| LATTICE SEMICONDUCTOR CORP Item 1A Risk Factors |
| The following risk factors and other information included in this Annual Report should be carefully considered |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations |
| If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected |
| We may be unsuccessful in defining, developing or selling the new FPGA products required to maintain or expand our business |
| As a semiconductor company, we operate in a dynamic environment marked by rapid product obsolescence |
| The programmable logic market is characterized by rapid technology and product evolution and in recent years the market for FPGA products has grown faster than the market for PLD products |
| Currently we derive a greater proportion of our revenue from PLD products than FPGA products |
| Consequently, our future success depends on our ability to introduce new FPGA and associated software design tool products that meet evolving customer needs while achieving acceptable margins |
| We are presently shipping our next generation FPGA product families that are critical to our ability to grow our FPGA product revenue and expand our overall revenue |
| We also plan to continue upgrading our customer design tool products and increase our offerings of intellectual property cores |
| If we fail to introduce new products in a timely manner, or if these products or future new products fail to achieve market acceptance, our operating results would be harmed |
| Fujitsu Limited has agreed to manufacture our current and future FPGA products on its 130 nanometer and 90 nanometer CMOS process technologies, as well as on a 130 nanometer technology with embedded flash memory that we have jointly developed with Fujitsu |
| The success of our next generation FPGA products is dependent on our ability to successfully partner with Fujitsu |
| If for any reason we are unsuccessful in our efforts to partner with Fujitsu in connection with these next generation FPGA products, our future revenue growth would be materially adversely affected |
| The introduction of new silicon and software design tool products in a dynamic market environment presents significant business challenges |
| Product development commitments and expenditures must be 12 ______________________________________________________________________ made well in advance of product sales |
| The market reception of new products depends on accurate projections of long-term customer demand, which by their nature are uncertain |
| Our future revenue growth is dependent on market acceptance of our new silicon and software design tool products and the continued market acceptance of our current products |
| The success of these products is dependent on a variety of specific technical factors including: · successful product definition; · timely and efficient completion of product design; · timely and efficient implementation of wafer manufacturing and assembly processes; · product performance; · product cost; and · the quality and reliability of the product |
| If, due to these or other factors, our new silicon and software products do not achieve market acceptance, our operating results would be harmed |
| Our products may not be competitive if we are unsuccessful in migrating our manufacturing processes to more advanced technologies or alternative fabrication facilities |
| To develop new products and maintain the competitiveness of existing products, we need to migrate to more advanced wafer manufacturing processes that use larger wafer sizes and smaller device geometries |
| We also may need to use additional foundries |
| Because we depend upon foundries to provide their facilities and support for our process technology development, we may experience delays in the availability of advanced wafer manufacturing process technologies at existing or new wafer fabrication facilities |
| As a result, volume production of our advanced process technologies at the fabs of Fujitsu, Seiko Epson, UMC or future foundries may not be achieved |
| This could harm our operating results |
| Currently, and expected to continue in the foreseeable future, our newest FPGA products are manufactured by Fujitsu |
| A downturn in the communications equipment end market or computing end market could cause a reduction in demand for our products and limit our ability to maintain revenue levels and operating results |
| The majority of our revenue is derived from customers in the communications equipment and computing end markets |
| Any deterioration in these end markets or any reduction in technology capital spending could lead to a reduction in demand for our products |
| For example, in the past, a general weakening in demand for programmable logic products from customers in the communications end market has adversely affected our revenue |
| Whenever adverse economic or end market conditions exist, there is likely to be an adverse effect on our operating results |
| The cyclical nature of the semiconductor industry may limit our ability to maintain revenue levels and operating results during industry downturns |
| The semiconductor industry is highly cyclical, to a greater extent than other less technology-driven industries |
| Our financial performance has periodically been negatively affected by downturns in the semiconductor industry |
| Factors that contribute to these industry downturns include: · the cyclical nature of the demand for the products of semiconductor customers; · general reductions in inventory levels by customers; 13 ______________________________________________________________________ · excess production capacity; · general decline in end-user demand; and · accelerated declines in average selling prices |
