Item 1. Business
Overview
We design, manufacture and sell a wide variety of high performance, logic-based memory subsystems for the global datacenter, storage
and high-performance computing markets. Our memory subsystems consist of combinations of dynamic random access memory integrated circuits ("DRAM ICs" or "DRAM"), NAND flash memory ("NAND"),
application-specific integrated circuits ("ASICs") and other components assembled on printed circuit boards ("PCBs"). We primarily market and sell our products to leading original equipment
manufacturer ("OEM") customers. Our solutions are targeted at applications where memory plays a key role in meeting system performance requirements. We leverage a portfolio of proprietary
technologbies and design techniques, including combining discrete semiconductor technologies such as DRAM and NAND flash to function as one, efficient planar design, and alternative packaging
techniques to deliver memory subsystems with persistence, high density, small form factor, high signal integrity, attractive thermal characteristics, reduced power consumption and low cost per bit.
Our NVvault product is the first to offer both DRAM and NAND in a standard form factor memory subsystem as a persistent dual-in line memory module ("DIMM") in mission critical
applications.
We
were incorporated in Delaware in June 2000 and commenced operations in September 2000. Our principal executive offices are located at 175 Technology Drive, Suite 150, Irvine,
California 92618
1
Table of Contents
and
our telephone number at that address is (949) 435-0025. Our website address is http://www.netlist.com. The information contained on our website is not incorporated by reference into, and
does not form any part of, this Annual Report on Form 10-K. We have included our website address as a factual reference and do not intend it to be an active link to our website.
Intellectual Property and Licensing
Our high performance memory subsystems are developed in part using our proprietary intellectual property, and we believe that the
strength of our intellectual property rights will be important to the success of our business. We utilize patent and trade secret protection, confidentiality agreements with customers and partners,
disclosure and invention assignment agreements with employees and consultants and other contractual provisions to protect our intellectual property and other proprietary information. We plan to
license specific, custom designs to our customers, charging royalties at a fixed amount per product or a percentage of sales. More generally, we intend to vigorously defend and monetize our
intellectual property through licensing arrangements and, where necessary, enforcement actions against those entities using our patented solutions in their products. Royalties resulting from these
patent monetization efforts can be structured in a variety of ways, including but not limited to one-time paid up licenses or on-going royalty arrangements. We expect to generate a portion of our
revenues with these types of licensing arrangements.
As
of December 28, 2013, we had 40 U.S. patents issued and 31 U.S. and foreign patent applications pending. Assuming that they are properly maintained, our patents will expire at
various dates between 2022 and 2029. Our issued patents and patent applications relate to the use of custom logic in high performance memory subsystems, PCB design, layout and packaging techniques. We
intend to actively pursue the filing of additional patent applications related to our technology advancements. While we believe that our patent and other intellectual property rights are important to
our success, our technical expertise and ability to introduce new products in a timely manner also will continue to be important factors in developing and maintaining our competitive position.
Accordingly, we believe that our business is not materially dependent upon any one claim in any of our existing patents or pending patent applications.
Litigation & Patent Reexamination
We own numerous patents and continue to enlarge and strengthen our patent portfolios which cover different aspects of our technology
innovations with various claim scopes. We plan to generate revenue by selling or licensing our technology, and intend to vigorously enforce our patent rights against infringers. We dedicate
substantial resources in protecting our intellectual property, including efforts to defend our patents against challenges made by way of reexamination proceedings at the USPTO. These activities are
likely to continue for the foreseeable future, without any guarantee that any ongoing or future patent protection and litigation activities will be successful. We also are subject to litigation claims
that we have infringed on the intellectual property of others, against which we intend to defend vigorously.
Our Products
Our HyperCloud® technology incorporates our patented rank multiplication technology that increases memory capacity and our
patented load reduction technology that increases memory bandwidth. We expect that these patented technologies will make possible improved levels of performance for memory intensive datacenter
applications and workloads, including enterprise virtualization, cloud computing infrastructure, business intelligence real-time data analytics, and high performance computing.
2
Table of Contents
We were the first to develop and market memory subsystems that incorporate both DRAM and NAND in a single NVvault
persistent DIMM solution for backup of volatile data to non-volatile NAND. NVvault is desirable for mission critical backups during power interruption in Redundant Array of Independent
Disks ("RAID") and main memory for Cloud, Big Data, on-line banking and other real time applications. NVvault is incorporated in our EXPRESSvault PCIe solution for both acceleration and
backup in storage applications.
Our
NVvault product line consists primarily of battery-free and battery-powered flash backed cache memory subsystem targeting RAID storage, application acceleration and
mission critical data integrityapplications. NVvault battery-free provides server and storage OEMs a solution for enhanced datacenter fault recovery. The NVvault
products have historically been sold primarily to Dell, for incorporation in its PERC 7 server products. Following Intel's launch of its Romley platform in the first quarter of 2012, we have
experienced a steady decline in NVvault sales to Dell. Sales of NVvault products to Dell totaled $5.5 million and $15.7 million for the years ended
December 28, 2013 and December 29, 2012, respectively. We expect minimal demand for Dell DDR2 NVvault in 2014.
In
order to leverage our NVvault technology into a more diverse customer base, we continue to pursue additional qualifications of next generation DDR3 NVvault
with other customers. We introduced EXPRESSvault in March 2011, and are currently qualified with multiple customers and continue to pursue qualifications with new customers. However, our
efforts may not result in significant revenues from the sale of NVvault products.
The remainder of our revenue is primarily from OEM sales of specialty memory modules and flash-based products, the majority of which
are utilized in data center and industrial applications. When developing custom modules for an equipment product launch, we engage with our OEM customers from the earliest stages of new product
definition, providing us unique insight into their full range of system architecture and performance requirements. This close collaboration has also allowed us to develop a significant level of
systems expertise. We leverage a portfolio of proprietary technologies and design techniques, including efficient planar design, alternative packaging techniques and custom semiconductor logic, to
deliver memory subsystems with high speed, capacity and signal integrity, small form factor, attractive thermal characteristics and low cost per bit. Revenues from our specialty modules and
flash-based products are subject to fluctuation as a result of the life cycles of the products into which our modules are incorporated. Our ability to continue to produce revenues from specialty
memory modules and flash-based products is dependent on our ability to
qualify our products on new platforms as current platforms reach the end of their lifecycles, and on the state of the global economy.
Technology
We have a portfolio of proprietary technologies and design techniques and have assembled an engineering team with expertise in
semiconductors, printed circuit boards, memory subsystem and system design. Our technology competencies include:
IC Design Expertise.
We have designed special algorithms that can be implemented in stand-alone integrated circuits or integrated into
other
functional blocks in ASICs. We utilize these algorithms in the HyperCloud ® chipset to incorporate rank multiplication and load reduction functionality. We also incorporate these
algorithms in our NVvault TM product line of RDIMMS.
NVvault.
We were the first to develop and market memory subsystems that incorporate both DRAM and NAND flash in a single
NVvault persistent DIMM solution for backup of volatile DRAM data to non-volatile NAND. NVvault combines the best attributes of DRAM; speed,
3
Table of Contents
durability
and reliability with high densities, lower power and lowest costs provided by NAND to provide application acceleration and mission critical backup during power interruption for cloud
infrastructure, virtualization, analytics and database applications. NVvault is incorporated in our EXPRESSvault PCIe solution for both acceleration and backup in storage applications.
Proprietary PCB Designs.
We utilize advanced, proprietary techniques to optimize electronic signal strength and integrity within a PCB.
These
techniques include the use of 8- or 10-layer boards, matching conductive trace lengths, a minimized number of conductive connectors, or vias, and precise
load balancing to, among other things, help reduce noise and crosstalk between adjacent traces. In addition, our proprietary designs for the precise placement of intra-substrate components allow us to
assemble memory subsystems with significantly smaller physical size, enabling OEMs to develop products with smaller footprints for their customers.
Very Low Profile Designs.
We were the first company to create memory subsystems in a form factor of less than one inch in height. We
believe our
proprietary board design technology is particularly useful in the blade server market, where efficient use of motherboard space is critical. Our technology has allowed us to decrease the system board
space required for memory, and improve thermal performance and operating speeds, by enabling our customers to use alternative methods of component layout.
Planar-X Designs.
Our patented Planar-X circuit design provides additional board space for a large number of DRAM components. This
enables us to
produce higher capacity RDIMM modules, such as our 32GB two-virtual rank HyperCloud ® RDIMM, at a lower cost by allowing us to use standard, currently available 4GB DRAM technology.
Thermal Management Designs.
We design our memory subsystems to ensure effective heat dissipation. We use thermal cameras to obtain
thermal profiles
of the memory subsystem during the design phase, allowing us to rearrange components to enhance thermal characteristics and, if necessary, replace components that do not meet specifications. We use
thermal simulation and modeling software to create comprehensive heat transfer models of our memory subsystems, which enables our engineers to quickly develop accurate solutions for potential thermal
issues. We also develop and use proprietary heat spreaders to enhance the thermal management characteristics of our memory subsystems.
Customers
During the year we primarily marketed and sold our products to leading OEMs in the server, storage and communications markets.
Consistent with the concentrated nature of the OEM customer base in our target markets, a small number of large customers have historically accounted for a significant portion of our net sales. Net
sales to our two largest customers, Dell and IBM, represented approximately 45% and 15% of our net sales in 2013, respectively. Dell and IBM represented approximately 60% and 18% of our net sales in
2012, respectively. Net sales to some of our OEM customers include memory modules that are qualified by us directly with the OEM customer and sold to electronic manufacturing services providers
("EMSs"), for incorporation into products manufactured exclusively for the OEM customer or, in some instances, to facilitate credit and logistics. These net sales to EMSs have historically fluctuated
period to period as a portion of the total net sales
to the OEM customers. Net sales to Hon Hai Precision Industry Co. Ltd., an EMS operating under the trade name of Foxconn that purchases memory modules from us for incorporation into
products manufactured exclusively for Dell, represented approximately 74% and 87% of net sales to Dell for 2013 and 2012, respectively. Net sales to Kingston Technology, an EMS manufacturer for IBM,
represented approximately 29% and 62% of net sales to IBM for 2013 and 2012, respectively. For further information regarding our sales to our OEM customer base, please refer to Note 12 of Notes
to Consolidated Financial Statements included in Part IV, Item 15 of this Report.
4
Table of Contents
The
composition of major customers and their respective contributions to our net sales have varied and will likely continue to vary from period to period as our OEMs progress
through the life cycle of the products they produce and sell. For example, we have experienced a significant decline in sales of our NVvault sales to Dell following its launch of servers
incorporating Intel's Romley platform. We expect that after product in the supply chain is consumed, sales of NVvault products for incorporation into PERC 7 servers will be minimal. This
reduction in sales is expected to continue to have a significant impact on our revenue and gross profit.
