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 April 4, 2009. The company operates in a single industry segment with significant exposure to the communications equipment end market, particularly the China 3G telecommunications network build-out.

Key Financial Metrics

Note: The company repurchased all outstanding Zero Coupon Convertible Subordinated Notes in July 2008; no debt remains outstanding.

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 23% year-over-year to $43.3 million, driven by a 13% sequential decline due to the global economic downturn. Mature and Mainstream product revenues fell, partially offset by a 50% increase in New product revenue.
• Margin Compression: Gross margin declined to 52.3% from 55.6%, attributed to a shift in product mix toward lower-margin New products and underabsorbed overhead costs due to lower production levels.
• Operating Expenses: Research and Development (R&D) expenses decreased to $14.9 million (from $17.7 million) and Selling, General, and Administrative (SG&A) expenses decreased to $12.9 million (from $15.0 million), primarily due to headcount reductions from restructuring plans.
• Restructuring: The company recorded a net restructuring credit of $0.025 million in Q1 2009, compared to a $1.8 million charge in Q1 2008.
• Investment Impairment: The company recorded a $0.7 million other-than-temporary impairment charge on long-term marketable securities (auction rate securities) due to failed auctions and illiquidity.

Outlook, Risks, and Management Commentary

• Liquidity and Auction Rate Securities: Lattice holds $39.2 million face value of auction rate securities, currently valued at $19.7 million and reclassified as long-term due to illiquidity. Management warns that liquidating these positions could result in amounts materially different from the estimated fair value.
• China 3G Dependency: Approximately 63% of revenue came from the communications end market, with two large telecommunications equipment providers accounting for 27% of total revenue. Future performance is heavily tied to the China 3G network build-out.
• Distribution Restructuring: Lattice is terminating distribution agreements with Promaster Technology Corporation in Taiwan and China (effective June 6, 2009), which accounted for ~10% of 2008 revenue. The company anticipates a $1.4 million increase in cost of products sold in Q2 and Q3 2009 related to repurchasing and reselling inventory.
• Fujitsu Receivables: The company has a significant unsecured receivable of $60.0 million from Fujitsu Limited (foundry partner), with $30.0 million received in April 2009 and the remainder due in October 2009.
• Guidance: Management states that forecasting for the remainder of 2009 is challenging with limited visibility due to the economic downturn.

Investor Verification Checklist

• Verify the collectability of the remaining $30.0 million receivable from Fujitsu Limited due in October 2009.
• Monitor the impact of the distribution channel restructuring in Greater China on Q2 and Q3 revenue and cost of goods sold.
• Assess the potential for further impairment charges on the $19.7 million portfolio of illiquid auction rate securities.
• Track the execution of the China 3G network build-out and its effect on the two major customers representing 27% of revenue.
• Review the progress of the patent infringement litigation filed by Lizy K. John, which is currently stayed pending PTO re-examination.