Item 1.
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Legal Proceedings
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Shareholder Derivative Actions
On July 18, 2006 and July 26, 2006, two purported shareholder derivative actions were filed against certain current and former
directors and officers of ISSI in the United States District Court for the Northern District of California, entitled (1)
Rick Tope v. Jimmy S.M. Lee, et al.
, Case No. C06-04387, and (2)
Murray Donnelly v. Jimmy S.M. Lee, et
al.
, Case No. C06-04545. The complaints purport to assert claims against the individual defendants on behalf of ISSI for breach of fiduciary duty, violations of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act)
and Rule 10b-5 promulgated thereunder, unjust enrichment, and restitution based upon our alleged stock option grant practices from 1995 through 2002. ISSI is named solely as a nominal defendant. The complaints seek damages in an unspecified amount
against the individual defendants, disgorgement of stock options or proceeds, equitable relief, attorneys fees, and other unspecified relief. Pursuant to the parties stipulation, the Court consolidated the two derivative actions on
August 22, 2006, under the caption
In re Integrated Silicon Solution, Inc. Shareholder Derivative Litigation
, Master File No. C-06-04387 RMW. Plaintiffs filed a consolidated complaint on November 27, 2006, based upon the same
underlying facts and circumstances alleged in the prior complaints. In addition to the claims asserted and the relief sought in the original complaints, the consolidated complaint purports to assert claims against the individual defendants for
aiding and abetting and violating Sections 14(a) and 20(a) of the Exchange Act and seeks an accounting. ISSI is again named solely as a nominal defendant.
On October 31, 2006, another purported shareholder derivative action was filed against certain current and former directors and officers of ISSI in the Superior Court of California for the County of Santa Clara,
entitled
Alex Chuzhoy v. Jimmy S.M. Lee, et al.
, Case No. 1:06-CV-074031. The complaint purports to assert claims against the individual defendants on behalf of ISSI for insider trading in violation of California Corporations Code
Sections 25402 / 25502.5, breach of fiduciary duty including in connection with the alleged insider selling and misappropriation, abuse of control, gross mismanagement, constructive fraud, corporate waste, unjust enrichment, and rescission, based
upon ISSI alleged stock option
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grant practices from 1995 through 2002. ISSI is named solely as a nominal defendant. The complaint seeks damages in an unspecified amount against the
individual defendants, an accounting, certain corporate governance changes, a constructive trust over the defendants stock options or proceeds, punitive damages, attorneys fees, and other unspecified relief.
The parties in both the state and federal shareholder derivative litigation have agreed to enter into settlement discussions, and both Courts have issued
orders staying the litigation until such time as the discussions result in a settlement which would then be presented to each Court for approval, or until such negotiations are unsuccessful, at which time litigation would resume. If the settlement
negotiations are unsuccessful, plaintiffs in the state and federal derivative complaints are expected to amend their complaints. Defendants will move to dismiss both the state and federal complaints.
SRAM Antitrust Litigation
Thirty-two purported class
action lawsuits were filed by U.S. Direct-Purchaser and U.S. Indirect-Purchaser Plaintiffs against us and other SRAM suppliers in various U.S. federal courts alleging violations of the Sherman Act, violations of state unfair competition laws, and
unjust enrichment relating to the sale and pricing of SRAM products. The U.S. lawsuits have been consolidated in a single federal court for coordinated pre-trail proceedings. The U.S. lawsuits seek treble damages for the alleged damages sustained by
purported class members, in addition to restitution, costs and attorneys fees, as well as an injunction against the allegedly unlawful conduct. As of August 30, 2007, we were voluntarily dismissed from twenty-eight of the thirty-two
pending lawsuits pursuant to a Tolling Agreement between us and the U.S. Indirect-Purchaser Plaintiffs. The U.S. Indirect-Purchaser Plaintiffs agreed not to name us as a defendant unless the Tolling Agreement is terminated according to terms
specified in that agreement. On January 9, 2008, we were voluntarily dismissed without prejudice from one of the lawsuits brought by the U.S. Direct-Purchaser Plaintiffs. We remain a defendant in three lawsuits brought by the U.S.
Direct-Purchaser Plaintiffs.
Three purported class action lawsuits were filed against us and other SRAM suppliers in three Canadian courts
alleging violation of the Canadian Competition Act and other unlawful conduct. The Canadian complaints seek compensatory and punitive damages, in addition to declaratory relief, restitution, and costs.
We are committed to defending ourself against these claims and have instructed our counsel to contest these actions vigorously. Given the preliminary
stage of these proceedings and the inherent uncertainty in litigation, we are unable to predict the outcome of these suits. The final resolution of these alleged violations of federal or state antitrust laws could have a material adverse effect on
our business, results of operations, or financial condition.