Our
sales are made primarily pursuant to standard purchase orders that may be rescheduled on relatively short notice. Customers are generally allowed limited rights of return for up to
30 days, except for sales of excess inventories, which contain no right-of-return privileges. Estimated returns are provided for at the time of sale based on historical experience or specific
identification of an event necessitating a reserve. While these returns have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to
experience similar return rates in the future. Any significant increase in product failure rates and the resulting product returns could have a material adverse effect on our operating results for the
period or periods in which such returns materialize.
We
offer warranties on our memory subsystems generally ranging from one to three years, depending on the product and negotiated terms of purchase agreements with our customers. Such
warranties require us to repair or replace defective product returned to us during such warranty period at no cost to the customer. Our estimates for warranty related costs are recorded at the time of
sale based on historical and estimated future product return rates and expected repair or replacement costs. While such costs have historically been within our expectations and the provisions
established, unexpected changes in failure rates could have a material adverse impact on us, requiring additional warranty reserves, and adversely affecting our gross profit and gross margins.
Sales and Marketing
We market and sell our products through a direct sales force and a network of independent sales representatives. Our sales activities
focus primarily on developing strong relationships at the technical, marketing and executive management levels within market-leading OEMs.
We
utilize well-trained, highly technical program management teams to successfully drive new product development and quickly respond to our customers' needs and expectations. Our program
management teams provide quick response times and act as a single point-of-contact for routine issues during the sales process. Additionally, they address the long-term business and technology goals
of our customers. We employ a team approach to business development whereby our sales team and independent representatives identify, qualify and prioritize customer prospects through offices in a
number of locations worldwide.
For
additional information regarding our net sales from external customers by geographic area, refer to Note 13 of Notes to Consolidated Financial Statements, included in
Part IV, Item 15 of this Report.
Manufacturing
We manufacture substantially all of our products at our facilities in Suzhou in the People's Republic of China (the "PRC"). Our
advanced engineering and design capabilities, combined with our in-house manufacturing processes, allow us to assemble our memory subsystems reliably and in high volume. Our advanced, customized
manufacturing facilities are capable of surface mount assembly, subsystem testing, system-level burn-in testing, programming, marking, labeling and packaging. At each stage of the production cycle,
including product prototyping, qualification sample production and high-volume manufacturing and delivery, we focus on providing our customers with rapid response and
5
Table of Contents
short
manufacturing turn-around times. Manufacturing cycle times for our products are typically one week or less, and in some cases as few as two days, from receipt of order.
We
acquire components and materials such as ASICs, DRAM ICs and NAND directly from integrated circuit manufacturers and assemble them into finished subsystems. We believe that one of our
key strengths is the efficient procurement and management of components for our subsystems, which benefits our customers in the form of lower costs and increased product availability. We have a
limited number of suppliers, including SK hynix Semiconductor America and Samsung Semiconductor, Inc., each of which have comprised more than 10% of our total purchases in both of 2013 and
2012. For further information regarding our supplier concentrations, refer to Note 12 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.
We have developed strong supplier relationships with these and other key DRAM IC and NAND manufacturers, which we believe gives us direct and ready access to the critical components that we need for
our production activities. We typically qualify our products with our customers using multiple manufacturers of DRAM ICs and NAND. The flexibility to choose from several DRAM IC and NAND providers
allows us to minimize product cost and maximize product availability. Our HyperCloud® RDIMM contains an ASIC chipset component. We intend to procure these ASICs from multiple integrated
circuit vendors.
We
schedule production based on purchase order commitments and anticipated orders. We release raw materials to the manufacturing floor by means of an on-line shop floor control system,
which allows for internal quality analysis, direct access to inventory information and production floor material tracking. We have a flexible manufacturing workforce which allows us to manage
unforecasted demand. In addition, in order to mitigate inventory risks, we have the capability to sell excess quantities of certain component inventories of DRAM ICs and NAND to distributors and other
users of memory integrated circuits. However, the ASIC and DRAM components used in our HyperCloud® product have limited alternative uses. As such, we may not be able to sell excess
quantities of the components, should we fail to obtain qualification with major OEMs.
Our
quality assurance engineers work with our suppliers to ensure that the raw materials we receive meet our high quality standards. These engineers also perform onsite supplier factory
audits and use our internal test and inspection systems to verify that purchased components and materials meet our specifications. Our supplier quality program and incoming material quality control
program are important aspects of our overall manufacturing process.
We
perform ongoing reliability testing on our memory subsystems and share the results of that testing with our customers. We believe that this improves the system design process and
allows for the elimination of potential problems at the earliest possible stage. In addition, we have implemented procedures which require that all of our memory subsystems undergo functional and
system burn-in testing prior to delivery to the customer. We complement our test capabilities with advanced imaging technology to inspect the quality of our assemblies.
We
are certified in ISO 9001:2008 Quality Management Systems and ISO 14001:2004 Environmental Management Standards.
Competition
Our products are primarily targeted for the server, high performance computing and communications markets. These markets are intensely
competitive, as numerous companies vie for business opportunities at a limited number of large OEMs. We face competition from DRAM suppliers, including SK hynix, Samsung and Micron for many of
our products, including HyperCloud®. Our primary competitors for the rest of our product lines are mainly memory module providers such as STEC, SMART Modular Technologies, Inc.,
Agigatech, and Viking Interworks, a division of Sanmina-SCI Corporation. We also face potential direct or indirect competition from logic suppliers
6
Table of Contents
such
as Inphi, IDT, Montage and Texas Instruments. As we enter new markets and pursue additional applications for our products, we may face competition from a larger number of competitors that produce
solutions utilizing similar or competing technologies.
Certain
of our competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines, lower cost structures, greater brand
recognition and longer standing relationships with customers and suppliers. Some of our competitors may also have a greater ability to influence industry standards than we do, as well as more
extensive patent portfolios.
Some
of our customers and suppliers may have proprietary products or technologies that are competitive with our products, or could develop internal solutions or enter into strategic
relationships with, or acquire, existing high-density memory module providers. Any of these actions could reduce our customers' demand for our products. Some of our significant suppliers of memory
integrated circuits may be able to manufacture competitive products at lower costs by leveraging internal efficiencies, or could choose to reduce our supply of memory integrated circuits, adversely
affecting our ability to manufacture our memory subsystems on a timely basis, if at all.
Our
ability to compete in our current target markets and in future markets will depend in large part on our ability to successfully develop, introduce and sell new and enhanced products
on a timely and cost-effective basis, and to respond to changing market requirements. We believe that the principal competitive factors in the selection of high performance memory subsystems by
potential customers are:
-
-
understanding of OEM system and business requirements;
-
-
timeliness of new value-add product introductions;
-
-
design characteristics and performance;
-
-
quality and reliability;
-
-
track record of volume delivery;
-
-
credibility with the customer;
-
-
fulfillment capability and flexibility; and
-
-
price.
We
believe that we compete favorably with respect to these factors. However, our current and future competitors could develop competing products that could cause a decline in sales or
loss of market acceptance of our products.
Research and Development
The market for high performance memory subsystems is constantly changing and therefore continuous development of new technology,
processes and product innovation is mandatory to be successful as a leading supplier. We believe that the continued and timely development of new products and improvement of existing products are
critical to maintaining our competitive position. Our team of engineers focuses on developing custom semiconductor logic devices, hybrid memory, DRAM and NAND flash products with innovative packaging
solutions, improved electrical signal integrity and thermal characteristics that enhances reliability over the life of the system and achieves higher speeds and lowers power consumption. Also, our
engineers incorporate various new techniques and methodologies for testing as well as new processes for manufacturing our products.
7
Table of Contents
Our engineering staff closely engages with our customers and their engineering teams at early stages in their system development. This collaboration allows our
engineers to understand the customer's system architecture, power budget, operating environment such as air flow and operating temperature and any mechanical constraints. Our engineers use this
information to provide guidance and solutions to implement optimum memory subsystems to our customers. An important aspect of our research and development effort is to understand the challenges faced
by our customers and provide cost effective solutions that satisfy their requirements by utilizing our industry knowledge, proprietary technologies and technical expertise.
We
use advanced design tools in development of our products that allow us to model behavior of a signal trace on our memory modules as well as airflow and thermal profiles of all
components in the system. These design tools enable real-time simulation for signal integrity and behavioral modeling of our designs using the Input/Output Buffer Information Specification ("IBIS") of
our suppliers' components. These simulation tools help us reduce or eliminate electronic signal reflections, clock skews, signal jitter and noise which can reduce system performance and reliability.
Also, our engineers use thermal simulation tools to identify potential thermal problems arising from inadequate airflow necessary to cool the components in the system. These efforts allow our
engineers to develop optimum thermal solutions for our customer base.
We
believe that to remain competitive we must continue to focus on developing advanced memory technologies. We have invested significant resources in the design of custom semiconductor
logic
devices. These logic devices are integrated into our next-generation memory subsystems in order to improve their performance. For example, our HyperCloud® logic devices enable our
DRAM-based subsystems to achieve higher speeds and address greater memory capacity at a lower price point than currently available products in the market. Logic devices in our NVvault
hybrid memory product enable DRAM and flash memory to be efficiently combined for the purposes of accelerating system performance and providing mission critical back up. The development of these
semiconductor devices are an important part of our overall effort to maintain a strong competitive position in our industry based on advanced memory technologies.
Our
customers typically do not separately compensate us for design and engineering work involved in developing application-specific products for them. Our total expenditures for research
and development were approximately $6.7 million and $12.8 million for 2013 and 2012, respectively.
Intellectual Property and Licensing
Our high performance memory subsystems are developed in part using our proprietary intellectual property, and we believe that the
strength of our intellectual property rights will be important to the success of our business. We utilize patent and trade secret protection, confidentiality agreements with customers and partners,
disclosure and invention assignment agreements with employees and consultants and other contractual provisions to protect our intellectual property and other proprietary information. We plan to
license specific, custom designs to our customers, charging royalties at a fixed amount per product or a percentage of sales. More generally, we intend to vigorously defend and monetize our
intellectual property through licensing arrangements and, where necessary, enforcement actions against those entities using our patented solutions in their products. Royalties resulting from these
patent monetization efforts can be structured in a variety of ways, including but not limited to one-time paid up licenses or on-going royalty arrangements. We expect to generate a portion of our
revenues with these types of licensing arrangements.
