Ladies and gentlemen, thank you for standing by, and welcome to the third quarter 2020 conference call. Please be advised that today's conference is being recorded. And without further delay, I would like to hand it over to your speaker today, Mr. Rick Muscha, Director of Investor Relations.

Thank you, operator, and good afternoon, everyone. With me today are Jim Anderson, Lattice's President and CEO; and Sherri Luther, Lattice's CFO. We'll provide a financial and business review of the third quarter of 2020 and the business outlook for the fourth quarter of 2020. If you have not obtained a copy of our earnings press release, it can be found in our company website in the Investor Relations section at latticesemi.com. I 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 that 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 2020. 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 that we present 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 of these non-GAAP financial measures to GAAP financial measures that can be found on the Investor Relations section of our website at latticesemi.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. To start off, I'd like to once again thank our customers and partners for their support. And I'd especially like to thank the Lattice team for their continued dedication and execution. While I'm pleased with our progress, I'm even more excited about the potential of the company moving forward. Let me cover a few highlights from Q3 of 2020. We continue to see year-over-year revenue growth in our 2 main segments of communications and computing and industrial and automotive. We also expanded non-GAAP gross margin by 170 basis points year-over-year, non-GAAP operating margin expanded to 26.5%, and non-GAAP net income increased 16% year-over-year. We launched our Sentry solution stack, which is focused on providing platform security in applications such as data center servers. This solution stack was the third installment in our expanding portfolio of application-specific software solutions. Finally, we remain on track to launch the third product based on our Nexus platform later this year. Let me now provide an overview of our business by end market. In the communications and computing market, revenue was down 4% sequentially, but up 6% on a year-over-year basis. After a strong Q2, we saw a modest sequential decline in communications and computing due to a decline in units shipped for servers as well as a decline in communications. Year-over-year growth of 6% was driven by growth in servers and client computing. We continue to see this segment as a long-term growth opportunity as we expand our business in computing as well as in 5G infrastructure deployments. Turning now to the industrial and automotive market. Revenue increased 8% sequentially in Q3 and was up 14% on a year-over-year basis. Q3 growth in the industrial segment reflects an improvement in…

Thank you, Jim. Third quarter revenue was $103 million, up 2.4% sequentially from the second quarter and was roughly flat year-over-year. The sequential increase from Q2 was driven by the industrial and automotive segment and licensing, while partially offset by a decline in consumer and communications and computing. Gross margin on a GAAP basis was up 30 basis points to 60.5% in Q3 compared to the prior quarter and was up 110 basis points compared to the year ago quarter. Our non-GAAP gross margin increased 20 basis points to 61.5% in Q3 compared to the prior quarter and was up 170 basis points compared to the year ago quarter. We continue to make steady progress on gross margin expansion as we benefit from our ongoing pricing optimization strategy, product cost reductions and some mix. Q3 GAAP operating expenses were $49.5 million compared to $48.1 million in the prior quarter and $44.8 million in the year ago quarter. On a non-GAAP basis, operating expenses were $36 million compared to $36.7 million in the prior quarter and $35.9 million in the year ago quarter. We continue to invest in our product road map while at the same time we remain committed to driving SG&A spending closer to our target model. Q3 GAAP earnings per basic and diluted share was $0.09 compared to $0.08 in the prior quarter and $0.10 in the year ago quarter. Q3 non-GAAP earnings per basic share was $0.20 and $0.19 per diluted share compared to $0.17 in the prior quarter and $0.17 from the year ago quarter. We continue to strengthen our balance sheet and remain focused on cash generation with our year-to-date cash from operations at approximately $69 million. A key driver for the healthy cash generation in Q3 was an improvement of 14 days in DSO compared to the prior quarter. Our ending cash balance increased to approximately $182 million, resulting in a positive net cash position. Let me now review our outlook for the fourth quarter. Revenue for the fourth quarter of 2020 is expected to be between $99 million and $107 million. Gross margin is expected to be 61%, plus or minus 1% on a non-GAAP basis. Total operating expenses for the fourth quarter are expected to be between $36.5 million and $37.5 million on a non-GAAP basis. While COVID-19 continues to create some near-term uncertainty, over the long term, we are focused on growth and profitability expansion driven by the strength and differentiation of our product road map. Operator, we can now open the call for questions.

