses were $37.8 million, compared to $38.4 million in the third quarter. Our GAAP net loss for the fourth quarter was $7.1 million or $0.05 per basic and diluted share, compared to net income of $7 million or $0.05 in the third quarter. The fourth quarter includes restructuring charges of $11.9 million compared to $90,000 in Q3.
On a Non-GAAP basis, fourth quarter net income was $11.1 million, or $0.09 per basic, and $0.08 per diluted share, as compared to $13.8 million or $0.11 per basic and diluted share in the third quarter. On a full year basis, GAAP net loss reduced to $26.3 million or $0.21 per basic and diluted share, compared to a net loss of $70.6 million or $0.58 per basic and diluted share in 2017. On a Non-GAAP basis, net income expanded for the full year 2018 to $43.4 million or $0.34 per basic and $0.33 per diluted share, compared to $13.6 million or $0.11 per basic and diluted share in 2017. During the fourth quarter, we generated $31 million in cash flow from operations, an increase of $20 million from the third quarter.
For the full year 2018, we increased cash flow from operations to $51.5 million as compared to $38.5 million in 2017. We have been actively working to de-lever our balance sheet, we made another $15 million discretionary debt payment in Q4, for a total of $40 million in discretionary principal payments during 2018. We expect to continue to reduce our corporate debt balance through discretionary payments. Finally, we increased our balance of cash and short-term investments to approximately $128.7 million at the end of Q4 from $117.5 million at the end of Q3. As we look forward, we remain committed to increasing our profitability and cash flow and de-levering our balance sheet. Once again, I'm very pleased to be part of the Lattice team and excited about our future. This concludes my financial review. Let me now turn the call back to Jim for Lattice's outlook.
Jim, please go ahead.
Thank you, Sherri. Revenue for the first quarter of 2019 is expected to be between approximately $94 million- $98 million. Gross margin is expected to be approximately 57.5%, ±2%, on a Non-GAAP basis. Total operating expenses for the first quarter are expected to be between $37 million- $39 million on a Non-GAAP basis. Operator, we can now open the call for questions.
At this time, if you would like to ask a question, please press star then one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Charlie Anderson with Dougherty & Company.
Yeah, thanks for taking my questions and my congrats on a strong Q1 guide in light of the tough conditions that are out there for sure. Wanted to start, Jim, with sort of a big picture question. I think you've outlined there's opportunities here at Lattice to enhance profitability and then also drive an enhanced product portfolio and roadmap for your customers. I wonder if you can maybe just update us on kind of roughly where you're at on those and maybe some things we should think about happening in 2019, sort of along those lines and those endeavors, and then I've got a follow-up.
Yeah, sure. Thanks, Charlie. Let me start with profitability. Certainly, we're very focused, especially with now having the new team in place, very focused on profitability expansion moving forward. A couple things that we're looking at is, first in gross margin, we are looking at how to expand gross margin moving forward, and we're looking at a couple different places. In Q4, we started what we're calling a strategic pricing optimization project to really look across all the different ways that we're pricing our products and making sure that we're kind of driving maximum value from our products. We're expecting to begin to see a little bit of benefit of that actually in Q1 as we started that program in Q4.
Also in gross margin, we're also looking at the product cost side of the equation, we also kicked off some efforts in Q4 on product cost improvement, and we expect to start to see a little bit of benefit of that in Q1 as well. That's kind of on gross margin. On OpEx, it's just being very disciplined about OpEx and how we're deploying our spending. On R&D, we believe that we're at about the right level from a percentile basis with R&D at kind of a target of around 20% of sales. Within that envelope, we're really trying to optimize and make sure that we've got our R&D focused on the highest ROI programs. We did some work in Q4 to make sure we're focused on the highest ROI programs.
In SG&A, SG&A is an area where we need to reduce spending over time, and that'll take some time, but our target is really to get SG&A more towards the mid-teens over time. Those are some things that we're doing in both gross margin and OpEx to kind of drive profitability moving forward. On the product portfolio, I'm very focused in building out our product roadmap and making sure that we've got really good plans in place for the R&D team moving forward to really deliver products on a more regular cadence and to really drive the innovation treadmill, again, deliver those products on a much more reliable and regular cadence than we have in the past.
I think we're doing that in partnership with our big customers, making sure that we understand exactly what they need, again, really tuning the roadmap to our customers and making sure we have a good beat rate. That's a little bit of color on both those of what we're focused on for 2019.
Excellent. Much appreciated commentary, Jim. Just a quick housekeeping question. The licensing and services line was a decent portion of the mix relative to usual, I guess, in Q4. Maybe just what was behind that, given that that's historically a higher margin line, I'm just sort of curious what its influence on gross margin was, seeing that it was a higher portion of the mix. Thanks.
What we saw in Q4 is we saw a little bit of an uptick in licensing and IP revenue. We expect that, moving into Q1, that'll settle back into its more normal run rate. Licensing and services is typically less than 5% of our revenue, sort of in the 3%-4% range, we expect it to kind of tick back down in Q1 to that kind of run rate. With respect to gross margin in Q4, if you look at where we had guided gross margin for Q4, we had, in terms of our midpoint, we had guided gross margin down from Q3- Q4. We were expecting some product mix negative impact from Q3- Q4, we saw that happen.