As
of December 28, 2013, we had 40 U.S. patents issued and 31 U.S. and foreign patent applications pending. Assuming that they are properly maintained, our patents will expire at
various dates between 2022 and 2029. Our issued patents and patent applications relate to the use of custom logic in high performance memory subsystems, PCB design, layout and packaging techniques. We
8
Table of Contents
intend
to actively pursue the filing of additional patent applications related to our technology advancements. While we believe that our patent and other intellectual property rights are important to
our success, our technical expertise and ability to introduce new products in a timely manner also will
continue to be important factors in developing and maintaining our competitive position. Accordingly, we believe that our business is not materially dependent upon any one claim in any of our existing
patents or pending patent applications.
Employees
At December 28, 2013, we had approximately 124 employees (including 73 regular employees and 51 temporary employees).
Approximately 23 of the regular employees were located in the U.S., and approximately 50 were located in in the PRC. We had 54 employees in operations, 10 employees in research and development, 3
employees in sales and marketing, and 6 employees engaged in other administrative functions. We are not party to any collective bargaining agreements with any of our employees. We have never
experienced a work stoppage, and we believe our employee relations are good.
General Information
We maintain a website at
www.netlist.com
(this uniform resource locator, or URL, is an
inactive textual reference only and is not intended to incorporate our website into this Form 10-K). We file reports with the Securities and Exchange Commission ("SEC"), and make available,
free of charge, on or through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable
after we electronically file such material with, or furnish it to, the SEC. Our website also contains copies of our corporate governance policy, code of business conduct and ethics, insider trading
policy and whistleblower policy, as well as copies of the charters for our audit committee, compensation committee and nominating and corporate governance committee.
Item 1A. Risk Factors
You should consider each of the following factors as well as the other information in this Report in evaluating
our business and our prospects. The risks described below are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our
business operations. If any of the events described below were to occur, our financial condition, our ability to access capital resources, our results of operations and/or our future growth
prospects could be materially and adversely affected and the market price of our common stock could decline. In assessing these risks, you should also refer to the other information contained or
incorporated by reference in this Report, including our consolidated financial statements and related notes.
Risks related to our business
We expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.
Our operating results have varied significantly in the past and will continue to fluctuate from quarter-to-quarter or year-to-year in
the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these quarterly and annual
9
Table of Contents
fluctuations
include the following factors, as well as other factors described elsewhere in this quarterly report:
-
-
general economic conditions, including the possibility of a prolonged period of limited economic growth in the U.S. and
Europe; disruptions to the credit and financial markets in the U.S., Europe and elsewhere;
-
-
our inability to develop new or enhanced products that achieve customer or market acceptance in a timely manner, including
our HyperCloud ® memory module, NVvault family of products and our flash-based memory products;
-
-
our failure to maintain the qualification of our products with our current customers or to qualify current and future
products with our current or prospective customers in a timely manner or at all;
-
-
the timing of actual or anticipated introductions of competing products or technologies by us or our competitors,
customers or suppliers;
-
-
the loss of, or a significant reduction in sales to, a key customer;
-
-
the cyclical nature of the industry in which we operate;
-
-
a reduction in the demand for our high performance memory subsystems or the systems into which they are incorporated;
-
-
our customers' failure to pay us on a timely basis;
-
-
costs, inefficiencies and supply risks associated with outsourcing portions of the design and the manufacture of
integrated circuits;
-
-
our ability to absorb manufacturing overhead if our revenues decline or vary from our projections;
-
-
delays in fulfilling orders for our products or a failure to fulfill orders;
-
-
our ability to procure an adequate supply of key components, particularly DRAM ICs and NAND;
-
-
dependence on large suppliers who are also competitors and whose manufacturing priorities may not support our production
schedules;
-
-
changes in the prices of our products or in the cost of the materials that we use to build our products, including
fluctuations in the market price of DRAM ICs and NAND;
-
-
our ability to effectively operate our manufacturing facility in the PRC;
-
-
manufacturing inefficiencies associated with the start-up of new manufacturing operations, new products and initiation of
volume production;
-
-
our failure to produce products that meet the quality requirements of our customers;
-
-
disputes regarding intellectual property rights and the possibility of our patents being reexamined by the USPTO;
-
-
the costs and management attention diversion associated with litigation;
-
-
the loss of any of our key personnel;
-
-
changes in regulatory policies or accounting principles;
-
-
our ability to adequately manage or finance internal growth or growth through acquisitions;
10
Table of Contents
-
-
the effect of our investments and financing arrangements on our liquidity; and
-
-
the other factors described in this "Risk Factors" section and elsewhere in this quarterly report.
Due
to the various factors mentioned above, and others, the results of any prior quarterly or annual periods should not be relied upon as an indication of our future operating
performance. In one or more future periods, our results of operations may fall below the expectations of securities analysts and investors. In that event, the market price of our common stock would
likely decline. In addition, the market price of our common stock may fluctuate or decline regardless of our operating performance.
We have historically incurred losses and may continue to incur losses.
Since the inception of our business in 2000, we have only experienced one fiscal year (2006) with profitable results. In order to
regain profitability, or to achieve and sustain positive cash flows from operations in the future, we must further reduce operating expenses and/or
increase our revenues and gross margins. Although we have in the past engaged in a series of cost reduction actions, and believe that we could reduce our current level of expenses through elimination
or reduction of strategic initiatives, such expense reductions alone may not make us profitable or allow us to sustain profitability if it is achieved. Our ability to achieve profitability will depend
on increased revenue growth from, among other things, increased demand for our memory subsystems and related product offerings, as well as our ability to expand into new and emerging markets. We may
not be successful in achieving the necessary revenue growth or the expected expense reductions. Moreover, we may be unable to sustain past or expected future expense reductions in subsequent periods.
We may not achieve profitability or sustain such profitability, if achieved, on a quarterly or annual basis in the future.
Any
failure to achieve profitability could result in increased capital requirements and pressure on our liquidity position. We believe our future capital requirements will depend on many
factors, including our levels of net sales, the timing and extent of expenditures to support sales, marketing, research and development activities, the expansion of manufacturing capacity both
domestically and internationally and the continued market acceptance of our products. Our capital requirements could result in our having to, or otherwise choosing to, seek additional funding through
public or private equity offerings or debt financings. Such funding may not be available on terms acceptable to us, or at all, either of which could result in our inability to meet certain of our
financial obligations and other related commitments.
Our future capital needs are uncertain and we may need to raise additional funds, which may not be available on acceptable terms or at all.
We believe our existing cash balances, borrowing availability under our bank credit facility with Silicon Valley Bank ("SVB"),
borrowing availability under our loan agreement with DBD Credit Funding, LLC, an affiliate of Fortress Investment Group, LLC (the "DBD"), and the cash expected to be generated from
operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need significant additional capital, which we may seek to raise through, among
other things, public and private equity offerings and debt financings. Our future capital requirements will depend on many factors, including our levels of net sales, the timing and extent of
expenditures to support research and development activities and patent infringement litigation, the expansion of manufacturing capacity both domestically and internationally and the continued market
acceptance of our products. Additional funds may not be available on terms acceptable to us, or at all. Furthermore, if we issue equity or convertible debt securities to raise additional funds, our
existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences, and privileges senior to those of our existing stockholders. If we incur additional
debt, it may increase our leverage relative to our earnings or to our equity capitalization.
11
Table of Contents
If
adequate working capital is not available when needed, we may be required to significantly modify our business model and operations to reduce spending to a sustainable level. It could
cause us to be unable to execute our business plan, take advantage of future opportunities, or respond to competitive pressures or customer requirements. It may also cause us to delay, scale back or
eliminate some or all of our research and development programs, or to reduce or cease operations.
We have incurred a material amount of indebtedness to fund our operations, the terms of which requires that we pledge substantially all of our assets as security and that we
agree to share certain patent monetization revenues that may accrue in the future. Our level of indebtedness and the terms of such indebtedness, could adversely affect our operations and liquidity.
We have incurred debt secured by all of our assets under our credit facilities and term loans with DBD and SVB. Our credit facility
with DBD is secured by a first-priority security interest in our intellectual property assets (other than certain patents and related assets relating to the NVvault product line) and a
second priority security interest in substantially all of our other assets. Our credit facility with SVB is secured by a first priority security interest in all of our assets other than our
intellectual property assets, to which SVB has a second priority security interest. The credit facility with DBD contains customary representations, warranties and indemnification provisions, as well
as affirmative and negative covenants that, among other things restrict our ability to:
-
-
incur additional indebtedness or guarantees;
-
-
incur liens;
-
-
make investments, loans and acquisitions;
-
-
consolidate or merge
-
-
sell or exclusively license assets, including capital stock of subsidiaries;
-
-
alter our business;
-
-
engage in transactions with affiliates; and
-
-
pay dividends or make distributions.
The
credit facilities also include events of default, including, among other things, payment defaults, breaches of representations, warranties or covenants, certain bankruptcy events,
and certain material adverse changes. If we were to default under either credit facility and were unable to obtain a waiver for such a default, interest on the obligations would accrue at an increased
rate. In the case of a default, the lenders could accelerate our obligations under the credit agreements and exercise their rights to foreclose on their security interests, which would cause
substantial harm to our business and prospects.
Incurrence
and maintenance of this debt could have material consequences, such as:
-
-
requiring us to dedicate a portion of our cash flow from operations and other capital resources to debt service, thereby
reducing our ability to fund working capital, capital expenditures, and other cash requirements;
-
-
increasing our vulnerability to adverse economic and industry conditions;
-
-
limiting our flexibility in planning for, or reacting to, changes and opportunities in, our business and industry, which
may place us at a competitive disadvantage; and
-
-
limiting our ability to incur additional debt on acceptable terms, if at all.
Concurrently
with the execution of the credit facility with DBD, we entered into a Patent Monetization Side Letter Agreement which provides, among other things, that an affiliate of DBD
may
12
Table of Contents
be
entitled to share in certain monetization revenues that we may derive in the future related to our patent portfolio (excluding certain patents relating to the NVvault product line).
Monetization revenues subject to this arrangement include revenues recognized during the seven year term of the Letter Agreement from net amounts actually paid to us or our subsidiaries in connection
with any assertion of, agreement not to assert, or license of, our patent portfolio. Monetization revenues subject to the arrangement also include the value attributable to our patent portfolio in any
sale of the Company during the seven year term, subject to a maximum amount. The Letter Agreement also requires that we use commercially reasonable efforts to pursue opportunities to monetize our
patent portfolio during the term of the Letter Agreement, provided that we are under no obligation to pursue any such opportunities that we do not deem to be in our best interest in our reasonable
business judgment. Notwithstanding the foregoing, there can be no assurance that we will be successful in these efforts, and we may expend resources in pursuit of monetization revenues that may not
result in any benefit to us. Moreover, the revenue sharing obligation will reduce the benefit we receive from any monetization transactions, which could adversely affect our operating results and
would reduce the amounts payable to our stockholders in the event of a sale transaction.
