Lattice Semiconductor Corporation (LSCC) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Saina and I will be your conference operator today. At this time, I'd like to welcome everyone to the Fourth Quarter and Full Year 2017 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. [Operator Instructions] Thank you. Mr. David Pasquale, Global IR Partners, you may begin your conference.

Thank you, operator. Welcome everyone to Lattice Semiconductor's fourth quarter and full year 2017 results conference call. Joining us today from the company today are Mr. Darin Billerbeck, 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 released, please e-mail Global IR Partners using LSCC@globalirpartners.com, where you can get a copy of the release off of the Investor Relations section of Lattice Semiconductors website. 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 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 31, 2016, 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 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 the call, you will find the required presentation of and reconciliation to the most directly comparable GAAP financial measure is in the Company's earnings we press release issued today. I would now like to turn the call over to Mr. Darin Billerbeck. Please go ahead, sir.

Thank you, David. And thanks to everyone for joining us on our call today. Results for the fourth quarter were in line with the outlook we provided back in October at our Analysts and Investor Day in New York City. We continue to execute on the themes that we outlined during that meeting with our focus on driving return to revenue growth, further reducing our OpEx and increasing our free cash flow to pay down to our debt. Driving a stable core business, accelerating our future growth while driving solid financial returns is not just our focus, its job one. At no time in the history of the company we had such an impressive portfolio of smart connectivity made easy solution with broad market appeal that is aligned directly to our low power, small form factor and production price programmable logic strategy. We remained focused on our execution and expect to deliver improved results to increase our shareholder value in 2018. From our most recent quarter, Q4, 2017 revenue was up about 3.5% over the third quarter led by our computing, industrial and automotive end markets. Consumer was expectedly flat Q4 compared to Q3 as our large handset win in 2017 tails off. Licensing and servicing revenue was down Q3 to Q4 as a royalty settlement we received in Q3 did not reoccur in Q4. In addition, we have in the process of divesting our HDMI test service business which lowered our licensing and service revenue around $800,000 a quarter. On a geographic basis, revenue was up in the fourth quarter in Europe and Asia and flat in Americas and Japan. Our overall revenue for the full 2017 was approximately $386 million, which was down around 9.5% from 2016. The decline came as we were hit with multiple headwinds at the same time. As you may recall, our major handset win volumes peaked in Q4 of 2016, leading to anticipated revenue decline in 2017. Tailwind package conversion was strengthened in 2016, ran its course and tailed off in 2017. Our wired ASSP business has significant declines in HTV and home theatre as a new HDMI specification was delayed and many of the older features were integrated into ASSP. And finally, our licensing and services revenue is down nearly $7 million as HDMI royalties have not been paid out to any of the founders for almost a year, as we continue to negotiate the next stage HDMI royalty sharing agreement. We do expect to receive these payments sometime in 2018, but due to the new 606 accounting standard, we will not be permitted to record this as revenue but will receive the cashing; meaning we will record this as free cash flow only not as EPS. The headwinds of 2017 were not a degradation of our core business. Obscured Secured by these headwinds, our core FPGA revenue grew 13% in 2017 compared to 2016. This growth was led by our industrial and automotive markets which absent the effects of the tailwind package conversion grew by more than 25%. In addition, our consumer market was buoyed by our iCE products enabling new and home consumer products, while the beginning of a new server ramp is benefiting our computing market. Looking forward, we are confident in our business is returning to more consistent revenue growth at or above industry growth rate. Our confidence comes from the underlying positive momentum in our core business, along with 27% year-over-year growth and the life time value of our design win funnel. Industrial and automotive, these are charged here along with wins in non-handset consumer market. As we've outlined, our core business for our control and connectivity solutions gives us a solid base to grow. The emergence of intelligence of the edged devices will continue to be our longer term growth driver on top of the current growth of our core business. Many of those longer term growth opportunities are considerable in size and ability to move the needle over time. As just one example, our relationship with Amazon and Home in Factory Automation has been one of our faster growing ramps. The smart home speaker portion alone has become significant revenue contributor for us. To give you a sense of the growth, a recent report from [Analysis] put the overall smart market feature at $30 million to $35 million in 2017, up from about $7 million in 2016. Amazon was expected to represent about $20 million to $25 million of the overall 30 million to 35 million units with Google making up the balance. Another firm, KGI Research is looking for nearly 50% unit growth in this market 2018 over 2017. The theme of automation and its expansion of both home and industrial environment are expected to be a major industry growth driver for the foreseeable future. The benefits of more intelligent devices with the ability to have higher levels of learning interaction are driving demand. We expect the expansion will only accelerate as the broader ecosystem of intelligent devices further evolves. After all, Lattice runs an application will change and evolution is constant. In other words, when the puck is always moving. Lattice's focus on low power and small size is a strong advantage for us in areas where battery life or small form factor matters and this is not about Lattice's future roadmap. We're talking about IP-owned existing silicon utilizing our existing tools. Short lead time efforts on stuff we have to date. Finally, consumers value Lattice for our reliability and our impressive track record of delivering high volume solution at the world's largest consumer electronics and home automation companies at defect levels so large, so low, they are hard to measure. Tiny, easy to use, lower-cost, lower power solutions are ideal for many markets. Let me now turn the call over for Max for details on our financial results, Max?