| Historically, the semiconductor industry has experienced periodic downturns of varying degrees of severity and duration |
| Typically, after such downturns, semiconductor industry conditions improve, although such improvement may not be significant or sustainable |
| Increased demand for semiconductor industry products may not proportionately increase demand for programmable logic products in general, or our products in particular |
| Even if demand for our products increases, average sales prices for our products may not increase, and could decline |
| Whenever adverse semiconductor industry conditions or other similar conditions exist, there is likely to be an adverse effect on our operating results |
| Typically, the majority of our revenue comes from “turns orders,” which are orders placed and filled within the same quarter |
| By definition, turns orders are not captured in a backlog measurement at the beginning of a quarter |
| Accordingly, we cannot use backlog as a reliable measure of predicting revenue |
| The potential impact of customer design-in activity on future revenue is inherently uncertain because it is unknown whether any particular customer design-in will ultimately result in sales of a significant volume, and, if a particular customer design-in does result in such sales, when such sales will ultimately occur and the amount of such sales |
| We face uncertainties relating to the potential impact of customer design-in activity because it is unknown whether any particular customer design activity will ultimately result in sales of significant volume, and, if customer design activity does result in such sales, when such sales will ultimately occur and what the amount of such sales will be |
| Measurements of customer design-in activity, such as “design-ins” and “design-wins,” are inherently imprecise as it is not possible to predict which designs will ultimately be mass produced, when such production may occur, or whether company products will be used in volume production |
| We may not be able to accurately manage production of products or predict sales of products, and, thus, our revenue levels may not match our product production |
| Our wafer supply could be interrupted or reduced, which may result in a shortage of products available for sale |
| We do not manufacture finished silicon wafers and many of our products, including all of our newest FPGA products, are manufactured by a sole source |
| Currently, our silicon wafers are manufactured by Fujitsu in Japan, Seiko Epson in Japan, UMC in Taiwan and Chartered Semiconductor in Singapore |
| If any of our current or future foundry partners significantly interrupts or reduces our wafer supply, our operating results could be harmed |
| In the past, we have experienced delays in obtaining wafers and in securing supply commitments from our foundries |
| At present, we anticipate that our supply commitments are adequate |
| However, these existing supply commitments may not be sufficient for us to satisfy customer demand in future periods |
| Additionally, notwithstanding our supply commitments, we may still have difficulty in obtaining wafer deliveries consistent with the supply commitments |
| We negotiate wafer prices and supply commitments from our suppliers on at least an annual basis |
| If any of our foundry partners were to reduce its supply commitment or increase its wafer prices, and we cannot find alternative sources of wafer supply, our operating results could be harmed |
| Since worldwide manufacturing capacity for silicon wafers is limited and inelastic, we could be harmed by significant industry-wide increases in overall wafer demand or interruptions in wafer supply |
| Additionally, a future 14 ______________________________________________________________________ disruption of any of our foundry partners’ foundry operations as a result of a fire, earthquake, act of terrorism, political unrest, governmental uncertainty, war, or other natural disaster or catastrophic event could disrupt our wafer supply and could harm our operating results |
| If our foundry partners experience quality or yield problems, we may face a shortage of products available for sale |
| We depend on our foundries to deliver reliable silicon wafers with acceptable yields in a timely manner |
| As is common in our industry, we have experienced wafer yield problems and delivery delays |
| If our foundries are unable for a prolonged period to produce silicon wafers that meet our specifications, with acceptable yields, our operating results could be harmed |
| The reliable manufacture of high performance programmable logic devices is a complicated and technically demanding process requiring: · a high degree of technical skill; · state-of-the-art equipment; · the availability of certain basic materials and supplies, such as chemicals, gases, polysilicon, silicon wafers and ultra-pure metals; · the absence of defects in production wafers; · the elimination of minute impurities and errors in each step of the fabrication process; and · effective cooperation between the wafer supplier and us |
| As a result, our foundries may experience difficulties in achieving acceptable quality and yield levels when manufacturing our silicon wafers |
| Our supply of assembled and tested products could be interrupted or reduced, which may result in a shortage of products available for sale |
| Currently, our finished products are assembled and tested by Amkor in the Philippines and South Korea, ASE in Malaysia, STATS/ChipPAC in China, Fujitsu in Japan, and other independent contractors in Asia |
| If any of our current or future assembly or test contractors significantly interrupts or reduces our supply of assembled and tested devices, our operating results could be harmed |