Our revenues and results of operations have been substantially dependent on NVvault and we may be unable to replace revenue lost from the rapid decline in
NVvault sales.
For the fiscal years ended December 28, 2013 and December 29, 2012, our NVvault non-volatile RDIMM used in
cache-protection and data logging applications, including our NVvault battery-free, the flash-based cache system, accounted for approximately 39% and 51% of total net sales, respectively.
Following Intel's launch of its Romley platform in the first quarter of 2012, we have experienced a rapid decline in NVvault sales to Dell, and we recognized $5.5 million in
NVvault sales to Dell in the fiscal year ended December 28, 2013, as compared to $15.7 million in the fiscal year ended December 29, 2012. We expect that after
product in the supply chain is consumed, sales of NVvault products for incorporation into PERC 7 servers will be minimal. In order to leverage our NVvault technology and
diversify our customer base, we continue to pursue additional qualifications of NVvault with other OEMs. We also introduced EXPRESSvault in March 2011, and we continue
to pursue qualification of next generation DDR3 NVvault with
customers. Our future operating results will depend on our ability to commercialize these NVvault product extensions, as well as other new products such as HyperCloud® and
other high-density and high-performance solutions. We may not be successful in marketing any new or enhanced products. If we are not successful in generating sales of other products, the decrease or
cessation of sales of NVvault products to Dell will significantly reduce our annual revenues and negatively affect our results of operations.
We are subject to risks relating to our focus on developing our HyperCloud ® product and lack of market diversification.
We have historically derived a substantial portion of our net sales from sales of our high performance memory subsystems for use in the
server market. We expect these memory subsystems to continue to account for a significant portion of our net sales in the near term. Continued market acceptance of these products for use in servers is
critical to our success.
In
an attempt to set our products apart from those of our competitors, we have invested a significant portion of our research and development budget into the design of ASIC devices,
including the HyperCloud ® memory subsystem, introduced in November 2009. This design and the products it is incorporated into are subject to increased risks as compared to our other
products. For example:
-
-
we may be unable to achieve customer or market acceptance of the HyperCloud ® memory subsystem or other new
products, or achieve such acceptance in a timely manner;
13
Table of Contents
-
-
the HyperCloud ® memory subsystem or other new products may contain currently undiscovered flaws, the
correction of which would result in increased costs and time to market;
-
-
we are dependent on a limited number of suppliers for both the DRAM ICs and the ASIC devices that are essential to the
functionality of the HyperCloud ® memory subsystem, and could experience supply chain disruption as a result of business issues that are specific to our suppliers or the industry as a
whole; and
-
-
we are required to demonstrate the quality and reliability of the HyperCloud ® memory subsystem or other new
products to our customers, and are required to qualify these new products with our customers, both of which have required and will continue to require a significant investment of time and resources
prior to the receipt of any revenue from such customers.
We
have experienced a longer qualification cycle than anticipated with our HyperCloud® memory subsystems, and as a result, we have not generated significant
HyperCloud® product revenues to date relative to our investment in the product. We entered into collaborative agreements with both IBM and HP pursuant to which these OEMs qualified
the 16GB and 32GB versions of HyperCloud® for use with their products. In February 2012 and May 2012, we achieved memory qualification of our 16GB HyperCloud® product at IBM
and HP, respectively. In September 2012 and July 2013, we achieved memory qualification of our 32GB HyperCloud® product at IBM and HP, respectively. While we and each of the
OEMs committed financial and other resources toward the collaboration, the efforts undertaken with each of these collaborative agreements have not resulted in significant product margins for us
to date relative to our investment in developing and marketing these products, and there is no assurance that we will achieve sufficient revenues or margins from our HyperCloud® products
under these arrangements.
Additionally,
if the demand for servers deteriorates or if the demand for our products to be incorporated in servers declines, our operating results would be adversely affected, and we
would be forced to diversify our product portfolio and our target markets. We may not be able to achieve this diversification, and our inability to do so may adversely affect our business.
We may lose our competitive position if we are unable to timely and cost-effectively develop new or enhanced products that meet our customers' requirements and achieve
market acceptance.
Our industry is characterized by intense competition, rapid technological change, evolving industry standards and rapid product
obsolescence. Evolving industry standards and technological change or new, competitive technologies could render our existing products obsolete. Accordingly, our ability to compete in the future will
depend in large part on our ability to identify and develop new or enhanced products on a timely and cost-effective basis, and to respond to changing
customer requirements. In order to develop and introduce new or enhanced products, we need to:
-
-
identify and adjust to the changing requirements of our current and potential customers;
-
-
identify and adapt to emerging technological trends and evolving industry standards in our markets;
-
-
design and introduce cost-effective, innovative and performance-enhancing features that differentiate our products from
those of our competitors;
-
-
develop relationships with potential suppliers of components required for these new or enhanced products;
-
-
qualify these products for use in our customers' products; and
-
-
develop and maintain effective marketing strategies.
14
Table of Contents
Our
product development efforts are costly and inherently risky. It is difficult to foresee changes or developments in technology or anticipate the adoption of new standards. Moreover,
once these things are identified, if at all, we will need to hire the appropriate technical personnel or retain third party designers, develop the product, identify and eliminate design flaws, and
manufacture the product in production quantities either in-house or through third-party manufacturers. As a result, we may not be able to successfully develop new or enhanced products or we may
experience delays in the development
and introduction of new or enhanced products. Delays in product development and introduction could result in the loss of, or delays in generating, net sales and the loss of market share, as well as
damage to our reputation. Even if we develop new or enhanced products, they may not meet our customers' requirements or gain market acceptance.
Our customers require that our products undergo a lengthy and expensive qualification process without any assurance of net sales.
Our prospective customers generally make a significant commitment of resources to test and evaluate our memory subsystems prior to
purchasing our products and integrating them into their systems. This extensive qualification process involves rigorous reliability testing and evaluation of our products, which may continue for six
months or longer and is often subject to delays. In addition to qualification of specific products, some of our customers may also require us to undergo a technology qualification if our product
designs incorporate innovative technologies that the customer has not previously encountered. Such technology qualifications often take substantially longer than product qualifications and can take
over a year to complete. Qualification by a prospective customer does not ensure any sales to that prospective customer. Even after successful qualification and sales of our products to a customer,
changes in our products, our manufacturing facilities, our production processes or our component suppliers may require a new qualification process, which may result in additional delays.
In
addition, because the qualification process is both product-specific and platform-specific, our existing customers sometimes require us to requalify our products, or to qualify our
new products, for use in new platforms or applications. For example, as our OEM customers transition from prior generation DDR2 DRAM architectures to current generation DDR3 DRAM architectures, we
must design and qualify new products for use by those customers. In the past, the process of design and qualification has taken up to six months to complete, during which time our net sales to those
customers declined significantly. After our products are qualified, it can take several months before the customer begins production and we begin to generate net sales from such customer.
Likewise,
when our memory component vendors discontinue production of components, it may be necessary for us to design and qualify new products for our customers. Such customers may
require of us or we may decide to purchase an estimated quantity of discontinued memory components necessary to ensure a steady supply of existing products until products with new components can be
qualified. Purchases of this nature may affect our liquidity. Additionally, our estimation of quantities required during the transition may be incorrect, which could adversely impact our results of
operations through lost revenue opportunities or charges related to excess and obsolete inventory.
We
must devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualify our products with prospective customers in anticipation of sales.
Significant delays in the qualification process, such as those experienced with our HyperCloud ® product, could result in an inability to keep up with rapid technology change or new,
competitive technologies. If we delay or do not succeed in qualifying a product with an existing or prospective customer, we will
not be able to sell that product to that customer, which may result in our holding excess and obsolete inventory and harm our operating results and business.
15
Table of Contents
Sales to a limited number of customers represent a significant portion of our net sales and the loss of, or a significant reduction in sales to, any one of these customers
could materially harm our business.
Sales to certain of our OEM customers have historically represented a substantial majority of our net sales. Approximately 45% and 15%
and 60% and 18% of our net sales in the fiscal years ended December 28, 2013 and December 29, 2012, respectively, were to two of our customers. The composition of major customers and
their respective contributions to our net sales have varied and will likely continue to vary from period to period as our OEMs progress through the life cycle of the products they produce and
sell. We do not have long-term agreements with our OEM customers, or with any other customer. Any one of these customers could decide at any time to discontinue, decrease or delay their purchase of
our products. In addition, the prices that these customers pay for our products could change at any time. The loss of any of our OEM customers, or a significant reduction in sales to any of them,
could significantly reduce our net sales and adversely affect our operating results.
Our
ability to maintain or increase our net sales to our key customers depends on a variety of factors, many of which are beyond our control. These factors include our customers'
continued sales of servers and other computing systems that incorporate our memory subsystems and our customers' continued incorporation of our products into their systems. Because of these and other
factors, net sales to these
customers may not continue and the amount of such net sales may not reach or exceed historical levels in any future period. Because these customers account for a substantial portion of our net sales,
the failure of any one of these customers to pay on a timely basis would negatively impact our cash flow. In addition, while we may not be contractually obligated to accept returned products, we may
determine that it is in our best interest to accept returns in order to maintain good relations with our customers. As we describe in more detail elsewhere in this Report, we have experienced a
significant decline in sales of NVvault to our key customer, Dell. This reduction in sales has had, and is expected to continue to have, a significant impact on our revenues and gross
profit.
A limited number of relatively large potential customers dominate the markets for our products.
Our target markets are characterized by a limited number of large companies. Consolidation in one or more of our target markets may
further increase this industry concentration. As a result, we anticipate that sales of our products will continue to be concentrated among a limited number of large customers in the foreseeable
future. We believe that our financial results will depend in significant part on our success in establishing and maintaining relationships with, and effecting substantial sales to, these potential
customers. Even if we establish and successfully maintain these relationships, our financial results will be largely dependent on these customers' sales and business results.
If a standardized memory solution which addresses the demands of our customers is developed, our net sales and market share may decline.
Many of our memory subsystems are specifically designed for our OEM customers' high performance systems. In a drive to reduce costs and
assure supply of their memory module demand, our OEM customers may endeavor to design JEDEC standard DRAM modules into their new products. Although we also manufacture JEDEC modules, this trend could
reduce the demand for our higher priced customized memory solutions which in turn would have a negative impact on our financial results. In addition, customers deploying custom memory solutions today
may in the future choose to adopt a JEDEC standard, and the adoption of a JEDEC standard module instead of a previously custom module might allow new competitors to participate in a share of our
customers' memory module business that previously belonged to us.
