Lattice Semiconductor Corp: Form 10-Q for the period ended Sep 30, 2023

The following discussion should be read along with the unaudited consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, as well as the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2022 10-K.

Overview

Lattice Semiconductor Corporation and its subsidiaries (“Lattice,” the “Company,” “we,” “us,” or “our”) develop technologies that we monetize through differentiated programmable logic semiconductor products, silicon-enabling products, system solutions, design services, and technology licenses. Lattice is the low power programmable leader. We solve customer problems across the network, from the Edge to the Cloud, in the growing communications, computing, industrial, automotive, and consumer markets. Our technology, long-standing relationships, and commitment to world-class support helps our customers quickly and easily unleash their innovation to create a smart, secure, and connected world.

Lattice has focused its strategy on delivering programmable logic products and related solutions based on low power, small size, and ease of use. We also serve our customers with intellectual property ("IP") licensing and various other services. Our product development activities include new proprietary products, advanced packaging, existing product enhancements, software development tools, soft IP, and system solutions for high-growth applications such as Edge Artificial Intelligence, wireless and wireline infrastructure, platform security, and factory automation.

Critical Accounting Policies and Use of Estimates

Critical accounting policies are those that are both most important to the portrayal of a company's financial condition and results of operations, and that require management's most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. There have been no material changes to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2022 10-K.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments affecting the amounts reported in our consolidated condensed financial statements and the accompanying notes. We base our estimates and judgments on historical experience, knowledge of current conditions, and our beliefs of what could occur in the future considering available information. While we believe that our estimates, assumptions, and judgments are reasonable, they are based on information available when made, and because of the uncertainty inherent in these matters, actual results may differ materially from these estimates under different assumptions or conditions. We evaluate our estimates and judgments on an ongoing basis.

Impact of Global Economic Activity on our Business

Increased financial market volatility, inflationary pressure, rising interest rates, recessionary concerns, uncertainty in the financial and banking industry, and geopolitical tension continue to impact business globally and may impact our operations by causing disruption to our labor markets and supply chains. The extent to which increased financial market volatility, inflationary pressures, global pandemics, and related uncertainty will impact our business activities will depend on future developments that are highly uncertain and cannot be predicted at this time.

Results of Operations

Key elements of our Consolidated Statements of Operations, including as a percentage of revenue, are presented in the following table:

(In thousands)

Revenue by End Market

We sell our products globally to a broad base of customers in three primary end market groups: Communications and Computing, Industrial and Automotive, and Consumer. We also provide IP licensing and services to these end markets.

Within these end markets, there are multiple segment drivers, including:

• Communications and computing: datacenter servers and networking equipment, client computing platforms, and wireless and wireline communications infrastructure deployments,
• Industrial and automotive: factory automation, robotics, automotive electronics, and industrial Internet of Things ("IoT"),
• Consumer: smart home, prosumer, and other applications.

The end market data we use is derived from data provided to us by our customers. With a diverse base of customers who may manufacture end products spanning multiple end markets, the assignment of revenue to a specific end market requires the use of judgment. We also recognize certain revenue for which end customers and end markets are not yet known. We assign this revenue first to a specific end market using historical and anticipated usage of the specific products, if possible, and allocate the remainder to the end markets based on either historical usage for each product family or industry application data for certain product types.

The following are examples of end market applications for the periods presented:

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The composition of our revenue by end market is presented in the following table:

(In thousands)

Revenue from the Communications and Computing end market decreased by 6% for the third quarter of fiscal 2023 compared to the third quarter of fiscal 2022 and decreased by 5% for the first nine months of fiscal 2023 compared to the first nine months of fiscal 2022 primarily due to softer end market demand in both wireless and wireline communications infrastructure, partially offset by strong demand in datacenter applications.

Revenue from the Industrial and Automotive end market increased by 28% for the third quarter of fiscal 2023 compared to the third quarter of fiscal 2022 and increased by 45% for the first nine months of fiscal 2023 compared to the first nine months of fiscal 2022 primarily due to strong customer adoption in a broad range of applications, including industrial automation and robotics. Growth in Automotive was driven by the adoption of new designs in advanced driver assistance ("ADAS") and infotainment applications.

