LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) designs, develops, and markets high-performance programmable logic devices (PLDs) and field-programmable gate arrays (FPGAs). This Form 10-Q covers the quarterly period ended July 3, 2010, and the six-month period ended on the same date. The company operates in a single industry segment with significant exposure to the communications equipment end market and the Asia Pacific region.

Key Financial Metrics

Liquidity and Debt: As of July 3, 2010, the company held $212.0 million in cash, cash equivalents, and short-term marketable securities. The company has no long-term debt but holds $12.7 million in long-term marketable securities classified as illiquid auction rate securities.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 64% year-over-year for the quarter ($77.1M vs. $46.9M) and 64% for the six-month period ($147.6M vs. $90.2M). Growth was driven by increased unit sales across all product lines, particularly new FPGA products.
• Profitability: The company returned to profitability, reporting net income of $16.7 million for the quarter compared to a net loss of $2.7 million in the prior year quarter. Operating income improved from a loss of $2.8 million to a profit of $15.8 million.
• Gross Margin Expansion: Gross margin improved to 61.2% from 52.4% in the prior year quarter, attributed to higher production volumes absorbing fixed overhead and a favorable product mix shift toward higher-margin mature and mainstream products.
• Geographic Shift: While export revenue remains dominant (88% of total), the Asia Pacific region's share of revenue decreased slightly to 55% from 57%, while Japan saw significant growth (13% of revenue vs. 7% prior year).

Guidance, Outlook, and Risks

Management Commentary: Management expects a significant portion of revenue to remain dependent on the communications end market. The company is transitioning its distribution model in the Asia Pacific region from "sell-in" to "sell-through," meaning revenue recognition is now tied to distributor resale rather than shipment. Capital expenditures are expected to increase as revenue grows and new products are introduced.

Risks and Contingencies:

• Executive Transition: On August 6, 2010, the company announced the resignation of CEO Bruno Guilmart, effective September 4, 2010. Christopher M. Fanning was appointed interim CEO. This transition poses a risk of business disruption.
• Illiquid Investments: The company holds $23.8 million par value of auction rate securities with a fair value of $12.7 million. These are classified as long-term due to illiquidity and failed auctions. A forced liquidation could result in material losses.
• Supply Chain Concentration: Fujitsu Semiconductor Limited is the sole source supplier of wafers for the company's newest FPGA and PLD products. Disruptions at Fujitsu could severely impact operations.
• Customer Concentration: Two large telecommunications equipment providers accounted for 11% of revenue in the first six months of 2010 (down from 23% in 2009).

Investor Verification Checklist

• Verify the timeline and impact of the CEO transition and the appointment of the interim CEO.
• Monitor the status of the $23.8 million par value auction rate securities and any potential impairment charges or realized losses upon sale.
• Assess the sustainability of the 61.2% gross margin given the shift in product mix and potential competitive pricing pressures.
• Review the progress of the "sell-through" distribution model transition and its effect on revenue recognition timing and predictability.
• Confirm the stability of the supply relationship with Fujitsu Semiconductor Limited for next-generation wafer production.