LSCC

Lattice Semiconductor Corp. 10-Q Summary

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the three and nine months ended September 30, 2006. Lattice Semiconductor Corporation designs, develops, and markets high-performance programmable logic devices (PLDs and FPGAs) used in communications, computing, industrial, automotive, and consumer markets. The company operates as a fabless semiconductor entity, relying on foundry partners for manufacturing.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 19% year-over-year for the quarter and 17% for the nine-month period. Growth was driven by a 121% increase in "New" product revenue and a 13% increase in "Mainstream" products.
• Profitability Turnaround: The company returned to profitability, reporting net income of $0.9 million for the quarter compared to a net loss of $7.1 million in the same period in 2005. For the nine months, net income was $2.2 million versus a loss of $26.1 million in 2005.
• Expense Reduction: Research and development expenses decreased significantly (33.8% of revenue vs. 43.4% in 2005) due to a restructuring plan implemented in late 2005 and the elimination of stock compensation expense related to prior acquisitions.
• Debt Reduction: The company extinguished $20.0 million of its Zero Coupon Convertible Subordinated Notes for $17.8 million in cash during the nine-month period, recognizing a gain of $2.0 million.
• Inventory Build: Inventories increased by $8.0 million year-over-year, primarily due to increased stock of new products.

Outlook, Risks, and Management Commentary

• Product Strategy: Future growth depends heavily on the market acceptance of new FPGA products. The company is transitioning to more advanced process technologies (90nm and 65nm) with partner Fujitsu.
• Liquidity & Obligations: Management believes current liquid resources ($268.1 million) are adequate for the next 12 months. However, the company has significant upcoming contractual obligations, including two remaining milestone payments totaling $75.0 million to Fujitsu for wafer advances ($37.5 million due in Q4 2006 and $37.5 million in Q1 2007).
• Legal Proceedings: A shareholder class action lawsuit regarding prior financial restatements has reached a preliminary settlement of $3.5 million, fully covered by insurance. Additionally, the company has offered to settle an informal SEC inquiry regarding prior restatements with a cease and desist order; no penalties are expected, but final approval is pending.
• Risk Factors: Key risks include dependence on sole-source foundry partners (Fujitsu), supply chain disruptions in Asia, the cyclical nature of the semiconductor industry, and the potential for stock price volatility. The company also faces risks related to the successful migration to advanced manufacturing nodes.

Investor Verification Checklist

• Fujitsu Milestone Payments: Verify the timing and funding of the upcoming $37.5 million payment to Fujitsu due in Q4 2006 and the subsequent $37.5 million payment in Q1 2007.
• Inventory Levels: Monitor inventory turnover and potential write-downs given the $8.0 million increase in inventory levels.
• Legal Settlement Finalization: Confirm final court approval of the $3.5 million class action settlement and final SEC approval of the cease and desist order.
• New Product Adoption: Track the revenue contribution of "New" FPGA products to ensure the 121% growth rate is sustainable.
• Convertible Notes: Review the remaining $113.5 million in convertible notes due in 2010 (with a put option in 2008) and the company's strategy for refinancing or repayment.