[Operator Instructions] Your first question comes from the line of Matt Ramsay from Cowen.

I guess for both of you, Jim and Sherri, if you could talk a little bit about the breakdown by segment of revenues in the guidance and how it might relate to gross margin being down slightly sequentially? And Jim, as you guys talk about that, I've had a few questions. Intel guided their DCG business down, I think, 25% in the fourth quarter. I know you guys have pretty broad exposure to the server market through all vendors, but that was a pretty alarming number for some. So if you could address that as you talk about mix in the fourth quarter that would be really helpful.

Yes. Got it. Thanks, Matt. So on the first part of your question on the Q4 segment outlook, so what we're expecting at this point is for our communications and computing segment to be sequentially up. We're expecting the IP revenue to be down, to go back to sort of its more normal run rate. It usually ranges within $3 million to $5 million. So that's where we expect it to go down to in Q4 and then for the other segments to remain roughly flat sequentially. So that's a little bit more color by segment. And then in terms of sequential gross margin guidance, yes, you'll see that our sequential gross margin is down a little bit relative to Q3. And that really reflects IP revenue being down sequentially from Q3 to Q4, which is clearly at a high gross margin. And then on the last part of your question with respect to Intel and server, what I would say is, I can just speak for our business. We expect communications and computing overall to be up. We are seeing good strength in computing in Q4. So we expect that overall segment to be up for us. And maybe just as a reminder, we're used in both Intel servers as well as AMD servers. So our products are used in both types of x86 platforms. But back to your question, yes, we expect communications and computing to go up sequentially.

Jim, that's really helpful. Just as a follow-up, you gave a number of milestones in the new product portfolio, both on the hardware side and on the software side that the company has hit some of those ahead of schedule and other ones that you intend to hit going forward. Just sort of stepping back, Jim, if you think about the design win traction that you're seeing for the new product portfolio, if you could help sort of characterize that, where it is versus where maybe you expected it to be 12 months ago? And what that means for pace of revenue acceleration as those design wins come into revenue over the coming quarters?

Yes. Thanks, Matt. Yes. So on product milestones, specifically with respect to our Nexus platform, if you recall, we launched the first Nexus product, CrossLink-NX, in December of last year. We launched the second in June of this year called Certus-NX. And then we're on track to launch the third before the end of this year. And so yes, execution remains on track. Design win traction, and I would say general customer engagement on Nexus, but I would say across our entire portfolio is quite healthy. We're very pleased with the design win progress that we're making this year. The sales team has been doing a really good job on that. I think the last part of your question was more towards revenue and revenue growth. I think maybe a couple, 2 or 3 key milestones to point out on some of those new products is, if you recall last year when we launched CrossLink-NX, we also said that we would expect to see initial revenue from CrossLink-NX, our first Nexus-based product, before the end of the year. We still expect to see that. It will be a small amount of revenue this quarter, but we expect to see production revenue this quarter. And then it would grow obviously next year. And then maybe a couple of other products that we launched last year that are now in production that I'd point out is the CrossLinkPlus product, which we launched in Q3 of last year. We saw revenue growth in that this year. We expect to see revenue growth again next year from that product. And then also the MachXO3D product that we launched last year. That's our FPGA with specific security technology that makes it able to provide platform root of trust in lots of different types of systems such as servers. We saw first production revenue in Q3 of this year, so this most recent quarter. The production revenue will grow in Q4. And we expect it again to grow next year. So that gives you a few proof points around some of the new products and how they're starting to get revenue and beginning to ramp.

Really appreciate all the color, Jim. Congrats on the results and I'll get back in the queue, appreciate it.

Thanks, Matt.

Your next question is from Charlie Anderson from Colliers Securities.

