LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) filed its Form 10-Q for the quarterly and nine-month periods ended September 30, 2000. Lattice designs, develops, manufactures, and markets high-performance programmable logic devices. The company operates as a fabless semiconductor entity, relying on foundry partners such as Seiko Epson, AMD, and UMC for wafer fabrication. The reporting period reflects the full integration of the Vantis Corporation acquisition completed in June 1999 and the impact of a follow-on public stock offering in July 2000.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 59% year-over-year for the quarter and 100% for the nine-month period. This growth is attributed to the Vantis acquisition and a significant shift in product mix toward high-density products, which now comprise 77% of quarterly revenue.
• Profitability: The company transitioned from a net loss of $44.3 million in the first nine months of 1999 to a net income of $144.3 million in the same period of 2000. This turnaround includes a one-time non-operating gain of $149.96 million from the appreciation of foundry investments (UICC/Utek merger into UMC).
• Expense Management: While R&D and SG&A expenses increased in absolute dollars due to the Vantis acquisition, they decreased as a percentage of revenue (R&D: 18.8% to 13.2%; SG&A: 21.5% to 13.7% for the quarter), indicating improved operating leverage.
• Liquidity: Cash and short-term investments grew by $300 million to $514.2 million, driven by operating cash flow, stock option exercises, and a $210 million net proceeds follow-on stock offering in July 2000.

Guidance, Outlook, and Risks

Management Commentary: Management expects to continue significant investments in R&D to maintain product leadership. Capital expenditures for the fiscal year ending December 31, 2000, are projected to be between $30 million and $35 million. The company believes its current liquidity and cash generation are sufficient to meet obligations for the next 12 months.

Key Risks and Contingencies:

• Supply Chain Dependence: Lattice relies entirely on third-party foundries (Seiko Epson, AMD, UMC) for wafer supply. Disruptions, yield issues, or capacity constraints at these facilities could severely impact operations.
• Geographic Concentration: A significant portion of revenue comes from export sales (Asia, Europe), exposing the company to foreign economic conditions and currency fluctuations (specifically the Japanese Yen).
• Intellectual Property Litigation: The company is involved in ongoing patent litigation with Altera Corporation regarding programmable logic devices. Management does not currently believe the outcome will have a material adverse effect, but no assurance can be given.
• Market Volatility: The semiconductor industry is cyclical, and quarterly results may fluctuate due to customer inventory levels, product obsolescence, and competitive pricing.

Investor Verification Checklist

• Foundry Investment Gain: Verify the sustainability of earnings by excluding the $150 million one-time gain on foundry investments to assess core operational profitability.
• Wafer Supply Commitments: Confirm the status of supply agreements with Seiko Epson, AMD, and UMC, particularly regarding capacity allocation and potential bottlenecks.
• Convertible Notes: Review the terms of the $260 million 4 3/4% convertible notes due in 2006, including conversion prices and potential dilution impact.
• Inventory Levels: Monitor the 65% increase in inventory to ensure it aligns with demand and does not signal future write-downs.
• Legal Exposure: Track the progress of the Altera patent litigation for any updates on potential damages or injunctions.