Thank you, Darin. As part of our press release today, we have provided detailed reconciliations of our GAAP to non-GAAP financial measures. For the fourth quarter of 2017, revenue was in line with expectations at $95.3 million. When compared to the third quarter, revenue increased $3.3 million or 3.6% primarily on increases in industrial and computing, offset by expected declines in our licensing services revenue. As you are aware, the accounting rules for revenue recognition have changed effective with the beginning of 2018 and our forward-looking guidance is provided on this new basis. We expect the new revenue recognition rules to positively impact our 2018 revenue by approximately 1%. Gross margin on a GAAP basis was 53.8% for the fourth quarter and within our range of expectations at 54% on a non-GAAP basis. The quarter-over-quarter margin decline is largely the result of a reduction in our year-end inventory valuation, driven by lower wafer and overhead costs. We expect our gross margins to trend higher in Q1, 2018. Our non-GAAP gross margin for the full year of 2017 was 56.3%. Fourth quarter GAAP operating expenses were $51.9 million compared to $90.8 million in the third quarter. On a non-GAAP basis, fourth quarter operating expenses were in line with our expectation at $44.1 million compared to $44.6 million in the third quarter. For the full year, our GAAP operating expenses were $264.2 million versus $273.1 million in 2016. In 2017, our non-GAAP operating expenses were down over 9% or approximately $18.5 million from 2016 and as we've discussed, we have taken aggressive actions to continue this trajectory into 2018, where we expect our non-GAAP operating expenses excluding mask costs to again decline in the 8% to 9% range. We continue to execute our facilities and infrastructure-related actions and are on track to reach our non-GAAP operating expense goal of roughly $40 million per quarter, excluding mask costs in the second half of 2018. We had income tax expense of $615,000 on a GAAP basis and $473,000 on a non-GAAP basis in the fourth quarter. Our tax expense for the full year of 2017 was $849,000. The enactment of the 2017 Tax Cuts and Jobs Act is not expected to result in a significant increase in the U.S. cash tax paid or our effective tax rate, given our net operating loss carryforwards positions. Our GAAP net loss for the fourth quarter was $7.2 million, or $0.06 per basic and diluted share. With net income of $1 million or $0.01 per basic and diluted share on a non-GAAP basis. For the full year of 2017 our GAAP net loss was $70.6 million or $0.58 per basic and diluted share. On a non-GAAP basis, our net income was $13.6 million or $0.11 per basic and diluted share. As a result of our continued focus on liquidity and cash flow management, we ended the quarter with cash and short-term investments of approximately $112 million up from $108 million in the third quarter of 2017. Net cash provided by operating activities was $3 million in the quarter and for the full year of 2017; net cash provided by operating activities was $38.5 million. Debt service payments were $6 million in Q4 and $56.1 million for the full year of 2017. This included $35.4 million for principal and $20.7 million per interest. Our plan is to reduce debt by 20% in 2018. Accounts receivable was $55.1 million in the fourth quarter compared to $79 million at the end of the third quarter. Day sales outstanding improved to 53 days in the fourth quarter from 78 days in Q3. The decrease in accounts receivable and improved DSO between the third and fourth quarter are mainly due to distributor inventory declining to more normal levels in Q4 from their peak in the third quarter. Inventory at the end of the quarter was $79.9 million compared to $77.5 million at the end of the third quarter. Months of inventory improved to 5.4 months at the end of Q4 compared to six months at the end of the third quarter. We spent approximately $500,000 on capital expenditures in Q4 compared to $5.3 million in the third quarter and depreciation and amortization expense was $12.3 million in Q4 compared to $15 million in the prior quarter. Interest expense for the quarter was $4.7 million. This concludes the financial review portion of the call. And I'll now turn it back to Darin for our outlook.