Revenue from the Consumer end market increased by 1% for the third quarter of fiscal 2023 compared to the third quarter of fiscal 2022 due to increased demand for our products in Consumer end market applications over the quarterly periods and decreased by 24% for the first nine months of fiscal 2023 compared to the first nine months of fiscal 2022 primarily due to macroeconomic weakness in Consumer over the year-to-date periods.

Revenue by Geography

We have a diverse base of customers where distributors represent a significant portion of our total revenue. Our revenue by geographical market is based on the ship-to location of our customers, which can vary from time to time. Revenue from Asia decreased in the periods presented primarily due to the macroeconomic environment in the region, while revenue from the Americas and Europe increased due to increased demand in these regions.

The composition of our revenue by geography is presented in the following table:

(In thousands)

Revenue from Customers

We sell our products to independent distributors and directly to customers. Distributors have historically accounted for a significant portion of our total revenue. Revenue attributable to distributors as a percentage of total revenue was 90% for the third quarter of both fiscal 2023 and 2022, and 89% for both the nine months ended September 30, 2023 and October 1, 2022, respectively.

Gross Margin

The composition of our Gross margin, including as a percentage of revenue, is presented in the following table:

(In thousands)

Gross margin, as a percentage of revenue, increased 120 basis points in the third quarter of fiscal 2023 compared to the third quarter of fiscal 2022 and increased by 170 basis points in the first nine months of fiscal 2023 compared to the first nine months of fiscal 2022. Improved margins were driven by benefits from our gross margin expansion strategy.

Operating Expenses

Research and Development Expense

The composition of our Research and development expense, including as a percentage of revenue, is presented in the following table:

(In thousands)

Research and development expense includes costs for compensation and benefits, stock compensation, engineering wafers, depreciation and amortization, licenses, and outside engineering services. These expenditures are for the design of new products, IP cores, processes, packaging, and software solutions. The increase in Research and development expense for the third quarter and first nine months of fiscal 2023 compared to the third quarter and first nine months of fiscal 2022 was due primarily to increased headcount-related costs, including stock compensation, as we continue to invest in our long-term product roadmap, and depreciation and amortization related to our research and development equipment and tools. We believe that investing in research and development is important to delivering innovative products to our customers and, therefore, we expect to continue to increase our investment in research and development.

Selling, General, and Administrative Expense

The composition of our Selling, general, and administrative expense, including as a percentage of revenue, is presented in the following table:

(In thousands)

Selling, general, and administrative expense includes costs for compensation and benefits related to selling, general, and administrative employees, commissions, depreciation, professional and outside services, trade show, and travel expenses. The increase in Selling, general, and administrative expense for the third quarter and first nine months of fiscal 2023 compared to the third quarter and first nine months of fiscal 2022 was due primarily to increased headcount-related costs, including stock compensation and other costs, related to demand creation to support the growth of our business.

Amortization of Acquired Intangible Assets

The composition of our Amortization of acquired intangible assets, including as a percentage of revenue, is presented in the following table:

(In thousands)

Amortization of acquired intangible assets was flat between the third quarter of fiscal 2023 and the third quarter of fiscal 2022, and decreased for the first nine months of fiscal 2023 compared to the first nine months of fiscal 2022 due to the end of the amortization period during the first quarter of fiscal 2022 for acquired intangible assets from previous acquisitions.

Restructuring

The composition of our Restructuring activity, including as a percentage of revenue, is presented in the following table:

(In thousands)

Restructuring activity is generally comprised of expenses resulting from consolidation of our facilities, cancellation of contracts, and headcount reductions. Details of our restructuring plans and expenses incurred under them are discussed in "Note 6 - Restructuring" to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Restructuring costs decreased in the third quarter and first nine months of fiscal 2023 compared to the third quarter and first nine months of fiscal 2022 primarily due to lower costs in the current year periods for severance compared to higher costs in the prior year periods for lease right-of-use impairment and contract termination fees.

Acquisition Related

Acquisition related activity of $0.5 million, or 0.1% of revenue, for the first nine months of fiscal 2022 were attributable to our acquisition of Mirametrix in November 2021 and were comprised primarily of professional services including legal and accounting fees, as well as closing costs.

