LSCC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2002, and the nine months ended on that date for Lattice Semiconductor Corporation. The company designs, develops, manufactures, and markets high-performance programmable logic devices. The reporting period was significantly impacted by a continuing downturn in the communications equipment and computing end markets, as well as the integration of two major acquisitions: the Agere FPGA business (completed January 2002) and Cerdelinx Technologies (completed August 2002).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 3% in the third quarter and 30% for the nine-month period compared to 2001, driven by a significant downturn in the semiconductor and PLD markets and reduced demand across all geographies.
• Acquisition Impact: The company recorded $29.9 million in In-Process Research and Development (IPR&D) expenses for the nine months ended September 30, 2002, primarily due to the Agere FPGA ($24.2 million) and Cerdelinx ($5.7 million) acquisitions. These costs were expensed immediately as technological feasibility was not yet proven.
• Amortization Changes: Amortization of intangible assets decreased by approximately $8.4 million quarterly due to the adoption of SFAS 142, which eliminated goodwill amortization. This was partially offset by new amortization from acquired intangibles.
• Foundry Investment Losses: Unlike the prior year, which included a massive $152.8 million loss on foundry investments (UMC), the current period recorded no such charge. However, a $31.4 million unrealized loss on UMC shares was recorded in Accumulated Other Comprehensive Income (net of tax: $20.4 million).
• Debt Reduction: The company extinguished approximately $33.5 million of its 4 3/4% convertible notes during the first nine months of 2002, recognizing a gain of $5.7 million.

Guidance, Outlook, and Risks

Management Commentary: Management expects to continue significant investments in research and development to maintain product leadership. The company anticipates capital expenditures of $17 million to $19 million for the fiscal year ending December 31, 2002. While operating cash flow improved due to federal tax refunds, revenue remains pressured by weak end-market demand.

Risks and Contingencies:

• Market Downturn: A prolonged downturn in communications and computing markets continues to limit revenue growth.
• Integration Risks: The company faces risks in integrating the Agere FPGA business, including potential loss of key employees, customers, or failure to achieve expected cost reductions.
• Supply Chain: Reliance on third-party foundries (Seiko Epson, UMC, Chartered Semiconductor) creates risks regarding wafer supply interruptions, yield problems, and capacity constraints.
• Goodwill Impairment: Under SFAS 142, if the company's stock price remains below book value for a sustained period, a goodwill impairment charge may be required.
• Equity Price Risk: The company holds significant equity in UMC Corporation; sustained declines in UMC's stock price could impact financial results.

Investor Verification Checklist

• Acquisition Integration: Verify the progress of integrating Agere FPGA and Cerdelinx technologies and whether projected revenue synergies are materializing.
• Inventory Levels: Monitor inventory levels ($60.9 million) relative to the 25% decrease in units sold to assess potential obsolescence risks.
• UMC Investment Valuation: Review the carrying value of the UMC foundry investment ($61.0 million) and the likelihood of further unrealized losses impacting equity.
• Convertible Note Redemption: Track the remaining balance of convertible notes ($226.5 million) and the company's strategy for further debt reduction or conversion.
• Product Mix Shift: Confirm the revenue contribution from the new FPGA product line (11% of 9-month revenue) versus legacy CPLD and SPLD products.