If
our OEM customers were to adopt JEDEC standard modules, our future business may be limited to identifying the next generation of high performance memory demands of OEM customers
16
Table of Contents
and
developing solutions that addresses such demands. Until fully implemented, this next generation of products may constitute a much smaller market, which may reduce our net sales and market share.
We may not be able to maintain our competitive position because of the intense competition in our targeted markets.
We participate in a highly competitive market, and we expect competition to intensify. Many of our competitors have longer operating
histories, significantly greater resources and name recognition, a larger base of customers and longer-standing relationships with customers and suppliers than we have. As a result, some of these
competitors are able to devote greater resources to the development, promotion and sale of products and are better positioned than we are to influence customer acceptance of their products over our
products. These competitors also may be able to respond better to new or emerging technologies or standards and may be able to deliver products with comparable or superior performance at a lower
price. For these reasons, we may not be able to compete successfully against these competitors. We also expect to face competition from new and emerging companies that may enter our existing or future
markets. These potential competitors may have similar or alternative products which may be less costly or provide additional features.
In
addition to the competition we face from DRAM and logic suppliers such as SK hynix, Samsung, Micron, Inphi and IDT, some of our OEM customers have their own internal design groups
that may develop solutions that compete with ours. These design groups have some advantages over us, including direct access to their respective companies' technical information and technology
roadmaps. Our OEM customers also have substantially greater resources, financial and otherwise, than we do, and may have lower cost structures than ours. As a result, they may be able to design and
manufacture competitive products more efficiently or inexpensively. If any of these OEM customers are successful in competing against us, our sales could decline, our margins could be negatively
impacted and we could lose market share, any or all of which could harm our business and results of operations. Further, some of our significant suppliers are also competitors, many of whom have the
ability to manufacture competitive products at lower costs as a result of their higher levels of integration.
We
expect our competitors to continue to improve the performance of their current products, reduce their prices and introduce new or enhanced technologies that may offer greater
performance and improved pricing. If we are unable to match or exceed the improvements made by our competitors, our market position would deteriorate and our net sales would decline. In addition, our
competitors may develop future generations and enhancements of competitive products that may render our technologies obsolete or uncompetitive.
If we fail to protect our proprietary rights, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could
adversely affect our operating results.
We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property
rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in the remaining applications will be
allowed. As of December 28, 2013, we had 40 U.S. patents issued. We intend to continue filing patent applications with respect to most of the new processes and technologies that we develop.
However, patent protection may not be available for some of these processes or technologies.
It
is possible that our efforts to protect our intellectual property rights may not:
-
-
prevent challenges to, or the invalidation or circumvention of, our existing intellectual property rights;
-
-
prevent our competitors from independently developing similar products, duplicating our products or designing around any
patents that may be issued to us;
17
Table of Contents
-
-
prevent disputes with third parties regarding ownership of our intellectual property rights;
-
-
prevent disclosure of our trade secrets and know-how to third parties or into the public domain;
-
-
result in valid patents, including international patents, from any of our pending or future applications; or
-
-
otherwise adequately protect our intellectual property rights.
Others
may attempt to reverse engineer, copy or otherwise obtain and use our proprietary technologies without our consent. Monitoring the unauthorized use of our technologies is
difficult. We cannot be certain that the steps we have taken will prevent the unauthorized use of our technologies. This is particularly true in foreign countries, such as the PRC, where we have
established a manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.
If
some or all of the claims in our patent applications are not allowed, or if any of our intellectual property protections are limited in scope by the USPTO or by a court or
circumvented by others, we could face increased competition with regard to our products. Increased competition could significantly harm our business and our operating results.
We are involved in and expect to continue to be involved in costly legal and administrative proceedings to defend against claims that we infringe the intellectual property
rights of others or to enforce or protect our intellectual property rights.
As is common to the semiconductor industry, we have experienced substantial litigation regarding patent and other intellectual property
rights. Lawsuits claiming that we are infringing others' intellectual property rights have been and may in the future be brought against us, and we are currently defending against claims of invalidity
in the USPTO. See Note 9 of Notes to Consolidated Financial Statements, included in the Report, for a more detailed description of our legal contingencies.
The
process of obtaining and protecting patents is inherently uncertain. In addition to the patent issuance process established by law and the procedures of the USPTO, we must comply
with JEDEC administrative procedures in protecting our intellectual property within its industry standard setting process. These procedures evolve over time, are subject to variability in their
application, and may be inconsistent with each other. Failure to comply with JEDEC's administrative procedures could jeopardize our ability to claim that our patents have been infringed.
By
making use of new technologies and entering new markets there is an increased likelihood that others might allege that our products infringe on their intellectual property rights.
Litigation is inherently uncertain, and an adverse outcome in existing or any future litigation could subject us to significant liability for damages or invalidate our proprietary rights. An adverse
outcome also could force us to take specific actions, including causing us to:
-
-
cease manufacturing and/or selling products, or using certain processes, that are claimed to be infringing a third party's
intellectual property;
-
-
pay damages (which in some instances may be three times actual damages), including royalties on past or future sales;
-
-
seek a license from the third party intellectual property owner to use their technology in our products, which license may
not be available on reasonable terms, or at all; or
-
-
redesign those products that are claimed to be infringing a third party's intellectual property.
If
any adverse ruling in any such matter occurs, any resulting limitations in our ability to market our products, or delays and costs associated with redesigning our products or payments
of license fees
18
Table of Contents
to
third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, financial condition and
results of operations.
There
is a limited pool of experienced technical personnel that we can draw upon to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or
potential
competitors at some point during their careers, and we anticipate that a number of our future employees will have similar work histories. In the past, some of these competitors have claimed that our
employees misappropriated their trade secrets or violated non-competition or non-solicitation agreements. Some of our competitors may threaten or bring legal action involving similar claims against us
or our existing employees or make such claims in the future to prevent us from hiring qualified candidates. Lawsuits of this type may be brought, even if there is no merit to the claim, simply as a
strategy to drain our financial resources and divert management's attention away from our business.
We
also may find it necessary to litigate against others, including our competitors, customers and former employees, to enforce our intellectual property, contractual and commercial
rights including, in particular, our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. We could become subject to counterclaims or countersuits against
us as a result of this litigation. Moreover, any legal disputes with customers could cause them to cease buying or using our products or delay their purchase of our products and could substantially
damage our relationship with them.
Any
litigation, regardless of its outcome, would be time consuming and costly to resolve, divert our management's time and attention and negatively impact our results of operations. We
cannot assure you that current or future infringement claims by third parties or claims for indemnification by customers or end users of our products resulting from infringement claims will not be
asserted in the future or that such assertions, if proven to be true, will not materially adversely affect our business, financial condition or results of operations.
Our operating results may be adversely impacted by worldwide economic and political uncertainties and specific conditions in the markets we address, including the cyclical
nature of and volatility in the memory market and semiconductor industry.
Adverse changes in domestic and global economic and political conditions have made it extremely difficult for our customers, our
vendors and us to accurately forecast and plan future business activities, and they have caused and could continue to cause U.S. and foreign businesses to slow spending on our products and services,
which would further delay and lengthen sales cycles. In addition, sales of our products are dependent upon demand in the computing, networking, communications, printer, storage and industrial markets.
These markets have been cyclical and are characterized by wide fluctuations in product supply and demand. These markets have experienced significant downturns, often connected with, or in anticipation
of, maturing product cycles, reductions in technology spending and declines in general economic conditions. These downturns have been characterized by diminished product demand, production
overcapacity, high inventory levels and the erosion of average selling prices.
We
may experience substantial period-to-period fluctuations in future operating results due to factors affecting the computing, networking, communications, printers, storage and
industrial markets. A decline or significant shortfall in demand in any one of these markets could have a material adverse effect on the demand for our products. As a result, our sales will likely
decline during these periods. In
addition, because many of our costs and operating expenses are relatively fixed, if we are unable to control our expenses adequately in response to reduced sales, our gross margins, operating income
and cash flow would be negatively impacted.
During
challenging economic times our customers may face issues gaining timely access to sufficient credit, which could impair their ability to make timely payments to us. If that were
to occur,
19
Table of Contents
we
may be required to increase our allowance for doubtful accounts and our days sales outstanding would be negatively impacted. Furthermore, our vendors may face similar issues gaining access to
credit, which may limit their ability to supply components or provide trade credit to us. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery,
worldwide, or in the memory market and related semiconductor industry. If the economy or markets in which we operate do not continue to improve or if conditions worsen, our business, financial
condition and results of operations will likely be materially and adversely affected. Additionally, the combination of our lengthy sales cycle coupled with challenging macroeconomic conditions could
compound the negative impact on the results of our operations.
Our lack of a significant backlog of unfilled orders, and the difficulty inherent in forecasting customer demand, makes it difficult to forecast our short-term production
requirements to meet that demand, and any failure to optimally calibrate our production capacity and inventory levels to meet customer demand could adversely affect our revenues, gross margins and
earnings.
We make significant decisions regarding the levels of business that we will seek and accept, production schedules, component
procurement commitments, personnel needs and other resource requirements, based on our estimates of customer requirements. We do not have long-term purchase agreements with our customers. Instead, our
customers often place purchase orders no more than two weeks in advance of their desired delivery date, and these purchase orders generally have no cancellation or rescheduling penalty provisions. The
short-term nature of commitments by many of our customers, the fact that our customers may cancel or defer purchase orders for any reason, and the possibility of unexpected changes in demand for our
customers' products each reduce our ability to accurately estimate future customer requirements for our products. This fact, combined with the quick turn-around times that apply to each order, makes
it difficult to forecast our production needs and allocate production capacity efficiently. We attempt to forecast the demand for the DRAM ICs, NAND, and other components needed to manufacture our
products. Lead times for components vary significantly and depend on various factors, such as the specific supplier and the demand and supply for a component at a given time.
Our
production expense and component purchase levels are based in part on our forecasts of our customers' future product requirements and to a large extent are fixed in the short term.
As a result, we likely will be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in those orders. If we overestimate customer demand, we may have excess raw
material inventory of DRAM ICs and NAND. If there is a subsequent decline in the prices of DRAM ICs or NAND, the value of our inventory will fall. As a result, we may need to write-down the value of
our DRAM IC or NAND inventory, which may result in a significant decrease in our gross margin and financial condition. Also, to the extent that we manufacture products in anticipation of future demand
that does not materialize, or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our finished goods inventory. In the past, we have had to
write-down inventory due to obsolescence, excess quantities and declines in market value below our costs. Any significant shortfall of customer orders in relation to our expectations could hurt our
operating results, cash flows and financial condition.
