LATTICE SEMICONDUCTOR CORP 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   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 2021 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 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, 5G 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 significant 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 2021 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 COVID-19 and Global Economic Activity on our Business   The ongoing COVID-19 pandemic, increasing market volatility, inflationary pressure, and geopolitical tension continue to impact business globally and may impact our operations on an ongoing basis by causing disruption to our labor markets and supply chains. The COVID-19 pandemic, including the resurgence of cases relating to the spread of new variants, has and continues to impact worldwide economic activity and poses the risk that our employees, contractors, suppliers and other partners may be prevented from conducting business activities. The extent to which the COVID-19 pandemic, increasing financial market volatility, inflationary pressure and related uncertainty will impact our business activities will depend on future developments that are highly uncertain and cannot be predicted at this time.   - 18 - Table of Contents   Results of Operations   Key elements of our Consolidated Statements of Operations, including as a percentage of revenue, are presented in the following table:       Three Months Ended     Nine Months Ended       October 1,     October 2,     October 1,     October 2,   (In thousands)   2022     2021     2022     2021   Revenue   $ 172,509       100.0 %   $ 131,911       100.0 %   $ 484,396       100.0 %   $ 373,532       100.0 %                                                                   Gross margin     118,732       68.8       82,825       62.8       329,984       68.1       230,595       61.7                                                                     Research and development     34,820       20.2       28,769       21.8       100,988       20.8       80,289       21.5   Selling, general and, administrative     31,926       18.5       26,272       19.9       89,721       18.5       76,971       20.6   Amortization of acquired intangible assets     869       0.5       603       0.5       2,908       0.6       1,809       0.5   Restructuring charges     2,315       1.3       166       0.1       2,505       0.5       546       0.1   Acquisition related charges     —       —       —       —       511       0.1       —       —   Income from operations   $ 48,802       28.3 %   $ 27,015       20.5 %   $ 133,351       27.5 %   $ 70,980       19.0 %   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: 5G infrastructure deployments, client computing platforms, and cloud and enterprise servers, • Industrial and automotive: industrial Internet of Things ("IoT"), factory automation, robotics, and automotive electronics, • Consumer: smart home, and prosumer.   We also generate revenue from the licensing of our IP, the collection of certain royalties, patent sales, the revenue related to our participation in consortia and standard-setting activities, and services. While these activities may be associated with multiple markets, Licensing and services revenue is reported as a separate end market as it has characteristics that differ from other categories, most notably a higher gross margin.   The end market data below is derived from data provided to us b y our customers. Wi th 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 fo r which end customers an d 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:   Communications and Computing Industrial and Automotive Consumer Licensing and Services Wireless Security and Surveillance Cameras IP Royalties Wireline Machine Vision Displays Adopter Fees Data Backhaul Industrial Automation Wearables IP Licenses Server Computing Robotics Televisions Patent Sales Client Computing Automotive Home Theater   Data Storage Drones       - 19 - Table of Contents   The composition of our revenue by end market is presented in the following table:       Three Months Ended     Nine Months Ended       October 1,     October 2,     October 1,     October 2,   (In thousands)   2022     2021     2022     2021   Communications and Computing   $ 70,522       40.9 %   $ 55,827       42.3 %   $ 203,723       42.1 %   $ 157,732       42.2 % Industrial and Automotive     85,730       49.7       58,953       44.7       229,820       47.4       166,137       44.5   Consumer     10,968       6.3       12,637       9.6       38,255       7.9       37,676       10.1   Licensing and Services     5,289       3.1       4,494       3.4       12,598       2.6       11,987       3.2   Total revenue   $ 172,509       100.0 %   $ 131,911       100.0 %   $ 484,396       100.0 %   $ 373,532       100.0 %   Revenue from the Communications and Computing end market increased by 26% for the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 and increased by 29% for the first nine months of fiscal 2022 compared to the first nine months of fiscal 2021 primarily due to our key growth drivers in data center servers, client computing and 5G infrastructure.   Revenue from the Industrial and Automotive end market increased by 45% for the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 and increased by 38% for the first nine months of fiscal 2022 compared to the first nine months of fiscal 2021 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 decreased by 13% for the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 primarily due to macroeconomic weakness in Consumer, and increased by 2% for the first nine months of fiscal 2022 compared to the first nine months of fiscal 2021 primarily due to increased demand for our products in Consumer end market applications over the year-to-date periods.   Revenue from the Licensing and services end market increased by 18% for the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 and increased by 5% for the first nine months of fiscal 2022 compared to the first nine months of fiscal 2021 primarily due to increased royalties.   