SRAM Antitrust Civil Investigative Demand
In May 2007, we received a civil investigative demand (CID) from the Attorney General of the State of Florida. The CID is issued pursuant to
the Florida Antitrust Act in the course of an official investigation to determine whether there is, has been, or may be a violation of state or federal antitrust laws. Although not alleging any wrongdoing, the CID seeks documents and data relating
to our business. As of January 14, 2008 and effective as of May 7, 2007, our obligation to respond to the CID was suspended pursuant to the terms of a Tolling Agreement between us and the Attorney General of Florida. We intend to cooperate
fully with the Attorney General of Florida in this investigation. Because the investigation is at an early stage, we cannot predict the outcome of the investigation and its effect, if any, on its business.
Other Legal Proceedings
In the ordinary course of
our business, as is common in the semiconductor industry, we have been involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of
these actions is not presently determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations. However, no assurances can be given with
respect to the extent or outcome of any such litigation in the future.
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We have incurred significant losses in
certain recent periods, and there can be no assurance that we will be able to maintain profitability in the future.
We incurred losses
of $14.2 million in fiscal 2006, which included inventory write-downs of $16.5 million. We incurred losses of $39.8 million in fiscal 2005, which included inventory write-downs of $13.9 million, charges of $11.7 million related to our equity
interest in ICSI, charges on impairment of goodwill and investments of $4.7 million and charges for in-process R&D of $2.8 million. Though we were profitable in fiscal 2007, we incurred inventory write-downs of $10.3 million and we would
not have been profitable except that we achieved significant income from non-operating activities such as gains on the sale of investments and interest income in such fiscal year. There is no assurance that we will maintain profitability in future
periods. Our ability to maintain profitability on a quarterly or fiscal year basis in the future will depend on a variety of factors, including the need for future inventory write-downs, our ability to increase net sales, maintain or expand gross
margins, introduce new products on a timely basis, secure sufficient wafer fabrication capacity and control operating expenses, including stock-based compensation as required by SFAS 123R. Adverse developments with respect to these or other factors
could result in quarterly or annual operating losses in the future.
Our operating results are expected to continue to fluctuate and may not meet our
financial guidance or published analyst forecasts. This may cause the price of our common stock to decline significantly.
Our future
quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including:
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the cyclicality of the semiconductor industry;
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declines in average selling prices of our products;
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inventory write-downs for lower of cost or market or excess and obsolete;
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excess inventory levels at our customers;
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decreases in the demand for our products;
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oversupply of memory products in the market;
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our ability to control or reduce our operating expenses;
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shortages in foundry, assembly or test capacity;
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disruption in the supply of wafers, assembly or test services;
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changes in our product mix which could reduce our gross margins;
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cancellation of existing orders or the failure to secure new orders;
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a failure to introduce new products and to implement technologies on a timely basis;
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market acceptance of ours and our customers products;
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economic slowness and low end-user demand;
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a failure to anticipate changing customer product requirements;
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fluctuations in manufacturing yields at our suppliers;
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fluctuations in product quality resulting in rework, replacement, or loss due to damages;
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a failure to deliver products to customers on a timely basis;
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the timing of significant orders;
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increased expenses associated with new product introductions, masks or process changes;
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the ability of customers to make payments to us;
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the outcome of any pending or future litigation; and
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the commencement of any future litigation or antidumping proceedings.
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Our sales depend on DRAM and SRAM products and reduced demand for these products or a decline in average selling
prices could harm our business.
In the first quarter of fiscal 2008 and in fiscal 2007, approximately 89% and 86%, respectively, of our
net sales were derived from the sale of DRAM and SRAM products, which are subject to unit volume fluctuations and declines in average selling prices that could harm our business. For example, we experienced a sequential decline in revenue from $62.1
million in our December 2006 quarter to $60.0 million in our March 2007 quarter. This decline in revenue was primarily the result of a decrease in unit shipments of our SRAM products. In addition, we experienced a sequential decline in revenue from
$61.5 million in our September 2005 quarter to $51.1 million in our December 2005 quarter. This decline in revenue was primarily the result of a decrease in unit shipments and the average selling prices of our DRAM products. From time to time, we
have turned down some orders for DRAM products that had unfavorable margins as a result of the decrease in the average selling prices in the market. We may not be able to offset any future price declines for our products by higher volumes or by
higher prices on newer products. Historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices for our products will decline in the future. Our ability to maintain or increase
revenues will depend upon our ability to increase unit sales volume of existing products and introduce and sell new products that compensate for the anticipated declines in the average selling prices of our existing products.
We are subject to pending legal proceedings related to the SRAM market.