Also,
any rapid increases in production required by our customers could strain our resources and reduce our margins. If we underestimate customer demand, we may not have sufficient
inventory of DRAM ICs and NAND on hand to manufacture enough product to meet that demand. We also may not have sufficient manufacturing capacity at any given time to meet our customers' demands for
rapid increases in production. These shortages of inventory and capacity will lead to delays in the delivery of our products, and we could forego sales opportunities, lose market share and damage our
customer relationships.
20
Table of Contents
Declines in our average sales prices, driven by volatile prices for DRAM ICs and NAND, among other factors, may result in declines in our revenues and gross profit.
Our industry is competitive and historically has been characterized by declines in average sales price, based in part on the market
price of DRAM ICs and NAND, which have historically constituted a substantial portion of the total cost of our memory subsystems. Our average sales prices may decline due to several factors, including
overcapacity in the worldwide supply of DRAM and NAND memory components as a result of worldwide economic conditions, increased manufacturing efficiencies, implementation of new manufacturing
processes and expansion of manufacturing capacity by component suppliers.
Once
our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. Consequently, we are
exposed to the risks associated with the volatility of the price of DRAM ICs and NAND during that period. If the market prices for DRAM ICs and NAND increase, we generally cannot pass the price
increases on to our customers for products purchased under an existing purchase order. As a result, our cost of sales could
increase and our gross margins could decrease. Alternatively, if there are declines in the price of DRAM ICs and NAND, we may need to reduce our selling prices for subsequent purchase orders, which
may result in a decline in our expected net sales.
In
addition, since a large percentage of our sales are to a small number of customers that are primarily distributors and large OEMs, these customers have exerted, and we expect they
will continue to exert, pressure on us to make price concessions. If not offset by increases in volume of sales or the sales of newly-developed products with higher margins, decreases in average sales
prices would likely have a material adverse effect on our business and operating results.
Our
production expense and component purchase levels are based in part on our forecasts of our customers' future product requirements and to a large extent are fixed in the short term.
As a result, we likely will be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in those orders. If we overestimate customer demand, we may have excess raw
material inventory of DRAM ICs and NAND. If there is a subsequent decline in the prices of DRAM ICs or NAND, the value of our inventory will fall. As a result, we may need to write-down the value of
our DRAM IC or NAND inventory, which may result in a significant decrease in our gross margin and financial condition. Also, to the extent that we manufacture products in anticipation of future demand
that does not materialize, or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our finished goods inventory. In the past, we have had to
write-down inventory due to obsolescence, excess quantities and declines in market value below our costs. Any significant shortfall of customer orders in relation to our expectations could hurt our
operating results, cash flows and financial condition.
Also,
any rapid increases in production required by our customers could strain our resources and reduce our margins. If we underestimate customer demand, we may not have sufficient
inventory of DRAM ICs and NAND on hand to manufacture enough product to meet that demand. We also may not have sufficient manufacturing capacity at any given time to meet our customers' demands for
rapid increases in production. These shortages of inventory and capacity will lead to delays in the delivery of our products, and we could forego sales opportunities, lose market share and damage our
customer relationships.
21
Table of Contents
We use a small number of custom ASIC, DRAM IC and NAND suppliers and are subject to risks of disruption in the supply of custom ASIC, DRAM ICs and NAND.
Our ability to fulfill customer orders or produce qualification samples is dependent on a sufficient supply of DRAM ICs and NAND, which
are essential components of our memory subsystems. We are also dependent on a sufficient supply of custom ASIC devices to produce our HyperCloud ® memory modules. There are a relatively
small number of suppliers of DRAM ICs and NAND, and we purchase from only a subset of these suppliers. We have no long-term DRAM or NAND supply contracts. Additionally, we could face obstacles in
moving production of our ASIC components away from our current design and production partners. Our dependence on a small number of suppliers and the lack of any guaranteed sources of ASIC components,
DRAM and NAND supply expose us to several risks, including the inability to obtain an adequate supply of these important components, price increases, delivery delays and poor quality.
Historical
declines in customer demand and our revenues caused us to reduce our purchases of DRAM ICs and NAND. Such fluctuations could occur in the future. Should we not maintain
sufficient purchase levels with some suppliers, our ability to obtain supplies of raw materials may be impaired due to the practice of some suppliers to allocate their products to customers with the
highest regular demand.
From
time to time, shortages in DRAM ICs and NAND have required some suppliers to limit the supply of their DRAM ICs and NAND. As a result, we may be unable to obtain the DRAM ICs or
NAND necessary to fill customers' orders for our products in a timely manner. If we are unable to obtain a sufficient supply of DRAM ICs or NAND to meet our customers' requirements, these customers
may reduce future orders for our products or not purchase our products at all, which would cause our net sales to decline and harm our operating results. In addition, our reputation could be harmed,
we may not be able to replace any lost business with new customers, and we may lose market share to our competitors.
Our
customers qualify the ASIC components, DRAM ICs and NAND of our suppliers for use in their systems. If one of our suppliers should experience quality control problems, it may be
disqualified by one or more of our customers. This would disrupt our supplies of ASIC components, DRAM ICs and NAND and reduce the number of suppliers available to us, and may require that we qualify
a new supplier. If our suppliers are unable to produce qualification samples on a timely basis or at all, we could experience delays in the qualification process, which could have a significant impact
on our ability to sell that product.
If the supply of other component materials used to manufacture our products is interrupted, or if our inventory becomes obsolete, our results of operations and financial
condition could be adversely affected.
We use consumables and other components, including PCBs, to manufacture our memory subsystems. We sometimes procure PCBs and other
components from single or limited sources to take advantage of volume pricing discounts. Material shortages or transportation problems could interrupt the manufacture of our products from time to time
in the future. These delays in manufacturing could adversely affect our results of operations.
Frequent
technology changes and the introduction of next-generation products also may result in the obsolescence of other items of inventory, such as our custom-built PCBs, which could
reduce our gross margin and adversely affect our operating performance and financial condition. We may not be able to sell some products developed for one customer to another customer because our
products are often designed to address specific customer requirements, and even if we are able to sell these products to another customer, our margin on such products may be reduced.
22
Table of Contents
A prolonged disruption of our manufacturing facility could have a material adverse effect on our business, financial condition and results of operations.
We maintain a manufacturing facility in the PRC for producing most of our products, which allows us to utilize our materials and
processes, protect our intellectual property and develop the technology for manufacturing. A prolonged disruption or material malfunction of, interruption in or the loss of operations at our
manufacturing facility, or the failure to maintain a sufficient labor force at such facility, would limit our capacity to meet customer demand and delay new product development until a replacement
facility and equipment, if necessary, were found. The replacement of the manufacturing facility could take an extended amount of time before manufacturing operations could restart. The potential
delays and costs resulting from these steps could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to manufacture our products efficiently, our operating results could suffer.
We must continuously review and improve our manufacturing processes in an effort to maintain satisfactory manufacturing yields and
product performance, to lower our costs and to otherwise remain competitive. As we manufacture more complex products, the risk of encountering delays or difficulties increases. The start-up costs
associated with implementing new manufacturing technologies, methods and processes, including the purchase of new equipment, and any resulting manufacturing delays and inefficiencies, could negatively
impact our results of operations.
If
we need to add manufacturing capacity, an expansion of our existing manufacturing facility or establishment of a new facility could be subject to factory audits by our customers. Any
delays or unexpected costs resulting from this audit process could adversely affect our net sales and results of operations. In addition, we cannot be certain that we will be able to increase our
manufacturing capacity on a timely basis or meet the standards of any applicable factory audits.
We depend on third-parties to design and manufacture custom components for some of our products.
Significant customized components, such as ASICs, that are used in some of our products such as HyperCloud® are designed
and manufactured by third parties. The ability and willingness of such third parties to perform in accordance with their agreements with us is largely outside of our control. If one or more of our
design or manufacturing partners fails to perform its obligations in a timely manner or at satisfactory quality levels, our ability to bring products to market or deliver products to our customers, as
well as our reputation, could suffer. In the event of any such failures, we may have no readily available alternative source of supply for such products,
since, in our experience, the lead time needed to establish a relationship with a new design and/or manufacturing partner is at least 12 months, and the estimated time for our OEM customers to
re-qualify our product with components from a new vendor ranges from four to nine months. We cannot assure you that we can redesign, or cause to have redesigned, our customized components to be
manufactured by a new manufacturer in a timely manner, nor can we assure you that we will not infringe on the intellectual property of our current design or manufacture partner when we redesign the
custom components, or cause such components to be redesigned by a new manufacturer. A manufacturing disruption experienced by our manufacturing partners, the failure of our manufacturing partners to
dedicate adequate resources to the production of our products, the financial instability of our manufacturing or design partners, or any other failure of our design or manufacturing partners to
perform according to their agreements with us, would have a material adverse effect on our business, financial condition and results of operations.
We
have many other risks due to our dependence on third-party manufacturers, including: reduced control over delivery schedules, quality, manufacturing yields and cost; the potential
lack of adequate capacity during periods of excess demand; limited warranties on products supplied to us; and potential misappropriation of our intellectual property. We are dependent on our
manufacturing partners to
23
Table of Contents
manufacture
products with acceptable quality and manufacturing yields, to deliver those products to us on a timely basis and to allocate a portion of their manufacturing capacity sufficient to meet
our needs. Although our products are designed using the process design rules of the particular manufacturers, we cannot assure you that our manufacturing partners will be able to achieve or maintain
acceptable yields or deliver sufficient quantities of components on a timely basis or at an acceptable cost. Additionally, we cannot assure you that our manufacturing partners will continue to devote
adequate resources to produce our products or continue to advance the process design technologies on which the qualification and manufacturing of our products are based.
If our products do not meet the quality standards of our customers, we may be forced to stop shipments of products until the quality issues are resolved.
Our customers require our products to meet strict quality standards. Should our products not meet such standards, our customers may
discontinue purchases from us until we are able to resolve the quality issues that are causing us to not meet the standards. Such "quality holds" could have a significant adverse impact on our
revenues and operating results.
If our products are defective or are used in defective systems, we may be subject to warranty, product recalls or product liability claims.
If our products are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could
be subject to warranty and product liability claims and product recalls, safety alerts or advisory notices. While we have product liability insurance coverage, it may not be adequate to satisfy claims
made against us. We also may be unable to obtain insurance in the future at satisfactory rates or in adequate amounts. Warranty and product liability claims or product recalls, regardless of their
ultimate outcome, could have an adverse effect on our business, financial condition and reputation, and on our ability to attract and retain customers. In addition, we may determine that it is in our
best interest to accept product returns in circumstances where we are not contractually obligated to do so in order to maintain good relations with our customers. Accepting product returns may
negatively impact our operating results.