Congrats on being a net cash position for the first time in an awfully long time. Just to kind of hit on your prior answer about the segments. I think if I keep consumer and industrial flat sequentially and punch in $4 million of sort of licensing implies something like 20% year-over-year growth for comms and computing, so just want to make sure I'm getting that right. And if that's indeed the case, just kind of elaborate on some of the growth drivers underlying that coming off of the sort of mid-single-digit growth rate year-over-year for that segment in Q3.

Yes. If I can, I'll speak kind of sequentially, so comms and computing relative to Q3. First of all, one headwind that we have in that segment is Huawei. Obviously, there were new U.S. government restrictions put in place with respect to Huawei earlier in Q3. And so we stopped shipment to Huawei per the new regulations ahead of that mid-September deadline that had been put in place by the government. And so in Q4, we're assuming no contribution from Huawei in Q4. And so that's a little bit of a headwind in our communications and computing segment in Q4, but we're seeing strength in other areas and in particular, in our computing segment. And so we expect that to offset the headwind. And actually that segment overall, we expect to grow sequentially. And then, yes, you're right, that would give us very healthy year-over-year growth as well.

Okay. Great. And then, Jim, I don't know if you wanted to weigh in at all on the AMD-Xilinx transaction. I mean Xilinx is a key competitor for you. You're very familiar with AMD, members of your team familiar with Xilinx. So just kind of curious over the long term how you think that impacts the strategic positioning of their company and yours as you have your various approaches to the market?

Yes. Thanks, Charlie. Yes. We don't see a change in the environment for the portion of the market that we're focused on. So just as a reminder of kind of what is our strategy and where is our focus. So Lattice is focused on being the absolute industry leader in small, power-efficient FPGAs. And so these are programmable devices that are used in a wide range of applications across edge computing, IoT, industrial IoT, control and security and all sorts of different types of systems. And look, when we look at our product portfolio today, we're very happy with the portfolio today. We think it's very strong. We're very pleased with the Nexus platform and its adoption. And we're actually even more excited about the road map that we have in front of us. And when we look at the industry, we see that we're really the only FPGA company that's focused on investing in this part of the market, small, power-efficient FPGAs. And I don't see that changing with this announcement. And certainly, our customers see our commitment to this space. The customer engagements are very strong, as I mentioned earlier. They see the new products that we're launching, the new road map that we have coming, and they're pretty excited. And so we remain focused on our strategy and executing to our road map and continuing to deliver to our long-term business goals.

Your next question is from Tristan Gerra of Baird.

Could you elaborate on your expectation for communication to be up sequentially in Q4? Is that 5G base station driven? And also, how sustainable is that trend into the first half of next year? And also, is it mostly outside of China? Any color you could provide would be helpful.

Yes. Tristan, my earlier comments were with respect to the overall segment of communications and computing, so we have that as a single segment. So I'm saying that overall segment, we expect to be sequentially up. And then look, 5G is, we see as a long-term revenue growth driver for us. We're seeing good growth from 5G this year. We certainly have more, significantly more 5G infrastructure revenue this year than we had last year. And we believe we're still early in the 5G global deployments. And if you might recall at our investor presentation back in May of 2019, we shared that in a 5G base station, we have over 30% more content in a 5G base station relative to a similar 4G base station. So we see it as a long-term growth vector for the entire industry, but also specifically for Lattice as well. So we expect it to contribute to growth next year as well.

Okay. And then as a follow-up, you talked last quarter about a PC win that sounds like it's with one OEM. And you've mentioned the opportunity that over time this could surpass the TAM that you see for data center given the PC units. What level of conviction do you have that you're going to win additional PC OEMs? And secondly, what problem solving does your FPGA provide in PC that's unique enough to get other PC OEMs to use your products?