Interest Income (Expense), net

The composition of our Interest expense, net, including as a percentage of revenue, is presented in the following table:

(In thousands)

The change in Interest income (expense) for the third quarter and first nine months of fiscal 2023 compared to the third quarter and first nine months of fiscal 2022 was driven by increased interest income, coupled with decreased interest expense as we paid off the outstanding balance of our long-term debt.

Other Income (Expense), net

The composition of our Other income (expense), net, including as a percentage of revenue, is presented in the following table:

(In thousands)

The changes in Other income (expense) for the third quarter and first nine months of fiscal 2023 compared to the third quarter and first nine months of fiscal 2022 were primarily due to the non-recurrence of the $0.7 million loss on refinancing of our long-term debt during the prior year period, and to foreign currency effects.

Income Tax Expense

The composition of our Income tax expense is presented in the following table:

(In thousands)

Our Income tax expense is composed primarily of taxes on foreign income and withholding taxes, partially offset by benefits resulting from excess tax benefits from stock compensation. The increase in tax expense in the third quarter and first nine months of fiscal 2023 as compared to the third quarter and first nine months of fiscal 2022 is primarily due to increased worldwide income and U.S. tax on foreign operations.

Liquidity and Capital Resources

The following sections discuss material changes in our financial condition from the end of fiscal 2022, including the effects of changes in our Consolidated Balance Sheets, and the effects of our credit arrangements and contractual obligations on our liquidity and capital resources. There continues to be uncertainty around the extent and duration of the disruption to our business, including from the effects of market volatility, inflationary pressures, rising interest rates, recessionary concerns, uncertainty in the financial and banking industry, and geopolitical tension, which may impact our liquidity and working capital needs in future periods.

We have historically financed our operating and capital resource requirements through cash flows from operations, and from the issuance of long-term debt to fund acquisitions. Cash provided by or used in operating activities will fluctuate from period to period due to fluctuations in operating results, the timing and collection of accounts receivable, and required inventory levels, among other things.

We believe that our financial resources, including current cash and cash equivalents, cash flow from operating activities, and our credit facilities, will be sufficient to meet our liquidity and working capital needs through at least the next 12 months. On September 1, 2022, we entered into our 2022 Credit Agreement, as described in "Note 5 - Long-Term Debt" under Part I, Item 1 of this report. As of September 30, 2023, we did not have significant long-term commitments for capital expenditures. For further information on our cash commitments for operating lease liabilities, see "Note 7 - Leases" under Part I, Item 1 of this report.

In the future, we may continue to consider acquisition opportunities to further extend our product or technology portfolios and further expand our product offerings. In connection with funding capital expenditures, acquisitions, securing additional wafer supply, increasing our working capital, or other operations, we may seek to obtain equity or additional debt financing. We may also seek to obtain equity or additional debt financing if we experience downturns or cyclical fluctuations in our business that are more severe or longer than we anticipated when determining our current working capital needs.

Cash and cash equivalents

(In thousands)

As of September 30, 2023, we had Cash and cash equivalents of $114.4 million, of which approximately $32.4 million was held by our foreign subsidiaries. We manage our global cash requirements considering, among other things, (i) available funds among our subsidiaries through which we conduct business, (ii) the geographic location of our liquidity needs, and (iii) the cost to access international cash balances. The repatriation of non-US earnings may require us to withhold and pay foreign income tax on dividends. This should not result in our recording significant additional tax expense as we have accrued expense based on current withholding rates. As of September 30, 2023, we could access all cash held by our foreign subsidiaries without incurring significant additional expense.

The net decrease in Cash and cash equivalents of $31.3 million between December 31, 2022 and September 30, 2023 was primarily driven by cash flows from the following activities:

Operating activities — Cash provided by operating activities results from net income adjusted for certain non-cash items and changes in assets and liabilities. Cash provided by operating activities for the first nine months of fiscal 2023 was $197.6 million compared to $156.8 million for the first nine months of fiscal 2022. This increase of $40.8 million was primarily driven by an increase of $46.6 million provided by improved operating performance, partially offset by $5.8 million of net changes in working capital, primarily from cash used for Accounts payable, Accrued liabilities, and Accrued payroll obligations offset by cash provided by Inventories.