Thank you, Max. In terms of our specific expectations for Q1, revenue for the first quarter of 2018 is expected to be between approximately $95 million and $100 million. Gross margin percentage for the first quarter of 2018 is expected to be approximately 56% plus or minus 2% above the GAAP and a non-GAAP basis. Total operating expenses for first quarter 2018 are expected to be between $52.7 million and $54.9 million on a GAAP basis and between $42.6 million and $44.4 million on a non-GAAP basis. In summary, 2018 is the year of execution for Lattice. This is not a year of reinvention. We already have an incredibly strong product portfolio is well positioned to meet our customer needs in the key growth markets we're targeting. We already have roughly 90% of our design wins that we need to hit our long-term revenue target in 2018 and continue to invest in the next growth areas for 2019 and beyond. OpEx is on a downward trend as we continue to drive towards our 20% operating income goal. We'll target higher goals after that, but one step at a time. Remember, we still expect OpEx to be closer to $40 million entering the second half of the year, but obviously we aren't giving guidance beyond Q1 right now and our corporate debt pay down will continue. This concludes our prepared remarks. Operator, we will now be happy to take any questions.

Thank you. [Operator instructions] Your first question comes from the line of Tristan Gerra from Baird. Your line is open.

Hi. Good afternoon. So, given the change in the way where you recognize, it's fair to assume that you currently are not recognizing any revenue from any major acquisition and it's more about the technology and revenue growth opportunity it brings including 60 gigahertz technology?

Yes, hold on Chris. Okay. So, we are not recognizing revenue from 2017 royalties that essentially are owed. We will recognize 2018 royalty and silicon image revenue from all of the products that we sell.

Okay. And then if you could provide some color on the Q1 revenue guidance and the components within that guidance sequentially that's moving up and down?

On a geographic basis or are you looking at it from a market basis?

End market please

Okay. So, consumer we expect to be down. There are some good wins up there, but we're not going to make up necessarily for the large North American handset OEM. So, consumer we expect to be down. Comps and compute, we expect to be up based on the strength of the reference design for the new servers that we have, plus we expect some of the comps devices to actually hold on a second. Sorry, comps and computer are going to be down looking at the full-year, sorry Tristan. For the current quarter-to-quarter, communications and comps are actually going to be down. Servers will be up but Huawei, ETE and the large communication guys, we expect to be down and slightly down at least through Q1 as they burn through some inventory and also rebuild their contracts. Industrial and auto, we expect to be up and that's based on some broad market, but also some key customers that we have in two different areas. One is robotics and the other one is the display technologies and then we expect licensing to be up because again we didn't recognize some of the licensing in the last quarter. We will recognize them during 606 in Q1. So again, consumer down, comps down, industrial up, licensing up and auto up.

Okay. Great. And just last quick one, could you quantify again what the mask cost would be for this fiscal year and/or any color by quarter?

Yes. They should be right around just under $6 million for the year and by quarter; it's a little bit lumpy as you know. The first quarter will have less than $1 million and then I think there's peaks in the second and third quarter associated with our mask cost.

Your next question comes from the line of David Duley from Steelhead. Your line is open.

Yes. Thanks for taking my question and Darin, I think you already kind of covered this but could you just remind us on a quarterly basis when you look at Q4 versus Q4 of the previous year, I think revenue was down $22 million, $23 million. What were the biggest components of that quarterly year-over-year decline?

North America handset, yes, North American handset OEM.

And that's all of it or is that just the biggest piece or is the one contributor on that or -

That was by far the largest piece of the decline.

Okay. Great. And as far as handsets going forward, what would you expect that to account for? Is it pretty much just going away or how should we think about that?

We are no longer forecasting handsets in our growth. If it happens, it will be upside.

But we do expect to have a small tail associated with that prior handset win kind of gradually declining. It's relatively small in the current outlook.

Yes. It's pretty small.

Okay. And I think you mentioned the size of the --excuse me, that the audio and industrial were going to be the fastest growing segments going forward. I think that was for the March quarter. When you think about the overall calendar year, will those be the same sectors? And then, I think you already addressed it or talked about in the past, what is your revenue target for 2018? Could just remind us, thank you?

So, let me talk about the places they we're going to grow. So, number one, comps for the full-year, we expect to be up based on the partly server reference design that we have along with Huawei and ZTE coming back. So that should help us quite a bit. Industrial and auto will also be up, based on robotics, some of the display technologies we're working with and also broad market. So that mile wide an inch deep. We expect licensing to be down just because we did have some patents and other things in 2017 that were not going to recur in 2018. And then consumer as we mentioned before will be down. Although there will be some consumer activities that bring it up from, it won't reach the North American handset OEM but there will be some growth in non-handset consumer, which is really what we're trying to focus on. Its things that aren't as cyclical and it's digital as far as going up and down. So, we do expect consumer down. We do expect licensing down, but both comps, compute, industrial and automotive will all be up.

Okay. And then the potential revenue target for 2018?

