LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) designs, develops, and markets high-performance programmable logic devices (PLDs). This Form 10-Q covers the quarterly period ended March 31, 2003. The company operates in a single industry segment serving communications, computing, industrial, automotive, medical, consumer, and military end markets. The reporting period reflects a continued downturn in the semiconductor and PLD markets.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Decreased 1% year-over-year to $58.3 million. This decline was driven by an 8% decrease in average selling prices, partially offset by a 7% increase in units sold. The price decline is attributed to market downturns and product mix shifts.
• Profitability: Net loss improved by $6.8 million compared to Q1 2002. The improvement was primarily due to a $2.9 million gain on the extinguishment of convertible debt and reduced interest expense, offsetting higher amortization costs.
• Expenses: Amortization of intangible assets increased to $21.1 million (from $18.6 million), largely due to a $2.2 million accelerated write-off of deferred compensation related to a stock option exchange program. R&D expenses rose slightly to $21.8 million due to headcount increases from recent acquisitions.
• Liquidity: Cash and cash equivalents dropped significantly from $169.5 million at year-end 2002 to $34.1 million at March 31, 2003, primarily due to the $29.9 million cash outlay to retire debt. However, total liquid resources (including short-term investments) remained at $252.8 million.

Outlook, Risks, and Unusual Items

• Debt Extinguishment: In Q1 2003, Lattice extinguished approximately $32.8 million of its 4 3/4% convertible notes for $29.9 million, recognizing a $2.9 million gain. This reduced total convertible debt to approximately $175 million.
• Stock Option Exchange: The company completed a stock option exchange program, canceling 11.2 million options in exchange for new options. This triggered a $2.2 million non-cash charge to amortization expense.
• Foundry Investment: Lattice recorded a $5.0 million unrealized loss on its investment in United Microelectronics Corporation (UMC), reflecting a decline in market value. This loss was recorded in Accumulated Other Comprehensive Loss, not net income.
• Market Risks: Management cites a prolonged downturn in communications and computing markets, cyclical industry conditions, and potential disruptions from the SARS outbreak in Asia as key risks. There is also a risk of goodwill impairment if the stock price remains below book value for a sustained period.
• Guidance: The filing does not provide specific numerical revenue or earnings guidance for the full year, noting that quarterly results may fluctuate significantly.

Investor Verification Checklist

• Goodwill Impairment Risk: Verify current stock price relative to book value to assess the likelihood of a future goodwill impairment charge under SFAS 142.
• UMC Investment Valuation: Monitor the market value of the UMC equity stake ($51.3 million carrying value) for further unrealized losses or potential "other than temporary" impairment charges.
• Debt Maturity Profile: Confirm the remaining terms and conversion prices of the $175.3 million in convertible notes due in 2006.
• Supply Chain Stability: Assess the impact of the SARS outbreak and geopolitical conditions in Asia on wafer supply from Seiko Epson, UMC, and Chartered Semiconductor.
• Amortization Run-Rate: Review the estimated future amortization of intangible assets ($53.5 million remaining in 2003) to understand the fixed cost burden on future margins.