LSCC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for Lattice Semiconductor Corporation, a Delaware corporation. The company designs, develops, manufactures, and markets high-performance programmable logic devices (PLDs), including Complex Programmable Logic Devices (CPLDs) and Field-Programmable Gate Arrays (FPGAs). A significant event during the period was the January 18, 2002, acquisition of the FPGA business from Agere Systems Inc. for $250 million in cash, which expanded the company's product portfolio and market share.

Key Financial Metrics

Note: Revenue and expense figures are in millions. The company reported a net loss for both periods due to the semiconductor market downturn and significant acquisition-related charges.

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 24% year-over-year for the quarter and 38% for the six-month period, driven by a significant downturn in the communications and computing end markets and reduced demand for PLDs.
• Acquisition Impact: The acquisition of Agere FPGA resulted in a one-time $24.2 million charge for In-Process Research and Development (IPR&D) and increased amortization of intangible assets. However, it also contributed approximately $7.1 million in FPGA revenue for the quarter.
• Operating Expenses: Research and Development (R&D) expenses increased by $3.0 million (quarter) and $6.1 million (six months) due to increased headcount from the Agere acquisition. Selling, General, and Administrative (SG&A) expenses decreased due to reduced revenue and discretionary spending cuts.
• Accounting Changes: The company adopted SFAS 142, eliminating the amortization of goodwill. This reduced quarterly amortization expenses by approximately $8 million compared to prior periods.
• Investment Gains/Losses: The company recorded a $4.0 million gain on the sale of United Microelectronics Corporation (UMC) shares and a $1.2 million gain on the extinguishment of convertible notes, partially offsetting operating losses.

Outlook, Risks, and Management Commentary

Management Commentary: Management attributes the revenue decline to the cyclical downturn in the semiconductor industry and excess inventory at customer sites. While average selling prices declined slightly due to product mix, the company remains committed to R&D to maintain product leadership. The integration of the Agere FPGA business is ongoing, with management noting risks related to employee retention and achieving expected revenue synergies.

Guidance and Outlook: The filing does not provide specific numerical guidance for future quarters. Management emphasizes that future results are difficult to predict due to the cyclical nature of the industry and the integration of the new business unit.

Risks and Contingencies:

• Market Downturn: Continued weakness in communications and computing markets could further reduce demand.
• Integration Risks: Failure to successfully integrate the Agere FPGA business could disrupt operations and delay new product introductions.
• Supply Chain: The company relies on third-party foundries (e.g., Seiko Epson, UMC) for wafer supply. Disruptions, yield issues, or capacity constraints at these facilities could impact production.
• Equity Price Risk: The company holds a significant investment in UMC (approx. 77 million shares). Fluctuations in UMC's stock price could materially impact financial results.
• Goodwill Impairment: With the stock price trading below book value, there is a risk of future goodwill impairment charges under SFAS 142.

Subsequent Events: On July 15, 2002, the company announced an agreement to acquire Cerdelinx Technologies, Inc. for approximately $23 million. Additionally, between July 1 and August 12, 2002, the company extinguished an additional $24.2 million of convertible notes, recognizing a $4.5 million gain.

Key Facts for Investor Verification

• Acquisition Integration: Verify the progress of integrating the Agere FPGA business and whether the projected revenue synergies are being realized.
• UMC Investment Valuation: Monitor the market value of the company's UMC holdings and the impact of any further sales or price declines on the balance sheet and income statement.
• Wafer Supply Security: Confirm the status of supply commitments with foundries (Seiko Epson, UMC, Chartered) given the history of capacity rationalization and potential delays.
• Goodwill Impairment: Assess the risk of goodwill impairment charges given the company's stock price relative to its book value and the adoption of SFAS 142.
• Cash Burn vs. Liquidity: While the company has strong liquidity ($308.2 million), verify the sustainability of cash flow from operations given the ongoing market downturn and high R&D spend.