LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) filed its Form 10-Q for the quarterly period ended July 3, 1999. The company designs, develops, manufactures, and markets high-performance programmable logic devices. The reporting period is significantly impacted by the acquisition of Vantis Corporation from Advanced Micro Devices, Inc. (AMD), completed on June 15, 1999. The results of operations include Vantis from June 16, 1999, onwards.

Key Financial Metrics

Debt Structure: To finance the Vantis acquisition, Lattice entered a credit agreement on June 15, 1999, consisting of a $220 million term loan and a $60 million revolving credit facility. Total borrowings at period end were approximately $253 million.

Material Changes vs. Prior Period

• Acquisition Impact: The most significant change is the acquisition of Vantis for a total purchase price of $583.1 million. This included a non-cash charge of $89.0 million for In-Process Research and Development (IPR&D), which drove the operating loss.
• Revenue Growth: Revenue increased 24% ($11.7 million) year-over-year, driven by the inclusion of Vantis sales, increased sales of ISP products, and recovering demand in Asia.
• Expense Increases: R&D expenses rose 25.3% and SG&A expenses rose 20% compared to the prior year, primarily due to the consolidation of Vantis operations.
• Liquidity Shift: While cash from operations improved, total cash and short-term investments decreased by $163.5 million due to the cash outlay for the acquisition. Working capital declined significantly from $324.2 million to $58.5 million due to the new debt obligations and cash utilization.

Guidance, Outlook, and Risks

Management Commentary: Management expects to continue significant investments in R&D to maintain product leadership. The company anticipates that the Vantis integration will be completed, though risks regarding employee retention and operational consolidation exist. Pro forma results (excluding the IPR&D charge) show a net loss of $4.7 million for the quarter, compared to a loss of $6.1 million in the prior year.

Key Risks and Contingencies:

• Integration Risk: Potential difficulties in integrating Vantis operations, retaining key employees, and achieving projected synergies.
• Supply Chain: Heavy reliance on third-party foundries (Seiko Epson, UMC, AMD) for wafer supply. Disruptions in Asia or yield issues could severely impact production.
• IPR&D Valuation: The $89 million IPR&D charge is based on management estimates of future cash flows. If projects fail to achieve commercial viability, future profitability could be adversely affected, and asset impairments may occur.
• Legal: Lattice assumed ongoing patent litigation between AMD and Altera Corporation regarding programmable logic devices.
• Market Cyclicality: The semiconductor industry is highly cyclical, subject to inventory corrections and price declines.

Investor Verification Checklist

• IPR&D Viability: Verify the progress of the $89 million in-process R&D projects (semiconductor and process technology) to ensure they meet the commercial viability assumptions used in the valuation.
• Debt Covenants: Monitor compliance with the new credit facility covenants regarding profitability, tangible net worth, and debt leverage ratios.
• Integration Progress: Assess the retention of key Vantis employees and the timeline for consolidating duplicative operations to realize cost synergies.
• Foundry Capacity: Confirm that wafer supply commitments from Seiko Epson, UMC, and AMD are sufficient to meet demand, particularly given the reliance on Asian manufacturing.
• Stock Split: Note the approved two-for-one stock split effective September 16, 1999, which will impact share count and per-share metrics in future filings.