Going forward to Q1, we are, from a midpoint gross margin perspective, guiding gross margin up, there's sort of a number of different factors there. We do expect the mix to kind of improve back from Q4- Q1, we expect some mix improvement. We also, again, as I mentioned earlier, expect to start to see some benefits from our pricing optimization. Those will start to be small in Q1, but we expect to see some benefit from that. Also, benefits from our cost optimization program that we kicked off in Q4. I hope that's a little bit more color for you, Charlie.
Yeah. Excellent. Great. Thank you guys so much.
Yeah. Thanks, Charlie.
Your next question comes from the line of Mark Lipacis with Jefferies.
Hi. Thanks for taking my question. On the data center side, what we're hearing from companies who sell processors into the data center is, the outlook seems to be lower, based on this idea that there has been a bit of over-investment in the data center, and the cloud players need to absorb some capacity. It seems like your data center business was stronger, and I was hoping you could help reconcile what we're hearing from the rest of the players with what you guys are seeing. Thanks.
Thanks, Mark. For us, what we saw in 2018 and into 2019 is we have a very strong position in the new platform generation that started ramping in 2018, and that'll continue to ramp in 2019. That position is much stronger than the prior generation. Sort of regardless of the particular market dynamics, we're benefiting from a much better position in this generation of servers. Like I said, that ramp started in 2018, and we expect that to continue into 2019. That's one of the growth vectors that we expect for ourselves in 2019 and beyond as well.
That's helpful. Thank you. A follow-up, if I may. On the 5G opportunity, I believe you suggested it could ramp in the second half of the year. Could you give us a sense of, to the extent that it's a macro base station play for you or a micro base station, how should we think about the kind of sockets or how you're going to ramp into those different sub-segments of 5G? Thank you.
Thanks, Mark. On 5G, first of all, we do have position in both the macro base stations as well as the smaller cells, so we have position in both. For instance, in a macro base station, where we're positioned is primarily in the radio head that's at the top of the mast, and we're in the control path of the radio head, for instance. We're beginning to see very early demand, as I mentioned earlier in my prepared remarks, early demand on 5G. That's still small at this point, and we believe that that'll start to materially contribute to our revenue in the second half of this year, the second half of 2019 and into 2020.
Thank you.
Thanks, Mark.
Again, if you would like to ask a question, press star one on your telephone keypad. Your next question comes from the line of Tristan Gerra with Baird.
Hi, this is Maggie Sims on for Tristan. Thank you for taking my question. Could you talk about the level of inventory days for Lattice products at distributors in the quarter?
Yeah. Sure. Thanks, Maggie. In Q4, where we ended the year in Q4 was distributor inventory levels very much within the normal levels that we expect for this type of business and have historically seen. Inventory well within the normal range. From a Q3- Q4 perspective, inventory really didn't change much. We saw inventory levels really flat from Q3- Q4. Again, that's inventory at our distributors.
Okay. Thank you. Then last quarter, you had talked about softness in the industrial and consumer markets, particularly in Asia. Is that weakness still ongoing, and do you have any visibility into those markets and geography?
Yeah. In Q4, we saw softness in industrial and automotive as well as the consumer markets, again, that was generally localized to the Asia market, and there was a little bit of softness in Europe as well that we saw in Q4. We're seeing a continuation of that softness into Q1. From a Q4- Q1 perspective, we're seeing a market climate that's pretty consistent from one quarter to the next. We're seeing that kind of same softness in Q1 as well.
Okay. Thank you so much.
Your next question comes from the line of Christopher Rolland with Susquehanna International Group.
Hey, guys. Congrats on navigating a tough quarter in semis. Sherri, welcome aboard.
Thank you, Chris.
Sherri, my first question, I guess, is for you. I think there were some articles or rumors going around. Is it true that you guys are moving out of the Portland offices and consolidating in Hillsboro? I would imagine that Hillsboro has cheaper lease space. I think that was maybe originally a sales lease back that you guys did. Is there some OpEx savings that you can share with us from that move?
Yeah. Thanks for the question, Christopher. From an OpEx perspective, our Q1 guidance is in the range of $37 million-$39 million. At the midpoint of that guidance, it's roughly flat from a midpoint perspective from Q4. We are remaining very diligent and disciplined in our approach to OpEx, the example that you mentioned there is exactly one of the things that we're looking at to try to bring out operational efficiencies in the company. In fact, in Q4, we consolidated from the second floor down to the first floor in our San Jose site here, creating operational efficiencies. In Q1, the item that you mentioned is what we're doing, where we are consolidating from two sites, the Portland and Hillsboro locations into Hillsboro. That will create operational efficiencies as well. You'll see that in Q1.
Those are just a couple examples of the things that we're trying to look at to reduce operating expenses and to really be more disciplined in our approach.
Great. Then, Jim, you talked about some pricing optimization. Some of our channel checks with distributors talked about this as well. For them, they kind of view it as price hikes, probably within the 10%-15% range for them. I guess, talk about how broad these price hikes are, and whether it's across all distis and all verticals, and even direct as well.