If we fail to protect our proprietary rights, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could
adversely affect our operating results.
We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property
rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in the remaining applications will be
allowed. As of December 28, 2013, we had 40 U.S. patents issued. We intend to continue filing patent applications with respect to most of the new processes and technologies that we develop.
However, patent protection may not be available for some of these processes or technologies.
It
is possible that our efforts to protect our intellectual property rights may not:
-
-
prevent challenges to, or the invalidation or circumvention of, our existing intellectual property rights;
-
-
prevent our competitors from independently developing similar products, duplicating our products or designing around any
patents that may be issued to us;
-
-
prevent disputes with third parties regarding ownership of our intellectual property rights;
-
-
prevent disclosure of our trade secrets and know-how to third parties or into the public domain;
-
-
result in valid patents, including international patents, from any of our pending or future applications; or
24
Table of Contents
-
-
otherwise adequately protect our intellectual property rights.
Others
may attempt to reverse engineer, copy or otherwise obtain and use our proprietary technologies without our consent. Monitoring the unauthorized use of our technologies is
difficult. We cannot be certain that the steps we have taken will prevent the unauthorized use of our technologies. This is particularly true in foreign countries, such as the PRC, where we have
established a manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.
If
some or all of the claims in our patent applications are not allowed, or if any of our intellectual property protections are limited in scope by the USPTO or by a court or
circumvented by others, we could face increased competition with regard to our products. Increased competition could significantly harm our business and our operating results.
We are involved in and expect to continue to be involved in costly legal and administrative proceedings to defend against claims that we infringe the intellectual property
rights of others or to enforce or protect our intellectual property rights.
As is common to the semiconductor industry, we have experienced substantial litigation regarding patent and other intellectual property
rights. Lawsuits claiming that we are infringing others' intellectual property rights have been and may in the future be brought against us, and we are currently defending against claims of invalidity
in the USPTO. See Note 9 of Notes to the Consolidated Financial Statements, for a more detailed description of our legal contingencies as of December 28, 2013.
The
process of obtaining and protecting patents is inherently uncertain. In addition to the patent issuance process established by law and the procedures of the USPTO, we must comply
with Joint Electron Device Engineering Council ("
JEDEC"
) administrative procedures in protecting our intellectual property within its industry standard
setting process. These procedures evolve over time, are subject to variability in their application, and may be inconsistent with each other. Failure to comply with JEDEC's administrative procedures
could jeopardize our ability to claim that our patents have been infringed.
By
making use of new technologies and entering new markets there is an increased likelihood that others might allege that our products infringe on their intellectual property rights.
Litigation is inherently uncertain, and an adverse outcome in existing or any future litigation could subject us to significant liability for damages or invalidate our proprietary rights. An adverse
outcome also could force us to take specific actions, including causing us to:
-
-
cease manufacturing and/or selling products, or using certain processes, that are claimed to be infringing a third party's
intellectual property;
-
-
pay damages (which in some instances may be three times actual damages), including royalties on past or future sales;
-
-
seek a license from the third party intellectual property owner to use their technology in our products, which license may
not be available on reasonable terms, or at all; or
-
-
redesign those products that are claimed to be infringing a third party's intellectual property.
If
any adverse ruling in any such matter occurs, any resulting limitations in our ability to market our products, or delays and costs associated with redesigning our products or payments
of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, financial
condition and results of operations.
25
Table of Contents
There
is a limited pool of experienced technical personnel that we can draw upon to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or
potential competitors at some point during their careers, and we anticipate that a number of our future employees will have similar work histories. In the past, some of these competitors have claimed
that our employees misappropriated their trade secrets or violated non-competition or non-solicitation agreements. Some of our competitors may threaten or bring legal action involving similar claims
against us or our existing employees or make such claims in the future to prevent us from hiring qualified candidates. Lawsuits of this type may be brought, even if there is no merit to the claim,
simply as a strategy to drain our financial resources and divert management's attention away from our business.
We
also may find it necessary to litigate against others, including our competitors, customers and former employees, to enforce our intellectual property, contractual and commercial
rights including, in particular, our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. We could become subject to counterclaims or countersuits against
us as a result of this litigation. Moreover, any legal disputes with customers could cause them to cease buying or using our products or delay their purchase of our products and could substantially
damage our relationship with them.
Any
litigation, regardless of its outcome, would be time consuming and costly to resolve, divert our management's time and attention and negatively impact our results of operations. We
cannot assure you that current or future infringement claims by third parties or claims for indemnification by customers or end users of our products resulting from infringement claims will not be
asserted in the future or that such assertions, if proven to be true, will not materially adversely affect our business, financial condition or results of operations.
We may become involved in non-patent related litigation and administrative proceedings that may materially adversely affect us.
From time to time, we may become involved in various legal proceedings relating to matters incidental to the ordinary course of our
business, including commercial, product liability, employment, class action, whistleblower and other litigation and claims, and governmental and other regulatory investigations and proceedings. Such
matters can be time-consuming, divert management's attention and resources and cause us to incur significant expenses. Furthermore, because litigation is inherently unpredictable, the results of any
of these actions could have a material adverse effect on our business, results of operations or financial condition.
If we are required to obtain licenses to use third party intellectual property and we fail to do so, our business could be harmed.
Although some of the components used in our final products contain the intellectual property of third parties, we believe that our
suppliers bear the sole responsibility to obtain any rights and licenses to such third party intellectual property. While we have no knowledge that any third party licensor disputes our belief, we
cannot assure you that disputes will not arise in the future. The operation of our business and our ability to compete successfully depends significantly on our continued operation without claims of
infringement or demands resulting from such claims, including demands for payments of money in the form of, for example, ongoing licensing fees.
We
are also developing products to enter new markets. Similar to our current products, we may use components in these new products that contain the intellectual property of third
parties. While we plan to exercise precautions to avoid infringing on the intellectual property rights of third parties, we cannot assure you that disputes will not arise.
26
Table of Contents
If
it is determined that we are required to obtain inbound licenses and we fail to obtain licenses, or if such licenses are not available on economically feasible terms, our business,
operating results and financial condition could be significantly harmed.
The flash memory market is constantly evolving and competitive, and we may not have rights to manufacture and sell certain types of products utilizing emerging flash
formats, or we may be required to pay a royalty to sell products utilizing these formats.
The flash-based storage market is constantly undergoing rapid technological change and evolving industry standards. Many consumer
devices, such as digital cameras, PDAs and smartphones, are transitioning to emerging flash memory formats, such as the Memory Stick, and xD Picture Card formats, which we do not currently manufacture
and do not have rights to manufacture. Although we do not currently serve the consumer flash market, it is possible that certain OEMs may choose to adopt these higher-volume, lower-cost
formats. This could result in a decline in demand, on a relative basis, for other products that we manufacture such as CompactFlash, SD and embedded USB drives. If we decide to manufacture flash
memory products utilizing emerging formats such as those mentioned, we will be required to secure licenses to give us the right to manufacture such products that may not be available at reasonable
rates or at all. If we are not able to supply flash card formats at competitive prices or if we were to have product shortages, our net sales could be adversely impacted and our customers would likely
cancel orders or seek other suppliers to replace us.
Our indemnification obligations for the infringement by our products of the intellectual property rights of others could require us to pay substantial damages.
As is common in the industry, we currently have in effect a number of agreements in which we have agreed to defend, indemnify and hold
harmless our customers and suppliers from damages and costs which may arise from the infringement by our products of third-party patents, trademarks or other proprietary rights. The scope of such
indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorneys' fees. Our insurance does not cover intellectual property infringement. The term of
these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these
indemnification agreements is unlimited. We may periodically have to respond to claims and litigate these types of indemnification obligations. Although our suppliers may bear responsibility for the
intellectual property inherent in the components they sell to us, they may lack the financial ability to stand behind such indemnities. Additionally, it may be costly to enforce any indemnifications
that they have granted to us. Accordingly, any indemnification claims by customers could require us to incur significant legal fees and could potentially result in the payment of substantial damages,
both of which could result in a material adverse effect on our business and results of operations.
We depend on a few key employees, and if we lose the services of any of those employees or are unable to hire additional personnel, our business could be harmed.
To date, we have been highly dependent on the experience, relationships and technical knowledge of certain key employees. We believe
that our future success will be
dependent on our ability to retain the services of these key employees, develop their successors, reduce our reliance on them, and properly manage the transition of their roles should departures
occur. The loss of these key employees could delay the development and introduction of, and negatively impact our ability to sell, our products and otherwise harm our business. We do not have
employment agreements with any of these key employees other than Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board. We maintain "Key Man" life insurance on Chun K. Hong;
however, we do not carry "Key Man" life insurance on any of our other key employees.
27
Table of Contents
Our
future success also depends on our ability to attract, retain and motivate highly skilled engineering, manufacturing, and other technical and sales personnel. Competition for
experienced personnel is intense. We may not be successful in attracting new engineers or other technical personnel, or in retaining or motivating our existing personnel. If we are unable to hire and
retain engineers with the skills necessary to keep pace with the evolving technologies in our markets, our ability to continue to provide our current products and to develop new or enhanced products
will be negatively impacted, which would harm our business. In addition, the shortage of experienced engineers, and other factors, may lead to increased recruiting, relocation and compensation costs
for such engineers, which may exceed our expectations and resources. These increased costs may make hiring new engineers difficult, or may increase our operating expenses.
Historically,
a significant portion of our workforce has consisted of contract personnel. We invest considerable time and expense in training these contract employees. We may experience
high turnover rates in our contract employee workforce, which may require us to expend additional resources in the future. If we convert any of these contract employees into permanent employees, we
may have to pay finder's fees to the contract agency.
We rely on third-party manufacturers' representatives and the failure of these manufacturers' representatives to perform as expected could reduce our future sales.
We sell some of our products to customers through manufacturers' representatives. We are unable to predict the extent to which our
manufacturers' representatives will be successful in marketing and selling our products. Moreover, many of our manufacturers' representatives also market and sell other, potentially competing
products. Our representatives may terminate their relationships with us at any time. Our future performance will also depend, in part, on our ability to attract additional manufacturers'
representatives that will be able to market and support our products effectively, especially in markets in which we have not previously distributed our products. If we cannot retain our current
manufacturers' representatives or recruit additional or replacement manufacturers' representatives, our sales and operating results will be harmed.
