LSCC

Lattice Semiconductor Corp. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Lattice Semiconductor Corporation for the three and six months ended June 30, 2007. The company designs, develops, and markets high-performance programmable logic devices (PLDs) and field programmable gate arrays (FPGAs). The report is unaudited and should be read in conjunction with the Annual Report on Form 10-K for the year ended December 30, 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 5.5% year-over-year for the quarter and 2.4% for the six-month period. This was primarily driven by a 24% decline in revenue from "Mature" products, partially offset by an 85% increase in "New" product revenue.
• Profitability: The company reported a net loss of $1.5 million for the quarter compared to a net income of $2.1 million in the prior year quarter. Operating loss widened to $5.6 million from $2.0 million.
• Gross Margin Compression: Gross margin percentage decreased from 57.0% to 55.1% for the quarter. Management attributed this to the lower initial margins of new products, the decline in higher-margin mature products, and a last-time buy charge for obsolete inventory.
• Operating Expenses: R&D expenses increased to $20.8 million (up from $20.4 million) and SG&A increased to $14.8 million (up from $14.6 million), driven primarily by increased salaries and stock-based compensation.
• Cash Flow: Net cash used in operating activities was $37.5 million for the six months ended June 30, 2007, compared to $1.8 million provided in the prior year period. This significant outflow was primarily due to a $37.5 million advance payment made to foundry partner Fujitsu Limited.

Outlook, Risks, and Unusual Items

• Unusual Items: The company recorded a $1.6 million gain on the sale of land and a $0.4 million gain on the extinguishment of convertible notes in the second quarter. These non-operating gains helped offset the operating loss.
• Debt Management: The company continues to repurchase its Zero Coupon Convertible Subordinated Notes. $80.0 million remains outstanding. Holders have the right to require payment on July 1, 2008, at which point the notes will be reclassified as a current liability.
• Foundry Dependency: The company relies heavily on Fujitsu as the sole source supplier for its newest FPGA products and advanced wafer processes. A significant portion of liquidity ($115.9 million) is tied up in unsecured advance payments to Fujitsu for wafer credits.
• Legal Proceedings: A patent infringement lawsuit was filed on June 11, 2007, by Lizy K. John. The company states that neither the likelihood nor the amount of potential exposure is estimable at this time.
• Guidance: The filing does not provide specific numerical guidance for future quarters. Management notes that future revenue growth depends on market acceptance of new products and overall economic conditions.

Investor Verification Checklist

• Wafer Supply Risk: Verify the status of the $115.9 million unsecured advance payment to Fujitsu and the timeline for receiving wafer credits.
• Convertible Notes Maturity: Confirm the company's liquidity plan to address the $80.0 million convertible note redemption right exercisable by holders on July 1, 2008.
• Product Mix Transition: Monitor the trajectory of "New" product revenue growth to ensure it sufficiently offsets the continued decline in "Mature" product revenue.
• Legal Exposure: Track the outcome of the patent infringement lawsuit filed by Lizy K. John.
• Margin Recovery: Assess whether gross margins can stabilize as new products mature and the impact of the last-time buy charge dissipates.