Yes. So in client computing, yes, on our last earnings call, we shared that we had a new program that started production. Obviously, that continued into Q3. It will continue into Q4 and into next year. We're quite pleased with the progress on that program and the revenue that we're seeing from that program. And we're also engaged more broadly in the industry to continue to win more business in the client computing space. We do believe we can bring some pretty unique value propositions to the client computing space. One of the areas is around artificial intelligence processing, inference processing, in particular, where we can do things like human presence detection as one example, also video connectivity, video integration, overall connectivity integration within the PC platform. So there's a number of different areas where we think we bring a pretty unique value proposition with our combination of great power efficiency, programmability, flexibility. Artificial intelligence algorithms, as you know, are constantly evolving. And so having a solution like ours that is reprogrammable and can adapt to changes in AI algorithms over time is a big plus for our customers. And so yes, we see this as a good long-term growth area for us in the computing segment.

Your next question is from Mark Lipacis of Jefferies.

Jim, you mentioned kind of the introduction of the software platform, sensAI, mVision and Sentry. Can you give us a sense of like where you think you are in the deployment of these or where your customer base is embracing these products? And to what extent, from your standpoint, are these kinds of software help you to grow the market versus to help you kind of lock customers into more of a sticky longer-term design wins because they kind of get entrenched in the software?

Yes, Mark, maybe I'll start with just a reminder of kind of what's our overall strategy with respect to software. So beyond the typical FPGA development environment that we provide, what we've been investing in is a portfolio of higher level software solution stacks that are application specific. And what that does for our customers is that makes it very easy for our customers to design our products into their systems and then really speeds up the time to market for them to get those systems to market. The first one that we introduced was sensAI, and that was around inference processing. The second one that we introduced was earlier this year in February, and that was our mVision stack around embedded vision processing. And then we just recently brought out our third version, which is Sentry, which is specifically around security and platform level security. And as you can imagine, we have on our road map additional software stacks that we're planning to bring out, for instance, next year as well. So we're going to continue to build out this platform or this portfolio of software solution stacks. And the deployment, what we're seeing is actually those being deployed across every market that we serve. So we're seeing -- now it's over time depending on the market. But for instance, sensAI, we're seeing that software stack being used in computing applications. It can be used in industrial applications. Obviously, there's consumer applications as well. We're seeing interest in Sentry across certainly server applications, but there's other computing applications and industrial applications where that has relevance. And so it's pretty broad-based deployment. And in terms of, you asked about, does it grow our market? Yes, it does in the sense that it makes it much easier for customers to adopt our products. And so what we're seeing is some examples of where customers may not have a history using FPGAs and may not have a lot of comfort with FPGAs, by providing them a complete solution stack we're able to help those customers switch to our devices very easily. So for instance, switch from a microcontroller device over to our devices, along with our software solution stack. So it helps new customers make that transition more easy. And then also, as you mentioned, it does create much more stickiness with our customers. As they integrate that software into their system-level software, that makes our solutions very sticky over a multigenerational basis.

Great. That's really helpful. And I had a question, a follow-up question on the gross margins, if I may. As you kind of approach the low 60s, and I apologize, I forgot if your target gross margin was 62% or 60% plus. Maybe if you could just remind us of that longer-term gross margin target is. As you approach that, do you think about re-evaluating that target? Is there a hard limit in the low 60 range? Like Xilinx, I think, is in the high 60s for another FPGA benchmark there. Is there like a physical limit to the gross margin here or is this kind of your initial target? Is that kind of like a milestone that you work towards and then you reassess as you hit it?

Yes. Thanks, Mark. Yes. It's more as you just summarized. I think that's an initial milestone, and we'll reassess once we've achieved that milestone. Just to be clear, the target that we had put out was greater than 62%. And we had shared that at our Investor Day back in May of 2019. And clearly, we've made significant progress since then. I mean just this most recent quarter in Q3, gross margins went up. I think it was 170 basis points year-over-year. So we remain focused on continuing to expand gross margins. Obviously, our first focus is to get to that greater than 62% target. And I think once we get there, we'll re-evaluate what the target should be. But I don't see, as you would call it, a hard limit at 62%. I think there's room beyond that, but we'll share that once we get past the 62% milestone. And just as a reminder of the gross margin expansion, kind of where that's coming from is, part of it is our pricing optimization strategy. We built that strategy out in late 2018, and we started implementing that in 2019. That continues to yield benefit, and we continue to drive that strategy moving forward. And that strategy is really about making sure that our products are priced for the right value in the market. They bring significant amount of differentiation to our customers. We want to make sure those products are priced correctly in the marketplace. And then the other part to the gross margin expansion has been the road map of product cost improvements that we've had. So we've had a multiyear road map of product cost improvements we've been executing to. And that's the other portion or the other driver of the gross margin expansion. And then there's been some mix change as well, but the 2 main drivers are the pricing optimization and product cost improvements.