| In the past, we have experienced delays in obtaining assembled and tested products and in securing assembly and test capacity commitments from our suppliers |
| At present, we anticipate that our assembly and test capacity commitments are adequate |
| However, these existing commitments may not be sufficient for us to satisfy customer demand in future periods |
| Additionally, notwithstanding our assembly and test capacity commitments we may still have difficulty in obtaining deliveries of finished products consistent with the capacity commitments |
| We negotiate assembly and test prices and capacity commitments from our contractors on a periodic basis |
| If any of our assembly or test contractors were to reduce its capacity commitment or increase its prices, and we cannot find alternative sources, our operating results could be harmed |
| Since worldwide capacity for assembly and testing of semiconductor products is limited and inelastic, we could be harmed by significant industry-wide increases in overall demand or interruptions in supply |
| The assembly of complex packages requires a consistent supply of a variety of raw materials such as substrates, leadframes, and mold compound |
| The worldwide manufacturing capacity for these materials is limited and inelastic |
| A significant industry-wide increase in demand, or interruptions in the supply of these materials 15 ______________________________________________________________________ to our assembly/test contractors, could harm our operating results |
| Additionally, a future disruption of any of our assembly or test contractors’ operations as a result of a fire, earthquake, act of terrorism, political unrest, governmental uncertainty, war, or other natural disaster or catastrophic event could disrupt our supply of assembled and tested devices and could harm our operating results |
| In addition, our quarterly revenue levels may be affected to a significant extent by our ability to match inventory and current production mix with the product mix required to fulfill orders |
| The large number of individual parts we sell and the large number of customers for our products, combined with limitations on our and our customer’s ability to forecast orders accurately and our relatively lengthy manufacturing cycles, may make it difficult to achieve a match of inventory on hand, production units, and shippable orders sufficient to realize quarterly or annual revenue projections |
| If our assembly and test supply contractors experience quality or yield problems, we may face a shortage of products available for sale |
| We rely on contractors to assemble and test our devices with acceptable quality and yield levels |
| As is common in our industry, we have experienced quality and yield problems in the past |
| If we experience prolonged quality or yield problems in the future, our operating results could be harmed |
| The majority of our revenue is derived from semiconductor devices assembled in advanced packages |
| The assembly of advanced packages is a complex process requiring: · a high degree of technical skill; · state-of-the-art equipment; · the absence of defects in assembly and packaging manufacturing; · the elimination of raw material impurities and errors in each step of the process; and · effective cooperation between the assembly contractor and us |
| As a result, our contractors may experience difficulties in achieving acceptable quality and yield levels when assembling and testing our semiconductor devices |
| Conditions in Asia may disrupt our existing supply arrangements and result in a shortage of finished products available for sale |
| Additionally, our finished silicon wafers are assembled and tested by independent contractors located in China, Japan, Malaysia, the Philippines and South Korea |
| Economic, financial, social and political conditions in Asia have historically been volatile |
| Financial difficulties, the effects of currency fluctuation, governmental actions or restrictions, prolonged work stoppages, political unrest, war, natural disaster or any other difficulties experienced by our suppliers may disrupt our supply and could harm our operating results |
| Export sales account for the majority of our revenues and may decline in the future due to economic and governmental uncertainties |
| Our export sales are affected by unique risks frequently associated with foreign economies including: · changes in local economic conditions; · exchange rate volatility; · governmental controls and trade restrictions; · export license requirements and restrictions on the export of technology; 16 ______________________________________________________________________ · political instability, war or terrorism; · changes in tax rates, tariffs or freight rates; · interruptions in air transportation; and · difficulties in staffing and managing foreign sales offices |
| Our future quarterly operating results may fluctuate and therefore may fail to meet expectations |
| Our quarterly operating results have fluctuated in the past and may continue to fluctuate |
| Consequently, our operating results may fail to meet the expectations of analysts and investors |