Investing activities — Investing cash flows consist primarily of transactions related to capital expenditures and payments for software and intellectual property licenses. Net cash used by investing activities in the first nine months of fiscal 2023 was $25.3 million compared to $21.4 million in the first nine months of fiscal 2022. This increase of $3.9 million is primarily a result of increased capital expenditures.

Financing activities — Financing cash flows consist primarily of activity on our long-term debt, tax payments related to the net share settlement of restricted stock units, proceeds from the exercise of options to acquire common stock, and repurchases of common stock. Net cash used by financing activities in the first nine months of fiscal 2023 was $203.1 million compared to $146.0 million in the first nine months of fiscal 2022. This $57.1 million increase was due to the following mix of activities. During the first nine months of fiscal 2023, we made discretionary payments totaling $130.0 million on our revolving loans under the 2022 Credit Agreement. In September 2022, we entered into our 2022 Credit Agreement and drew down an initial $150.0 million revolving loan at closing, which we used to pay off the $150.0 million outstanding balance on our previous term and revolving loans. In connection with the 2022 Credit Agreement, we paid $1.4 million in debt issuance costs. In the first nine months of fiscal 2022 we paid required quarterly installments of $8.8 million on our long-term debt under our prior Credit Agreement, dated May 17, 2019. Payments for tax withholdings on vesting of RSUs partially offset by employee exercises of stock options used net cash flows of $43.1 million in the first nine months of fiscal 2023, a decrease of approximately $2.6 million from the net $45.7 million used in the first nine months of fiscal 2022. During the first nine months of fiscal 2023, we repurchased approximately 0.4 million shares of common stock for $30.0 million compared to repurchases in the first nine months of fiscal 2022 of approximately 1.7 million shares of common stock for $90.1 million.

Accounts receivable, net

(In thousands)

Accounts receivable, net as of September 30, 2023 increased by approximately $11.9 million, or 13%, compared to December 31, 2022. This increase resulted primarily from higher revenue shipments in the third quarter of fiscal 2023 compared to the fourth quarter of fiscal 2022. We calculate Days sales outstanding on the basis of a 365-day year as Accounts receivable, net at the end of the quarter divided by sales during the quarter annualized and then multiplied by 365.

Inventories

(In thousands)

Inventories as of September 30, 2023 decreased $6.4 million, or approximately 6%, compared to December 31, 2022 primarily as a result of increased product shipments to meet customer demand.

The Days of inventory on hand ratio compares the inventory balance at the end of a quarter to the cost of sales in that quarter. We calculate Days of inventory on hand on the basis of a 365-day year as Inventories at the end of the quarter divided by Cost of sales during the quarter annualized and then multiplied by 365.

Credit Arrangements

On September 1, 2022, we entered into our 2022 Credit Agreement. The details of this arrangement are described in "Note 5 - Long-Term Debt" in the Notes to Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

As of September 30, 2023, we had no used or unused credit arrangements beyond the secured revolving loan facility described in the 2022 Credit Agreement.

Share Repurchase Program

See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” of this Quarterly Report on Form 10-Q for more information about the share repurchase program.

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. We assess these risks on a regular basis and have established policies that are designed to protect against the adverse effects of these and other potential exposures. There have been no material changes to either the foreign currency exchange rate risk or interest rate risk previously disclosed in Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our 2022 10-K.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

In connection with the filing of this Quarterly Report on Form 10-Q, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that occurred during the third quarter of fiscal 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

We do not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors associated with our business previously described in Part I, Item 1A, “Risk Factors,” in our 2022 10-K. There have been no material changes in the risk factors included in our 2022 10-K, and this report should be read in conjunction with the risk factors set forth in our 2022 10-K. These risk factors are not the only risks facing our company. Additional risks and uncertainties not presently known to us or that we may currently deem to be immaterial could materially adversely affect our business, financial condition, or operating results, including those related to adverse macroeconomic conditions, such as rising inflation and labor shortages, which may affect demand for our products or increase our product or labor costs, negatively impacting our revenues, gross margins, and overall financial results. If any of these risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected, and the trading price of our common stock could decline. These factors, together with all of the other information in this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, should be carefully considered before making an investment decision relating to our common stock.