Revenue by Geography   We assign revenue to geographies based on ship-to location of the customer.   The composition of our revenue by geography is presented in the following table:       Three Months Ended     Nine Months Ended       October 1,     October 2,     October 1,     October 2,   (In thousands)   2022     2021     2022     2021   Asia   $ 122,860       71.2 %   $ 98,897       75.0 %   $ 350,332       72.3 %   $ 283,742       76.0 % Americas     23,154       13.4       20,261       15.4       66,976       13.8       53,930       14.4   Europe     26,495       15.4       12,753       9.6       67,088       13.9       35,860       9.6   Total revenue   $ 172,509       100.0 %   $ 131,911       100.0 %   $ 484,396       100.0 %   $ 373,532       100.0 %   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, and the two distributor groups noted below individually accounted for more than 10% of our total revenue in the periods covered by this report .   The composition of our revenue by customer is presented in the following table:       % of Total Revenue     % of Total Revenue       Three Months Ended     Nine Months Ended       October 1,     October 2,     October 1,     October 2,       2022     2021     2022     2021   Weikeng Group     31.1 %     44.0 %     32.9 %     39.1 % Arrow Electronics Inc.     24.7       30.0       27.2       26.9   Other distributors     33.7       15.6       29.4       21.9   All distributors     89.5       89.6       89.5       87.9   Direct customers     7.4       7.0       7.9       8.9   Licensing and services revenue     3.1       3.4       2.6       3.2   Total revenue     100.0 %     100.0 %     100.0 %     100.0 %   - 20 - Table of Contents   Gross Margin   The composition of our Gross margin, including as a percentage of revenue, is presented in the following table:       Three Months Ended     Nine Months Ended       October 1,     October 2,     October 1,     October 2,   (In thousands)   2022     2021     2022     2021   Gross margin   $ 118,732     $ 82,825     $ 329,984     $ 230,595   Gross margin percentage     68.8 %     62.8 %     68.1 %     61.7 % Product gross margin %     67.8 %     61.5 %     67.3 %     60.5 % Licensing and services gross margin %     100.0 %     100.0 %     100.0 %     100.0 %   Gross margin, as a percentage of revenue, increased 600 basis points in the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 and increased by 640 basis points in the first nine months of fiscal 2022 compared to the first nine months of fiscal 2021. Improved margins were driven by benefits from our pricing optimization and gross margin expansion strategy.   Because of its higher margin, the licensing and services portion of our overall revenue can have a disproportionate impact on Gross margin.   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:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Research and development   $ 34,820     $ 28,769       21.0 %   $ 100,988     $ 80,289       25.8 % Percentage of revenue     20.2 %     21.8 %             20.8 %     21.5 %           Research and development expense includes costs for compensation and benefits, stock compensation, engineering wafers, depreciation, 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 2022 compared to the third quarter and first nine months of fiscal 2021 was due primarily to increased headcount-related costs as we continue to invest in our long-term product roadmap. 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:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Selling, general, and administrative   $ 31,926     $ 26,272       21.5 %   $ 89,721     $ 76,971       16.6 % Percentage of revenue     18.5 %     19.9 %             18.5 %     20.6 %           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 2022 compared to the third quarter and first nine months of fiscal 2021 was due primarily to increased headcount-related costs to support ongoing customer growth, and to increased legal expenses primarily related to the defense of claims outside the ordinary course of business.   - 21 - Table of Contents   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:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Amortization of acquired intangible assets   $ 869     $ 603       44.1 %   $ 2,908     $ 1,809       60.8 % Percentage of revenue     0.5 %     0.5 %             0.6 %     0.5 %           The increase in Amortization of acquired intangible assets for the third quarter and first nine months of fiscal 2022 compared to the third quarter and first nine months of fiscal 2021 is due to the amortization expense for new intangible assets added in the fourth quarter of fiscal 2021 through the acquisition of Mirametrix, Inc., partially offset by end of the amortization period during the first quarter of fiscal 2022 for acquired intangible assets from previous acquisitions.   Restructuring Charges   The composition of our Restructuring charges, including as a percentage of revenue, is presented in the following table:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Restructuring charges   $ 2,315     $ 166       100+%     $ 2,505     $ 546       100+%   Percentage of revenue     1.3 %     0.1 %             0.5 %     0.1 %           Restructuring charges are 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 charges increased in the third quarter and first nine months of fiscal 2022 compared to the third quarter and first nine months of fiscal 2021 primarily due to lease right-of-use impairment and contract termination fees in the current year periods, as compared to minimal activity in the prior year.   Acquisition Related Charges   The composition of our Acquisition related charges, including as a percentage of revenue, is presented in the following table:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Acquisition related charges   $ —     $ —       — %   $ 511     $ —       100.0 % Percentage of revenue     — %     — %             0.1 %     — %           For the first nine months of fiscal 2022, Acquisition related charges were attributable to our acquisition of Mirametrix in November 2021 and were comprised primarily of professional services including legal and accounting fees.   