| As a result of industry conditions and the following specific factors, our quarterly operating results are more likely to fluctuate and are more difficult to predict than a typical non-technology company of our size and maturity: · general economic conditions in the countries where we sell our products; · conditions within the end markets into which we sell our products; · the cyclical nature of demand for our customers’ products; · excessive inventory accumulation by our end customers; · the timing of our and our competitors’ new product introductions; · product obsolescence; · the scheduling, rescheduling and cancellation of large orders by our customers; · the willingness and ability of our customers and distributors to make payment to us in a timely manner; · our ability to develop new process technologies and achieve volume production at the fabs of Fujitsu, Seiko Epson, UMC, Chartered Semiconductor or at other foundries; · changes in manufacturing yields including delays in achieving target yields on new products; · adverse movements in exchange rates, interest rates or tax rates; and · the availability of adequate supply commitments from our wafer foundries and assembly and test subcontractors |
| Our quarterly results may also fluctuate as a result of the legal expenses accrued in any given period in connection with the pending shareholder class action suit and the Securities and Exchange Commission’s ongoing informal inquiry |
| As a result of these factors, our past financial results are not necessarily a good predictor of our future results |
| We may have failed to adequately insure against certain risks, and, as a result, our financial condition and results may be adversely affected |
| We carry insurance customary for companies in our industry, including, but not limited to, liability, property and casualty, worker’s compensation and business interruption insurance |
| We also carry basic medical insurance, subject to a true insurance stop loss for catastrophic illness |
| In addition, we have insurance contracts that provide director and officer liability coverage for our directors and officers |
| Other than the specific areas mentioned above, we are self-insured with respect to most other risks and exposures, and the insurance we carry in many cases is subject to a significant policy deductible or other limitation before coverage applies |
| Based on management’s assessment and judgment, we have determined that it is more cost effective to self-insure against certain risks than to incur the insurance premium costs |
| The risks and exposures for which we self-insure include, but are not limited to, natural disasters, product 17 ______________________________________________________________________ defects, political risk, theft, patent infringement and some employment practice matters |
| Should there be a catastrophic loss due to an uninsured event such as an earthquake or a loss due to adverse occurrences in any area in which we are self-insured, our financial condition, results of operations and liquidity may be adversely affected |
| We may not realize the expected benefits of our corporate restructuring, which may adversely affect our financial conditions and operating results |
| In October 2005, we announced a corporate restructuring to consolidate operations, streamline engineering functions and lower operating expenses |
| We also announced a voluntary separation program for certain employees |
| As a result of these actions, we reduced total headcount by approximately 14prca |
| We currently estimate that the restructuring will result in a reduction in our operating expenses, effective in the first quarter of 2006, of an estimated dlra3dtta5 million to dlra4dtta5 million per quarter |
| Remaining costs to complete the restructuring will be recorded in future periods as incurred and are not expected to be significant |
| Although the restructuring was substantially completed during the fourth quarter of 2005, we cannot be certain as to the actual amount of any remaining restructuring charges or the timing of their recognition for financial reporting purposes |
| The benefits of the restructuring may not materialize for a number of reasons, including the possibility that we may incur unanticipated costs in closing facilities or consolidating our operations |
| In addition, we expect that a portion of the estimated reduction in our operating expenses resulting from the restructuring will be offset by other operating expenses, including stock compensation expense that we will recognize beginning in the first quarter of 2006 as a result of the adoption of SFAS Nodtta 123R If we are unsuccessful in realizing the benefits of our restructuring plan, we may experience disruptions in our operations and higher ongoing costs, which may adversely affect our operating results |
| We face risks related to pending litigation and an ongoing informal inquiry by the Securities and Exchange Commission |
| In September and October 2004, three putative class action complaints were filed in the United States District Court for the District of Oregon against Lattice Semiconductor Corporation, our Chief Executive Officer and President Stephen A Skaggs, and our former Chief Executive Officer Cyrus Y Tsui |
| These complaints were filed on behalf of a putative class of investors who purchased our stock between April 22, 2003 and April 19, 2004 |
| They generally allege violations of federal securities laws arising out of our previously announced restatement of financial results for the first, second, and third quarters of 2003 |
| Consistent with the usual procedures for cases of this kind, these cases were amended and consolidated into a single action |
| In an amended and consolidated complaint filed January 27, 2005 our former President and our former Controller were added as defendants |
| The complaints generally seek an unspecified amount of damages, as well as attorney fees and costs |
| We believe that the complaints are without merit, and we intend to vigorously defend against the lawsuits |
| The cases are still in the preliminary stages, and it is not possible for us to quantify the extent of our potential liability, if any |
| An unfavorable outcome in any of these matters could have a material adverse effect on our business, our liquidity and our financial results |
