LSCC

Business Context and Reporting Period

Lattice Semiconductor Corporation (Lattice) designs, develops, and markets programmable logic devices (PLDs), specifically In-System Programmable (ISP) devices. The company operates as a fabless semiconductor firm, relying on external foundries for wafer fabrication and assembly. This Form 10-K covers a nine-month transition period from April 4, 1999, to January 1, 2000 (referred to as "fiscal period 1999"), during which the company changed its fiscal year-end from March 31 to December 31.

A defining event of the period was the acquisition of Vantis Corporation (AMD's PLD division) on June 15, 1999, for approximately $500 million in cash. The transaction was accounted for under the purchase method, significantly altering the company's financial structure and operations.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 35% to $269.7 million compared to the prior fiscal year, driven primarily by the inclusion of Vantis sales and recovering demand in Asia.
• Profitability Decline: The company reported a net loss of $48.1 million, a sharp reversal from the $42.0 million net income in the prior year. This was caused by significant non-recurring charges related to the Vantis acquisition.
• Acquisition Charges: The company recorded an $89.0 million charge for In-Process Research and Development (IPR&D) and $45.8 million in amortization of intangible assets acquired from Vantis.
• Debt Structure: To finance the acquisition, the company initially utilized a credit facility but subsequently issued $260 million in 4.75% Convertible Subordinated Notes due in 2006, replacing the term loan.
• Liquidity: Cash and short-term investments decreased by $105.3 million to $214.1 million due to the cash outlay for the acquisition, partially offset by operating cash flow.

Guidance, Outlook, and Risks

Management Commentary: Management expects R&D expenses to approximately double following the Vantis acquisition to accelerate new product development. The company anticipates export sales will continue to represent a significant portion of revenue (53% in the current period).

Subsequent Event: The company announced a $150 million pre-tax gain to be recognized in the first quarter of 2000 resulting from the appreciation of foundry investments in UICC and Utek, which merged into UMC.

Key Risks and Contingencies:

• Supply Chain Dependence: Lattice relies entirely on third-party foundries (Seiko Epson, AMD, UMC Group) for wafer fabrication. Interruptions or yield issues could materially impact operations.
• Integration Risks: Unexpected costs, loss of key employees, or failure to achieve synergies from the Vantis integration could adversely affect results.
• Market Cyclicality: The semiconductor industry is highly cyclical; downturns in customer demand or inventory levels could reduce revenue.
• Legal Proceedings: The company assumed ongoing patent litigation between AMD and Altera regarding PLD technology. Management does not currently believe the outcome will have a material adverse effect.
• Foreign Exchange: Significant exposure to the Japanese Yen due to wafer purchases, though hedging strategies are in place.

Investor Verification Checklist

• Verify the realization of the $150 million pre-tax gain from the UMC foundry investment merger announced as a subsequent event.
• Monitor the integration progress of Vantis operations, specifically regarding cost synergies and retention of key technical personnel.
• Assess the impact of the $260 million convertible notes on future interest expenses and potential dilution upon conversion.
• Track wafer supply commitments and yield rates from Seiko Epson, AMD, and UMC to ensure no production bottlenecks.
• Review the status of the AMD vs. Altera patent litigation assumed during the acquisition.
• Confirm the sustainability of the 60% gross margin given the mix of legacy and new Vantis products.