Interest Expense   The composition of our Interest expense, including as a percentage of revenue, is presented in the following table:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Interest expense   $ (1,267 )   $ (661 )     91.7 %   $ (2,866 )   $ (2,081 )     37.7 % Percentage of revenue     (0.7 )%     (0.5 )%             (0.6 )%     (0.6 )%           Interest expense is primarily related to our long-term debt. This interest expense is comprised of contractual interest and amortization of original issue discount and debt issuance costs based on the effective interest method. The increase in Interest expense for the third quarter and first nine months of fiscal 2022 compared to the third quarter and first nine months of fiscal 2021 was driven by the increase in the effective interest rate on our long-term debt.   - 22 - Table of Contents   Other (Expense) Income, net   The composition of our Other (expense) income, net, including as a percentage of revenue, is presented in the following table:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Other (expense) income, net   $ (820 )   $ (87 )     100+%     $ (1,085 )   $ (384 )     100+%   Percentage of revenue     (0.5 )%     (0.1 )%             (0.2 )%     (0.1 )%           The changes in Other (expense) income, net for the third quarter and first nine months of fiscal 2022 compared to the third quarter and first nine months of fiscal 2021 were primarily due to the $0.7 million loss on refinancing of our long-term debt during the period.   Income Taxes   The composition of our Income tax expense (benefit) is presented in the following table:       Three Months Ended             Nine Months Ended               October 1,     October 2,             October 1,     October 2,           (In thousands)   2022     2021     % change     2022     2021     % change   Income tax expense (benefit)   $ 356     $ (472 )     100+%     $ 2,431     $ 1,125       100+%     Our Income tax expense (benefit) is composed primarily of foreign income and withholding taxes, partially offset by benefits resulting from the release of uncertain tax positions due to statute of limitation expirations that occurred in the respective periods. The increase in tax expense in the third quarter and first nine months of fiscal 2022 as compared to the third quarter and first nine months of fiscal 2021 is primarily due to increased worldwide income and changes in uncertain tax positions.   Liquidity and Capital Resources   The following sections discuss material changes in our financial condition from the end of fiscal 2021, 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 the ongoing COVID-19 pandemic, market volatility, and the rising rate of inflation, 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 October 1, 2022, 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)   October 1, 2022     January 1, 2022     $ Change     % Change   Cash and cash equivalents   $ 118,766     $ 131,570     $ (12,804 )     (9.7 )%   As of October 1, 2022, we had Cash and cash equivalents of $118.8 million, of which approximately $21.1 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 October 1, 2022, we could access all cash held by our foreign subsidiaries without incurring significant additional expense.   - 23 - Table of Contents   The net decrease in Cash and cash equivalents of $12.8 million between January 1, 2022 and October 1, 2022 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 2022 was $156.8 million compared to $116.1 million for the first nine months of fiscal 2021 . This increase of $40.8 million was primarily driven by an increase of $73.7 million provided by improved operating performance, partially offset by $32.9 million of net changes in working capital, primarily from cash used by inventories and accounts receivable . We are using cash provided by operating activities to fund our operations.   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 2022 was $21.4 million compared to $16.7 million in the first nine months of fiscal 2021.   Financing activities — Financing cash flows consist primarily of activity on our long-term debt, proceeds from the exercise of options to acquire common stock, tax payments related to the net share settlement of restricted stock units, and repurchases of common stock. 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. During the first nine months of fiscal 2022, we paid required quarterly installments on our previous long-term debt totaling $8.8 million.  Payments for tax withholdings on vesting of RSUs partially offset by employee exercises of stock options used net cash flows of $45.7 million in the first nine months of fiscal 2022, an increase of approximately $9.4 million from the net $36.3 million used in the first nine months of fiscal 2021. During the first nine months of fiscal 2022, we also repurchased approximately 1.7 million shares of common stock for $90.1 million, as further discussed below under "Share Repurchase Program."   Accounts receivable, net   (In thousands)   October 1, 2022     January 1, 2022     Change     % Change   Accounts receivable, net   $ 100,446     $ 79,859     $ 20,587       25.8 % Days sales outstanding - Overall     53       51       2             Accounts receivable, net as of October 1, 2022 increased by approximately $20.6 million, or 26% , compared to January 1, 2022. This increase resulted primarily from higher revenue shipments in the third quarter of fiscal 2022 compared to the year-end period. 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)   October 1, 2022     January 1, 2022     Change     % Change   Inventories   $ 93,964     $ 67,594     $ 26,370       39.0 % Days of inventory on hand     159       122       37             Inventories as of October 1, 2022 increased $26.4 million, or approximately 39%, compared to January 1, 2022 primarily to meet the increased demands of our customers.   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 October 1, 2022 , 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.   - 24 - Table of Contents