LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) designs, develops, and markets high-performance programmable logic devices (PLDs), including FPGAs, CPLDs, and SPLDs. This Form 10-Q covers the quarterly period ended September 27, 2003, and the nine-month period ended September 30, 2003. The company operates in a single industry segment serving communications, computing, industrial, automotive, medical, consumer, and military markets.

Key Financial Metrics

Operating Expenses (9M 2003): Cost of products sold was $67.2 million; R&D was $64.7 million; SG&A was $37.2 million; Amortization of intangible assets was $58.5 million.

Material Changes vs. Prior Period

• Revenue Decline: Q3 2003 revenue decreased 9% ($5.0 million) compared to Q3 2002, and 2% ($3.9 million) for the nine-month period. This reflects a continued downturn in the semiconductor industry, declining average selling prices for SPLD and CPLD products, and reduced demand in communications and computing markets.
• Increased Net Loss: Net loss widened to $21.9 million in Q3 2003 from $14.4 million in Q3 2002. The nine-month loss increased to $57.6 million from $48.1 million.
• Debt Restructuring: In Q3 2003, Lattice redeemed all outstanding 4 3/4% Convertible Notes due in 2006 (approx. $172.3 million par value) for $178.8 million. Simultaneously, the company issued $200 million in Zero Coupon Convertible Notes due in 2010. A portion ($16.0 million) of the new notes was extinguished in Q3 for a gain of $1.4 million.
• Inventory Reduction: Inventories decreased 15% ($8.3 million) year-over-year to $47.9 million, driven by reduced wafer starts in response to lower revenue.
• Foundry Investment Gain: The company recorded an unrealized gain of $19.8 million on its investment in United Microelectronics Corporation (UMC), increasing the carrying value to $76.2 million.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the revenue decline to a prolonged downturn in the communications and computing end markets. While FPGA revenue growth helped offset declines in legacy products, overall unit sales and average selling prices decreased. The company expects to continue significant investment in R&D to maintain product leadership.

Liquidity: Lattice reported $278.8 million in cash and short-term investments. Management believes existing resources and cash flow from operations are adequate for the next 12 months. Capital expenditures for the full year 2003 are expected to be between $10 million and $12 million.

Risks and Contingencies:

• Goodwill Impairment: The company's stock price is trading near its consolidated book value. A sustained decline could trigger a goodwill impairment charge under SFAS 142.
• Supply Chain: Lattice relies on third-party foundries (Seiko Epson, UMC, Chartered Semiconductor) for wafer manufacturing. Disruptions, yield issues, or capacity constraints could harm operations.
• Market Cyclicality: The semiconductor industry is highly cyclical. Continued downturns in IT capital spending could further reduce demand.
• Integration Risks: Ongoing integration of the Agere FPGA business acquired in 2002 carries risks regarding employee retention and product development timelines.

Investor Verification Checklist

• Debt Maturity Profile: Verify the terms and conversion triggers of the new $184 million Zero Coupon Convertible Notes due in 2010.
• Goodwill Valuation: Monitor stock price performance relative to book value to assess the risk of future goodwill impairment charges.
• UMC Investment: Review the valuation and liquidity restrictions on the $76.2 million UMC equity stake, noting that 23.3 million shares are restricted.
• Product Mix Shift: Track the revenue contribution of FPGAs versus legacy CPLD/SPLD products to gauge the success of the strategic pivot.
• Amortization Burden: Confirm the impact of the $58.5 million in intangible asset amortization on future operating margins.