LSCC

Business Context and Reporting Period

Company: Lattice Semiconductor Corp.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2002
Business Overview: Lattice designs, develops, manufactures, and markets high-performance programmable logic devices (PLDs), including FPGAs, CPLDs, and SPLDs. The company operates in a single industry segment with significant exposure to the communications and computing end markets.

Key Financial Metrics

Cash Flow: Net cash provided by operating activities was $4.4 million, a significant decrease from $19.5 million in the prior year quarter. Net cash used in investing activities was $176.6 million, primarily driven by the $254.2 million acquisition of Agere FPGA.

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 47% ($52.2 million) year-over-year due to a significant downturn in the semiconductor and PLD markets, particularly in the communications sector. Average selling prices also declined.
• Acquisition Impact: On January 18, 2002, Lattice acquired the FPGA business of Agere Systems for $250 million in cash. This resulted in a one-time charge of $24.2 million for In-Process Research and Development (IPR&D) and added $142.0 million in goodwill.
• Profitability Reversal: The company swung from a net income of $11.3 million in Q1 2001 to a net loss of $25.6 million in Q1 2002. This was driven by the revenue decline, the IPR&D charge, and increased R&D expenses ($21.4 million vs. $18.2 million).
• Accounting Changes: Adoption of SFAS 142 eliminated the amortization of goodwill, saving approximately $8.0 million in quarterly expenses compared to prior periods, though this was offset by amortization of new intangible assets from the Agere acquisition.
• Liquidity Reduction: Total cash and short-term investments dropped from $531.6 million at year-end 2001 to $279.9 million at March 31, 2002, primarily due to the cash outlay for the Agere acquisition.

Guidance, Outlook, and Risks

Management Commentary: Management expects to continue significant investments in R&D to maintain product leadership. The company is currently integrating the Agere FPGA business. Capital expenditures for the fiscal year are expected to be between $15 million and $20 million.

Key Risks and Contingencies:

• Market Downturn: Continued weakness in communications and computing end markets and excess inventory at customer sites threaten future revenue.
• Integration Risks: Potential difficulties in integrating the Agere FPGA business, including loss of key employees, failure to achieve revenue synergies, or unexpected costs.
• Supply Chain: Reliance on third-party foundries (Seiko Epson, UMC, Chartered) for wafer manufacturing. Disruptions, yield issues, or capacity constraints could limit product availability.
• Equity Investment Volatility: The company holds approximately 84 million shares of UMC Corporation. Fluctuations in UMC's stock price create equity price risk, though a 10% change is not currently deemed material.
• Product Development: Risks associated with the timely introduction of new products (ORCA 4, ORCA 5, FPSC) and the migration to advanced manufacturing technologies.

Investor Verification Checklist

• Acquisition Integration: Verify the progress of integrating Agere FPGA and whether the projected revenue synergies are being realized.
• Inventory Levels: Monitor accounts receivable and inventory levels to assess the impact of the market downturn and potential write-downs.
• Foundry Capacity: Confirm the status of wafer supply commitments with Seiko Epson and UMC, especially given recent facility closures mentioned in the filing.
• Intangible Asset Amortization: Review future amortization schedules for the new intangible assets acquired from Agere, which are expected to total $52.0 million for the remainder of 2002.
• Convertible Notes: Note the $260 million in 4 3/4% convertible notes due in 2006 and the company's ability to service this debt given the current operating loss.