Yeah, Chris, it's a part of a program that we kicked off in Q4. I would say it's not just about price hikes, but it's really about making sure that our products are priced appropriately, for the right level of value that they're delivering to their solutions across our full range of distributions. We are working with our distributors on that, and it could be things like higher prices for older products, but it could also be another factor is, for instance, volume-based pricing for our customers or just a reduction in the rate of pricing declines that we may have historically had in the past. It's a variety of different initiatives as part of that overall strategy. As I said, we started to execute that in Q4. We'll start to see just the early benefits of that in Q1.
Great. Thanks, guys. I'll get back in queue for a follow-up.
Okay. Thanks, Chris.
Again, if you would like to ask a question, please press star then one on your telephone keypad. Your next question comes from line of Richard Shannon with Craig-Hallum.
Well, hi, Jim and Sherri. Thanks for taking my questions. Sherri, look forward to working with you. I guess a couple questions. Maybe first one following up on the earlier question on gross margin. Jim, maybe if you could give us a little bit more understanding of the mix shift. Obviously consumer down and licensing up would have normally driven the gross margin higher. Net, it was just slightly below the midpoint, and I think you're mentioning some mix within the buckets. Maybe if you can help us understand a little bit better how normal is that? Is this more of a snap back to what you consider to be kind of a stable level? Help us understand that better, please.
Yeah. Thanks, Richard. Yeah. In Q4, industrial and automotive was down from Q3- Q4. Industrial and automotive is our highest margin segment. When that part of our revenue declines, that's very decretive to our margin. That was a factor in terms of the mix by segment. Even within the segments, we saw a mix towards lower margin products within some of the segments. Now we are expecting some of that to snap back in Q1. When you look at our Q1 gross margin guidance from a midpoint perspective being sequentially higher, it's partially mix, and then also what I mentioned earlier around some improvement in product costs and some improvement from our pricing initiatives.
To follow on that, Jim, I was trying to do some modeling real quick here and just trying to guess on what your implied guidance for the product gross margins, and I was getting something along the lines of 100 basis points- 120 basis points improvement. Is that about what's implied in there?
It's probably better for a Sherri question, I think, I'll let Sherri answer that. We are seeing good improvement in the product margin, right? Again, that's due to that mix, the product cost and the pricing initiative. Sherri, do you want to add anything to that?
I'll just add that the sales margin improvement on a Non-GAAP basis quarter-over-quarter is in the neighborhood of 60 basis points.
60 basis points. Maybe just one last follow-up, one last question for me, just kind of general on the bookings patterns. I think both of you prepared comments as well as one other question talking about that, but just want to crystallize that into one thought here in terms of the booking trends you've seen so far this quarter. Obviously, I think we're getting close, if not past Chinese New Year, and typically visibility gets a little bit better after that. Jim, if you can give us a view on ordering patterns coming out of distribution and large customers in Asia, it'd be great, please.
Yeah, sure. What I would say is overall bookings are well within the normal of historical patterns. We view it as a very normal quarter to date in terms of both billings and bookings, and so well within the normal range.
Okay. That is all the questions from me. Thank you.
Thanks, Richard.
Again, to ask a question, that is star one on your telephone keypad. Your next question comes from the line of Christopher Rolland with Susquehanna International Group.
Hey, guys. Just two quick follow-ups, I guess, on 5G. Which vendors are you guys best aligned with? Is it the Korean guys, the European guys, the Chinese guys? Lattice didn't really benefit on the 4G comm cycle very much. Do you guys have a high degree of confidence that it's going to be different in 5G for this Lattice?
Yeah. Thanks, Chris. First on the vendors, we have good position across multiple vendors. Can't name out the specific vendors, but really nice position. If you look at our 5G position across vendors and across OEM platforms, relative to 4G, we had a nice expansion in our position from 4G to 5G. That's why we see 5G as a nice growth vector for us here over the next few years.
Okay, great. Finally, for segment guidance, can you give us any additional color or any color on the directional move for each segment?
Yeah, sure. A little bit of qualitative color for Q1 is, from a segment perspective, we expect the communications and compute to be sequentially up from Q4- Q1. Licensing and IP, as I already mentioned earlier, will be down from Q4-ff Q1. The other segments, consumer and industrial and automotive, are roughly flat sequentially.
Thanks so much, guys. Congrats again on a great quarter.
Thanks, Chris.
Thank you.
I would now like to turn the call back over to Lattice Semiconductor Chief Executive Officer, Jim Anderson, for closing remarks.
All right. Just to wrap up, I want to say thanks everybody for joining us on our call today. We really appreciate you spending time with us today. Just to summarize, our new leadership team is now in place and very focused on executing our strategy to grow Lattice's position in the multibillion-dollar programmable logic market. We remain focused on increasing our profitability, expanding cash flow, and getting some really great new products out to market this year. We appreciate your continued support and encourage you to reach out with any follow-up questions. Operator, that concludes today's call.
This concludes today's conference call. You may now disconnect.