LSCC

Business Context and Reporting Period

Company: Lattice Semiconductor Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 30, 2006 (52-week fiscal year)
Business Overview: Lattice designs, develops, and markets high-performance programmable logic products (FPGAs and PLDs) and related software. The company operates as a fabless semiconductor entity, sourcing wafers from foundries (primarily Fujitsu, Seiko Epson, UMC, and Chartered) and utilizing third-party contractors for assembly and testing. End markets include communications, computing, consumer, industrial, automotive, medical, and military sectors.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 16% to $245.5 million, driven by a 43% increase in FPGA unit sales and growth in communications, consumer, and military end markets. Total units sold rose 16% while average selling prices remained relatively constant.
• Profitability Turnaround: The company returned to profitability with $3.1 million in net income, reversing a $49.1 million net loss in 2005. This was aided by a significant reduction in restructuring charges (from $11.9 million in 2005 to $0.3 million in 2006) and lower amortization of intangible assets.
• Expense Management: Research and Development (R&D) expenses decreased 16% to $82.0 million due to the 2005 restructuring plan and the elimination of stock compensation expense related to previous acquisitions. Selling, General, and Administrative (SG&A) expenses increased slightly to $58.5 million, partially offset by a $6.5 million reduction in legal expenses compared to 2005.
• Product Mix: FPGA revenue grew to 20% of total revenue (up from 18% in 2005), while PLD revenue remained the dominant segment at 80%.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects to continue significant investments in R&D to maintain product leadership, particularly in migrating to advanced process technologies (90nm and beyond). The company anticipates that existing liquid resources and future cash generation will meet operating requirements for the next 12 months.
• Unusual Items:
  • Accounting Change: Effective January 1, 2006, the company adopted SFAS No. 123(R), recognizing $3.6 million in stock-based compensation expense.
  • Legal Settlements: A $3.5 million class action settlement regarding 2003 financial restatements was fully paid by insurance carriers, resulting in no net impact on operations. An SEC informal inquiry was resolved via a Cease-and-Desist Order in January 2007.
  • Foundry Advance: The company accrued a final $37.5 million payment to Fujitsu for wafer credits, paid in January 2007.
• Risks:
  • Supply Chain: Heavy reliance on foundry partners (Fujitsu is the sole source for newest FPGA products) and assembly contractors in Asia exposes the company to supply interruptions, yield issues, and geopolitical risks.
  • Market Cyclicality: Revenue is heavily dependent on the communications and computing end markets, which are subject to cyclical downturns and inventory corrections.
  • Competition: Intense competition from larger firms (Altera, Xilinx, Actel) with greater resources.

Investor Verification Checklist

• Wafer Supply Agreements: Verify the status of the $125 million advance payment to Fujitsu and the utilization of wafer credits against future production needs.
• Convertible Notes: Review the terms of the $109.6 million Zero Coupon Convertible Notes due in 2010, noting the holder's option to require repurchase in 2008.
• Inventory Levels: Assess the $38.8 million inventory balance (up from $28.6 million in 2005) to ensure it aligns with demand forecasts and does not require future write-downs.
• Goodwill Impairment: Monitor stock price performance relative to book value ($4.45 per share at year-end) to assess potential future goodwill impairment charges.
• Export Concentration: Confirm the stability of export markets, which accounted for 80% of revenue, with significant exposure to China (17%) and Japan (13%).