The next question is from Christopher Rolland of Susquehanna.

I guess first on the industrial and auto. I was wondering if maybe we could isolate automotive more specifically here. How big is it? And then perhaps if you could talk about the kind of sequential bounce back we had for automotive more specifically here and what applications might be driving that?

Yes. Thanks, Chris. So in industrial and auto, so that segment for us is, the vast majority of the revenue is industrial. Automotive is still a pretty small part of that segment, although we do see automotive as a long-term growth driver for us. We have a healthy design win funnel in automotive electronics. We're getting designed into a number of different new types of applications in automotive electronics. Of course, that part of the market ramps slowly. Those are long time to revenue design win cycles. So it drives more long-term growth. But we do see it as a good long-term growth driver. But for today, that segment is mostly industrial. So that sequential improvement that we saw from Q2 to Q3 of 8% up sequentially or 14% up year-over-year, that's almost all driven by industrial. And I would say a couple of things going on there in terms of the sequential improvement. If you recall back in Q2, we did see some softness in industrial related to COVID-19 and the market impact of COVID-19. We started to see that end market demand strengthen in Q3. So that was good to see industrial end market demand strengthen. But on top of that, there's Lattice growth in the industrial segment in applications like industrial automation, robotics, industrial safety, embedded vision, that's growing on top of that end market improvement. So we're quite pleased with the overall progress that we've been making in industrial and automotive. And I think our performance in this segment has been quite strong despite the COVID-19 backdrop this year.

Okay. And I guess one for Sherri, too. For licensing, that one was kind of unexpectedly strong. I'm assuming nothing's changed here with licensing. If there has, I'd love to know about any updates there. But I think it was 150 basis point benefit there to gross margin for the quarter. Sherri, I don't know if you had any thoughts on that and how gross margins kind of flowed here if you ex out that benefit maybe versus expectations.

Yes. So in terms of the lower or higher rather IP licensing revenue in Q3 versus what we had expected, it did come in higher than we expected. This area can be difficult to forecast. When we look at Q4, we expect it to be more in the normal range of $3 million to $5 million versus the slightly higher amount that it was in Q3. When you look at the product gross margin, it was down about 60 basis points sequentially. So when you exclude the IP component that you mentioned, it was down sequentially. But if you remember in our Q2 earnings call, we said that we anticipated that we would experience some gross margin headwinds within our market segments. And that's ultimately what happened. And so when you look at our product gross margin year-over-year, we saw an increase of 170 basis points. And that's really coming from our gross margin expansion strategy, as Jim mentioned, with pricing optimization, product cost reductions and some mix. So as we continue to execute toward our long-term model of greater than 62% that we laid out in our Analyst Day last year, that's the way that you can kind of think about that.

Your next question is from Alessandra Vecchi of William Blair.

Congratulations on a great quarter. Sherri, I have a question for you as well, if you can. It looks like your DSO decreased nicely this quarter from last quarter. If I recall, I believe last quarter, you had some onetime things like due to supply constraints and mix and back end nature of the quarter. But can you maybe remind us on how we should be thinking about the DSO target going forward?

Yes. Thank you for the question, Alex. So we did see DSO improvement in Q3. We had the improvement of 14 days. We achieved a 65 DSO at the end of the quarter, and that was really due to improved shipment linearity. As you referenced in Q2, we did experience supplier constraints within the supply chain due to COVID-19 restrictions. So our ops team worked through those constraints last quarter and really enabling them to generate an improvement in shipment linearity in Q3, and that's what generated the 14-day improvement during the quarter. So we're going to continue to work on improving our DSO, but there can be fluctuations on a quarterly basis just due to the timing of when our customers want, may want the product. Our goal is to generate further improvements there. But again, there could be some fluctuations on a quarterly basis.