Well, we had told you originally that we're looking for double-digit growth and with some of the 606 things, we're still fundamentally sound on that as far as the double-digit growth, but we're going to have to work through what that actually means as we get more understanding of 606 and the trade-ups that we'll see throughout the year. But fundamentally, we're still focused on our double-digit growth and the fundamentals behind that are still solid.

But you could see some fluctuation just because you won't be recognizing royalty revenues that are what you're referring to.

Yes. I mean potentially what would happen is you would you not be able to record cash as in EPS add or but you will report cash still as cash. So, it will be free cash flow. You might not be able to recognize it in revenue. So what we said is still fundamentally the same thing. The difference is how it's recognized.

Your next question comes from the line of Delos Elder from Jefferies. Your line is open.

Hi. Good afternoon. Thank you for letting me ask a question. I was wondering if you might be able to touch on seasonality in your segments or even your business overall?

Yes, it's kind of weird. I mean the old day's comps for us were incredibly cyclical and then we eliminated some of the cyclicality with handsets because Samsung and Apple were both on completely different trajectories. One was launching earlier. One launching later and so we didn't have a lot of cyclicality. Today as we look at it, we haven't seen in between Q4 and Q1, but I think a lot of that is because industrial and auto continue to grow, but we don't have a lot of exposure anymore to the handsets. So that helps us quite a bit. However, we still do see some cyclicality on the comp side, which we're seeing in Q1. It's just being offset by some of the strength that we're seeing in both industrial auto and then some of the strength we're seeing in licensing. So again Huawei, ZTE, we think are soft in Q1, but the rest of our business is pretty strong.

Great. And you mentioned that industrial or distributors took down inventory during the quarter. I guess what's your sense of what is the demand that's pulling broad market for your products? Are people prepared to take higher levels of inventory normal? I guess I just want to get a sense of you're seeing some strong growth in industrial. So just want to get a good sense of how sustainable or how much visibility you have into that?

Yeah Delos, this is Max. We're seeing - I think that the year-end distributor inventory coming down from its third quarter peak really is more a factor of them managing their year-end cash flow inventory balance targets that they got at the end of the year. We're seeing really strong demand in particular in XO2 XO3 product lines building for various production ramps in the broad market as well as in the compute segment.

And Delos, to add a little color on that, XO2 and XO3 follow XO, which took about five years to get rolling and we're kind of in that five-year stay as far as production and those are pretty diversified products as far as how they service us with multiple packages, multiple voltages. And so those design wins that are turning into actual revenue today we're actually received for us back in 2012 and 2013 and you're finally starting to see those come in. So there's no indication for us that we would stop growing those particular products. Let's not forget that we have newer products out there, ECP5 that is just starting to ramp. Cross-link, which is just starting to ramp and then new versions of iCE, which serve as more than just a handset market. So one thing that you have to remember in FPGA land if you don't build the product and then it ships to this month. You build the product and that design win funnel takes a long time. But once you're in it in the broad market it stays there for a long time, which is why we're not forecasting handset volumes because when we do that, you have a tendency of not having the stability of the base that we want. So we're going to create a stable base that we can run off of - run our OpEx off of and when we hit those handset wins or just come it, it will tell you guys they're margin hits for us, but they're cash positive for us. So we'll go ahead and take that cash pay down the debt, but we don't want to forecast those.

Got you. And if I could sneak one more in. your gross margin I think has been volatile in terms of relative to expectations. And so you looking into 2018, it sounds like you're expecting the gross margin north of 2017, $56.3 million. I guess - I just to confirm that. And then, is there any I guess approach you're making to get gross margin to be a little bit more predictable?

This is Max, Delos. On the predictability question, yes absolutely. We've got line of sight on those things and are driving towards those pretty assertively. Relative to 2018 expectations, our full year and second half of 2017 was right around the 56% range. As you know, our model is mid-50s. Our guidance is 56. I would expect us to be right in that neighborhood as we go forward through 2018, again absent some handset win or other meaningful change to our mix.

There are no further questions at this time. I'll turn the call back over to Lattice's President and CEO, Mr. Darin Billerbeck.

Thank you, operator. In closing, we're optimistic about our business moving forward. As I noted earlier, 2018 is the year of execution for Lattice. This is not a year of reinvention. We really have an incredibly strong product portfolio that's well positioned to meet our customer needs in the key growth markets we service. OpEx is on a downward trend as we continue to move closer to our 35% OpEx target model while paying down our debt. Finally, both our Board of Directors and management team remain fully committed and highly motivated to build shareholder value for all of us as we move forward. That concludes our call. Thanks for joining us today and as always, we appreciate your support.

This concludes today's conference call. You may now disconnect.