The operation of our manufacturing facility in the PRC could expose us to significant risks.
Since 2009, substantially all of our world-wide manufacturing production has been performed at our manufacturing facility in the PRC.
Language and cultural differences, as well as the geographic distance from our headquarters in Irvine, California, further compound the difficulties of running a manufacturing operation in the PRC.
Our management has limited experience in creating or overseeing foreign operations, and this facility may divert substantial amounts of their time. We may not be able to maintain control over product
quality, delivery schedules, manufacturing yields and costs. Furthermore, the costs related to having excess capacity have in the past and may in the future continue to have an adverse impact on our
gross margins and operating results.
We
manage a local workforce that may subject us to regulatory uncertainties. Changes in the labor laws of the PRC could increase the cost of employing the local workforce. The increased
industrialization of the PRC, as well as general economic and political conditions in the PRC, could also increase the price of local labor. Any or a combination of these factors could negatively
impact the cost savings we currently enjoy from having our manufacturing facility in the PRC.
Economic, political and other risks associated with international sales and operations could adversely affect our net sales.
Part of our growth strategy involves making sales to foreign corporations and delivering our products to facilities located in foreign
countries. To facilitate this process and to meet the long-term projected demand for our products, we have set up a manufacturing facility in the PRC. Selling and
28
Table of Contents
manufacturing
in foreign countries subjects us to additional risks not present with our domestic operations. We are operating in business and regulatory environments in which we have limited previous
experience. We will need to continue to overcome language and cultural barriers to effectively conduct our operations in these environments. In addition, the economies of the PRC and other countries
have been highly volatile in the past, resulting in significant fluctuations in local currencies and other instabilities. These instabilities affect a number of our customers and suppliers in addition
to our foreign operations and continue to exist or may occur again in the future.
In
the future, some of our net sales may be denominated in Chinese Renminbi ("RMB"). The Chinese government controls the procedures by which RMB is converted into other currencies, and
conversion of RMB generally requires government consent. As a result, RMB may not be freely convertible into other currencies at all times. If the Chinese government institutes changes in currency
conversion procedures, or imposes restrictions on currency conversion, those actions may negatively impact our operations and could reduce our operating results. In addition, fluctuations in the
exchange rate between RMB and U.S. dollars may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. These fluctuations may also adversely affect
the comparability of our period-to-period results. If we decide to declare dividends and repatriate funds from our Chinese operations, we will be required to comply with the procedures and regulations
of applicable Chinese law. Any changes to these procedures and regulations, or our failure to comply with those procedures and regulations, could prevent us from making dividends and repatriating
funds from our Chinese operations, which could adversely affect our financial condition. If we are able to make dividends and repatriate funds from our Chinese operations, these dividends would be
subject to U.S. corporate income tax.
International
turmoil and the threat of future terrorist attacks, both domestically and internationally, have contributed to an uncertain political and economic climate, both in the U.S.
and globally, and have negatively impacted the worldwide economy. The occurrence of one or more of these instabilities could adversely affect our foreign operations and some of our customers or
suppliers, each of which could adversely affect our net sales. In addition, our failure to meet applicable regulatory requirements or overcome cultural barriers could result in production delays and
increased turn-around times, which would adversely affect our business.
Our
international sales are subject to other risks, including regulatory risks, tariffs and other trade barriers, timing and availability of export licenses, political and economic
instability, difficulties in accounts receivable collections, difficulties in managing distributors, lack of a significant local sales presence, difficulties in obtaining governmental approvals,
compliance with a wide variety of complex foreign laws and treaties and potentially adverse tax consequences. In addition, the U.S. or foreign countries may implement quotas, duties, taxes or other
charges or restrictions upon the importation or exportation of our products, leading to a reduction in sales and profitability in that country.
Our operations could be disrupted by power outages, natural disasters or other factors.
Due to the geographic concentration of our manufacturing operations and the operations of certain of our suppliers, a disruption
resulting from equipment failure, power failures, quality control issues, human error, government intervention or natural disasters, including earthquakes and floods like those that have struck Japan
and Thailand, respectively, could interrupt or interfere with our manufacturing operations and consequently harm our business, financial condition and results of operations. Such disruptions would
cause significant delays in shipments of our products and adversely affect our operating results.
29
Table of Contents
Our failure to comply with environmental laws and regulations could subject us to significant fines and liabilities or cause us to incur significant costs.
We are subject to various and frequently changing U.S. federal, state and local and foreign governmental laws and regulations relating
to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of
contaminated sites and the maintenance of a safe workplace. In particular, some of our manufacturing processes may require us to handle and dispose of hazardous materials from time to time. For
example, in the past our manufacturing operations have used lead-based solder in the assembly of our products. Today, we use lead-free soldering technologies in our manufacturing processes, as this is
required for products entering the European Union. We could incur substantial costs, including clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or
personal injury, as a result of violations of, or noncompliance with, environmental laws and regulations. These laws and regulations also could require us to incur significant costs to remain in
compliance.
Our internal controls over financial reporting may not be effective, which could have a significant and adverse effect on our business.
Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, which we collectively refer to
as Section 404, require us to evaluate our internal controls over financial reporting to allow management to report on those internal controls as of the end of each year. Effective internal
controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. In the course of our Section 404 evaluations, we may identify
conditions that may result in significant deficiencies or material weaknesses and we may conclude that enhancements, modifications or changes to our internal controls are necessary or desirable.
Implementing any such matters would divert the attention of our management, could involve significant costs, and may negatively impact our results of operations.
We
note that there are inherent limitations on the effectiveness of internal controls, as they cannot prevent collusion, management override or failure of human judgment. If we fail to
maintain an effective system of internal controls or if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls, we may be unable
to produce reliable financial reports or prevent fraud, and it could harm our financial condition and results of operations, result in a loss of investor confidence and negatively impact our stock
price.
If we do not effectively manage future growth, our resources, systems and controls may be strained and our results of operations may suffer.
Any future growth may strain our resources, management information and telecommunication systems, and operational and financial
controls. To manage future growth effectively, including any expansion of volume in our manufacturing facility in the PRC, we must be able to improve and expand our systems and controls. We may not be
able to do this in a timely or cost-effective manner, and our current systems and controls may not be adequate to support our future operations. In addition, our officers have relatively limited
experience in managing a rapidly growing business. As a result, they may not be able to provide the guidance necessary to manage future growth or maintain future market position. Any failure to manage
our growth or improve or expand our existing systems and controls, or unexpected difficulties in doing so, could harm our business.
30
Table of Contents
If we acquire other businesses or technologies in the future, these acquisitions could disrupt our business and harm our operating results and financial condition.
We will evaluate opportunities to acquire businesses or technologies that might complement our current product offerings or enhance our
technical capabilities. We have no experience in acquiring other businesses or technologies. Acquisitions entail a number of risks that could adversely affect our business and operating results,
including, but not limited to:
-
-
difficulties in integrating the operations, technologies or products of the acquired companies;
-
-
the diversion of management's time and attention from the normal daily operations of the business;
-
-
insufficient increases in net sales to offset increased expenses associated with acquisitions or acquired companies;
-
-
difficulties in retaining business relationships with suppliers and customers of the acquired companies;
-
-
the overestimation of potential synergies or a delay in realizing those synergies;
-
-
entering markets in which we have no or limited experience and in which competitors have stronger market positions; and
-
-
the potential loss of key employees of the acquired companies.
Future
acquisitions also could cause us to incur debt or be subject to contingent liabilities. In addition, acquisitions could cause us to issue equity securities that could dilute the
ownership percentages of our existing stockholders. Furthermore, acquisitions may result in material charges or adverse tax consequences, substantial depreciation, deferred compensation charges,
in-process research and development charges, the amortization of amounts related to deferred stock-based compensation expense and identifiable purchased intangible assets or impairment of goodwill,
any or all of which could negatively affect our results of operations.
Our principal stockholders have significant voting power and may take actions that may not be in the best interest of our other stockholders.
As of February 28, 2014, approximately 14.7% of our outstanding common stock was held by affiliates, including 14.6% held by
Chun K. Hong, our chief executive officer and chairman of our board of directors. As a result, Mr. Hong has the ability to exert substantial influence over all matters requiring approval by our
stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other
corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of Mr. Hong.
Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our stock.
Our certificate of incorporation and bylaws contain provisions that could delay or prevent a change of control of our company or
changes in our board of directors that our stockholders might consider favorable. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of
our common stock. The following are examples of provisions which are included in our certificate of incorporation and bylaws, each as amended:
-
-
our board of directors is authorized, without prior stockholder approval, to designate and issue preferred stock, commonly
referred to as "blank check" preferred stock, with rights senior to those of our common stock;
31
Table of Contents
-
-
stockholder action by written consent is prohibited;
-
-
nominations for election to our board of directors and the submission of matters to be acted upon by stockholders at a
meeting are subject to advance notice requirements; and
-
-
our board of directors is expressly authorized to make, alter or repeal our bylaws.
In
addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning 15%
or more of our outstanding voting stock. These and other provisions in our certificate of incorporation and bylaws, and of Delaware law, could make it more difficult for stockholders or potential
acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including delaying or impeding a merger, tender offer, or proxy
contest or other change of control transaction involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could prevent the consummation of
a transaction in which our stockholders could receive a substantial premium over the then-current market price for their shares.
The price of and volume in trading of our common stock has and may continue to fluctuate significantly.
Our common stock has been publicly traded since November 2006. The price of our common stock and the trading volume of our shares are
volatile and have in the past fluctuated significantly. There can be no assurance as to the prices at which our common stock will trade in the future or that an active trading market in our common
stock will be sustained in the future. The market price at which our common stock trades may be influenced by many factors, including but not limited to, the
following:
-
-
our operating and financial performance and prospects, including our ability to achieve and sustain profitability in the
future;
-
-
investor perception of us and the industry in which we operate;
-
-
the availability and level of research coverage of and market making in our common stock;
-
-
changes in earnings estimates or buy/sell recommendations by analysts;
-
-
sales of our newly issued common stock or other securities associated with our $40 million effective shelf
registration, or the perception that such sales may occur;
-
-
general financial and other market conditions; and
-
-
changing and recently volatile domestic and international economic conditions.
In
addition, shares of our common stock and the public stock markets in general have experienced, and may continue to experience, extreme price and trading volume volatility. These
fluctuations may adversely affect the market price of our common stock and a stockholder's ability to sell their shares into the market at the desired time or at the desired price.
In
2007, following a drop in the market price of our common stock, securities litigation was initiated against us. Given the historic volatility of our industry, we may become engaged in
this type of litigation in the future. Securities litigation is expensive and time-consuming.
32
Table of Contents