| In addition, defending any litigation may be costly and divert management’s attention from the day-to-day operations of our business |
| On June 14, 2005, we announced that our Audit Committee, in connection with its responsibilities for financial oversight, was conducting an internal examination |
| The examination concerned issues primarily associated with executive compensation and several items pertaining to our internal controls |
| On August 9, 2005, we announced that the Audit Committee had concluded the examination |
| We have furnished information regarding the matters examined by the Audit Committee to the Securities and Exchange Commission, which is conducting an ongoing informal inquiry into our prior restatement of financial results |
| On September 30, 2005 the Securities and Exchange Commission issued a Cease and Desist Order 18 ______________________________________________________________________ concerning our former Controller, and referenced certain events in connection with our prior restatement of financial results |
| We are cooperating fully with the Securities and Exchange Commission and intend to continue to do so |
| We cannot predict the duration or outcome of the Securities and Exchange Commission’s inquiry |
| If the Securities and Exchange Commission expands its informal inquiry or decides to pursue enforcement action against us, or any other governmental agency or regulatory body takes similar action, our management could be distracted, we could incur substantial costs and there could be a material adverse effect on our business |
| We are exposed to certain asserted and unasserted potential claims |
| There can be no assurance that, with respect to potential claims made against us, we could resolve such claims under terms and conditions that would not have a material adverse effect on our business, our liquidity or our financial results |
| If we are unable to effectively and efficiently implement our plan to improve our internal controls there could be a material adverse effect on our operations or financial results |
| We received notice from our independent registered public accounting firm that, in connection with the 2003 year-end audit, the independent registered public accounting firm identified a material weakness in our internal controls and procedures relating to separation of duties and establishment of standards for review of journal entries and related file documentation |
| We have implemented various initiatives that have remedied this material weakness |
| During our 2004 year-end financial statement closing, we identified a significant deficiency in our internal controls relating to a mechanical error in calculating a unique inventory allowance, which occurred because newly assigned employees did not recognize that the required allowance had been calculated and recorded by existing procedures |
| The error was not present in previously issued financial statements and was corrected before the year-end financial statements were issued |
| Additional training and review procedures have been instituted to remedy this deficiency |
| During 2005, we performed additional training as well as identified ways to modify and automate our inventory compilation processes to make them less vulnerable to manual errors |
| On August 9, 2005, we announced that our Audit Committee had completed its previously announced examination, which concerned issues primarily associated with executive compensation and several items pertaining to our internal controls |
| In connection with the completion of its examination, the Audit Committee recommended, and the Board of Directors adopted, a number of recommended enhancements to our policies and procedures, including internal control procedures, which are described in Item 9A of this report |
| No assurance can be given that we will be able to successfully implement our revised internal controls and procedures and the recently adopted enhancements, or that our revised controls and procedures or enhancements will have the desired effect |
| In addition, we may be required to hire additional employees, and may experience higher than anticipated capital expenditures and operating expenses, during the implementation of these changes and thereafter |
| Furthermore, future assessments of our internal controls and procedures may reveal new material weaknesses or significant deficiencies |
| If we are unable to implement these changes to our internal controls and procedures effectively or efficiently, or if we discover additional material weaknesses or significant deficiencies, there could be a material adverse effect on our operations or financial results |
| Changes in accounting for equity compensation will adversely affect our consolidated statement of operations and could adversely affect our ability to attract and retain employees |
| We have historically used stock options as a key component of employee compensation in order to align employees’ interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages |
| The Financial Accounting Standards Board has adopted 19 ______________________________________________________________________ changes to generally accepted accounting principles that require us and other companies to record a charge to earnings for employee stock option grants and other equity incentives beginning in the quarter ended March 31, 2006 |
| To the extent that these or other new regulations make it more difficult or expensive to grant options to employees, we will incur increased compensation costs |
| We may also change our equity compensation strategy, and this could make it difficult to attract, retain and motivate employees |
| Any of these results could materially and adversely affect our business |