Great. That's helpful. And then similarly, on the operating expense line, Lattice has done a tremendous job sort of keeping those in check and coming in sort of at the lower end or better than expected. As we look forward to next year and the continued new product introductions, tapeouts, attempts at gaining traction in potentially new end markets and verticals, how should we think about OpEx growth relative to maybe revenue growth or some other metric?

Yes. So the way I would look at OpEx, I'll comment on the short term and then kind of direct you to our long-term model that we laid out at our Analyst Day last year. So during the quarter, our OpEx spending was down. We had some spending efficiencies as well as some benefits from lower payroll taxes. When we look to our Q4 guide, which is slightly higher at the midpoint, that's going to be primarily due to program costs. So higher program costs as we roll out our Nexus product in Q4 that Jim mentioned. And then when you look into further out beyond the next quarter, at our Analyst Day last year, we talked about our goal for OpEx to be at 35%. So we're actually at 35% in Q3, but what we are going to continue working on is sort of dialing in on the mix between R&D and SG&A. And so the goal that we laid out last year was a 15% target for SG&A and then for R&D to be around 20%. And so we've got a little ways to go on SG&A to get further down to the 15% goal, but that's how you can think about overall OpEx target of 35% and then within that, the R&D and SG&A composition.

Your next question is from Hans Mosesmann of Rosenblatt.

Congrats, guys, good execution. Jim, I don't know if you've ever kind of split out on the computing side of your data center business, specifically between your FPGAs that are aligned with the actual motherboard or server CPU and say, acceleration ASICs or GPUs or network interface cards and storage. I'm not sure if you've done that, but if you could provide us some flavor of your exposure in those other markets that seem to be growing quite nicely.

Yes, Hans. Yes, we haven't broken that out. I would say most of the revenue, though, is associated with FPGAs on the main CPU board, usually doing control or security type functionality on the main CPU motherboard, although we are used on other cards as well. So we are used on daughter cards, accelerator cards and other type of sort of ancillary cards, ancillary to the main motherboard. But I would say that most of the revenue from that part of the market is driven from the main CPU motherboard.

Okay. On Huawei, can you give us a reference point since there's no part of Huawei included in your outlook for Q4. How much was it roughly in Q3 and also Q2 just as a reference point?

Yes. Maybe I'll just give you the full year since we know what Huawei revenue is going to be at this point given that we haven't assumed any for Q4. Huawei revenue for this year would have been, I'd say, low single digits this year, kind of in the 2%, maybe 2% to 3% range, low single digits.

Okay. That's helpful. And then the last question I have, on 5G, I don't know if you -- I may have missed it. How is that particular end market doing for you guys? It's an area of penetration or market share gains. So any updates there would be helpful.

Yes, Hans. On 5G, we were pleased again in Q3. 5G grew from a year-over-year standpoint. We've seen really good growth in revenue for 5G through the first 3 quarters of this year relative to last year, was a nice growth contributor this year. And we expect it to grow again next year. We're still early in the 5G rollout cycle. If you look at worldwide deployments, we're still early in that cycle. And again, we've got 30% more content in a 5G base station than we did in a 4G. So we expect it to be a good long-term growth driver, good multiyear growth driver for us as deployments happen worldwide over the coming years.

Your next question is from Richard Shannon of Craig-Hallum.

Richard, if you're speaking, you might be on mute. We can't hear you. So Richard, we can't hear you.

[Operator Instructions] There's no further questions. And I would like to turn it back to Mr. Jim Anderson, CEO, for any further comments.

Okay. Thank you, operator. And thanks, everybody, for being on the call today with us. We're pleased with our continued progress, but we have a lot more work to do as we unlock the full potential of Lattice. We're excited about the future of Lattice, and we remain focused on consistent execution of both our business strategy and our product road maps. Thanks, everybody, for joining us today. And operator, that concludes today's call.

Ladies and gentlemen, thank you for participating. You may now disconnect.