| Our stock price may continue to experience large fluctuations |
| In recent years, the price of our common stock has fluctuated greatly |
| These price fluctuations have been rapid and severe and have left investors little time to react |
| The price of our common stock may continue to fluctuate greatly in the future due to a variety of company specific factors, including: · quarter-to-quarter variations in our operating results; · shortfalls in revenue or earnings from levels expected by investors; · announcements of technological innovations or new products by other companies; and · any developments in the pending shareholder class action suit and the Securities and Exchange Commission’s informal inquiry |
| At December 31, 2005, our book value per share was dlra4dtta38 compared to our stock price, which has ranged from a low of dlra3dtta85 per share to a high of dlra5dtta79 per share for fiscal 2005 |
| Presently, our stock price is trading slightly above our consolidated book value |
| Should our stock price drop below book value for a sustained period, it may become necessary to record an impairment charge to goodwill, which would reduce our results of operations |
| We may not be able to successfully compete in the highly competitive semiconductor industry |
| The semiconductor industry is intensely competitive and many of our direct and indirect competitors have substantially greater financial, technological, manufacturing, marketing and sales resources |
| If we are unable to compete successfully in this environment, our future results will be adversely affected |
| The current level of competition in the programmable logic market is high and may increase in the future |
| We currently compete directly with companies that have licensed our technology or have developed similar products |
| We also compete indirectly with numerous semiconductor companies that offer products based on alternative technical solutions |
| These direct and indirect competitors are established multinational semiconductor companies as well as emerging companies |
| We may fail to retain or attract the specialized technical and management personnel required to successfully operate our business |
| To a greater degree than most non-technology companies or larger technology companies, our future success depends on our ability to attract and retain highly qualified technical and management personnel |
| As a mid-sized company, we are particularly dependent on a relatively small group of key employees |
| Competition for skilled technical and management employees is intense within our industry |
| As a result, we may not be able to retain our existing key technical and management personnel |
| In addition, we may not be able to attract additional qualified employees in the future |
| If we are unable to retain existing key employees or are unable to hire new qualified employees, our operating results could be adversely affected |
| 20 ______________________________________________________________________ If we are unable to adequately protect our intellectual property rights, our financial results and competitive position may suffer |
| Our success depends in part on our proprietary technology |
| However, we may fail to adequately protect this technology |
| As a result, we may lose our competitive position or face significant expense to protect or enforce our intellectual property rights |
| We intend to continue to protect our proprietary technology through patents, copyrights and trade secrets |
| Despite this intention, we may not be successful in achieving adequate protection |
| Claims allowed on any of our patents may not be sufficiently broad to protect our technology |
| Patents issued to us also may be challenged, invalidated or circumvented |
| Finally, our competitors may develop similar technology independently |
| Companies in the semiconductor industry vigorously pursue their intellectual property rights |
| If we become involved in protracted intellectual property disputes or litigation we may be forced to use substantial financial and management resources, which could have an adverse effect on our operating results |
| Our industry is characterized by frequent claims regarding patents and other intellectual property rights of others |
| We have been, and from time-to-time expect to be, notified of claims that we are infringing the intellectual property rights of others |
| If any third party makes a valid claim against us, we could face significant liability and could be required to make material changes to our products and processes |
| In response to any claims of infringement, we may seek licenses under patents that we are alleged to be infringing |
| However, we may not be able to obtain a license on favorable terms, or at all, without our operating results being adversely affected |
| Our marketable securities, which we hold for strategic reasons, are subject to equity price risk and their value may fluctuate |
| Currently we hold substantial equity in UMC, which we acquired as part of a strategic investment to obtain certain manufacturing rights |
| The market price and valuation of these equity shares has fluctuated widely due to business, stock market or other conditions over which we have little control |
| During 2001, we recorded a pre-tax impairment loss related to this investment |
| In the future, UMC common stock may continue to experience significant price volatility |
| In 2004 and 2005, we sold the majority of our UMC shares, but have otherwise not attempted to reduce or eliminate this equity price risk through hedging or similar techniques |
| As a result, substantial, sustained changes in the market price of UMC common stock could impact our financial results |