We have been named as a defendant in a number of civil antirust complaints filed against semiconductor companies on behalf of purchasers of SRAM products throughout the United States. The complaints allege that the
defendants conspired to raise the price of SRAM in violation of Section 1 of the Sherman Act, the California Cartwright Act, and several other State antitrust, unfair competition and consumer protection statutes. We have also been named as a
defendant in several class action lawsuits filed in Canadian courts alleging violation of the Canadian Competition Act and other unlawful conduct. We believe that we have meritorious defenses to the allegations in the complaints, and we intend to
defend these lawsuits vigorously. However, the litigation is in the preliminary stage and we cannot predict its outcome. Multidistrict antitrust litigation is particularly complex and can extend for a protracted time, which can substantially
increase the cost of such litigation. The defense of these lawsuits is also expected to divert the efforts and attention of some of our key management and technical personnel. As a result, our defense of this litigation, regardless of its
eventual outcome, will likely be costly and time consuming. Should the outcome of the litigation be adverse to us, we could be required to pay significant monetary damages, which could adversely affect our business, financial condition, operating
results and cash flows.
We have been named as a party to several lawsuits related to our historical stock option practices and related accounting and
we may be named in additional litigation in the future, all of which could result in an unfavorable outcome and have a material adverse effect on our business, financial condition, results of operations, cash flows and the trading price for our
securities.
Several shareholder derivative lawsuits have been filed against certain of our current directors and officers and certain
former directors and officers relating to our historical stock option practices and related accounting. We are named as nominal defendant in such matters. See Item 1Legal Proceedings for a more detailed description of these
proceedings. We may become the subject of additional private or government actions regarding these matters in the future. These pending actions are in the preliminary stages, and their ultimate outcome could have a material adverse effect on our
business, financial condition, results of operations, cash flows and the trading price for our securities. Litigation may be time-consuming, expensive and disruptive to our normal business operations, and the outcome of litigation is difficult to
predict. The defense of these lawsuits has resulted and will continue to result in significant legal and accounting expenditures and the continued diversion of our managements time and attention from the operation of our business. All or a
portion of any amount we may be required to pay to satisfy a judgment or settlement of any or all of these claims may not be covered by insurance.
We have entered into indemnification agreements with each of our present and former directors and officers. Under those agreements, we are required to indemnify each such director or officer against expenses, including attorneys fees,
judgments, fines and settlements, paid by such individual in connection with the pending litigation subject to applicable Delaware law.
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We have used and plan to use a significant amount of our cash resources to repurchase shares of our common stock and
such repurchases present potential risks and disadvantages to ISSI and its continuing stockholders.
From September 2007
through January 3, 2008, we repurchased shares of our common stock in the open market under Rule 10b-18 and pursuant to our offer to purchase for cash up to $30 million in shares of our common stock at a price not greater than $6.30 nor less
than $5.70 per share. Under this tender offer, in September 2007, we repurchased 1,181,148 shares of our common stock at an aggregate price of approximately $7.4 million. On December 3, 2007, we announced an additional tender offer
for up to 10,000,000 shares of our common stock at a price of $7.00 per share. Under this offer, in January 2008, we repurchased 10,000,000 shares at an aggregate price of $70 million. At January 31, 2008, we had outstanding authorization
from our Board to purchase up to an additional $10.0 million of our common stock from time to time. Although our Board of Directors has determined that these repurchase programs are in the best interests of our stockholders, these repurchases expose
us to a number of risks including:
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the use of a substantial portion of our existing cash reserves, which may reduce our ability to engage in significant cash acquisitions or to pursue other business
opportunities that could create significant value to our stockholders;
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the risk that we would not be able to replenish our cash reserves by raising debt or equity financing in the future on terms acceptable to us, or at all;
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the risk that these repurchases will reduce our public float, which is the number of our shares owned by non-affiliate stockholders and
available for trading in the securities markets, and is likely to reduce the number of our stockholders, which may reduce the volume of trading in our shares and may result in lower stock prices and reduced liquidity in the trading of
our shares; and
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the risk that our stock price could decline and that we would be able to repurchase shares of our common stock at a lower price per share than the prices
we pay in our repurchase programs.
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Any future downturn in the markets we serve would harm our business and financial results.
Substantially all of our products are incorporated into products for the digital consumer electronics, networking, mobile communications
and automotive electronics markets. Historically, these markets have experienced cyclical depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions or due to adverse supply and demand
conditions in such markets. Industry downturns have resulted in reduced demand and declining average selling prices for our products which adversely affected our business. We expect that our industry will remain cyclical, and we are unable to
predict when any upturn or downturn will occur or how long it will last.
Shifts in industry-wide capacity may cause our results to fluctuate. These
shifts may occur quickly with little or no advance notice. Such shifts have historically resulted in significant inventory write-downs.
The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. Shifts in industry-wide capacity from shortages to
oversupply or from oversupply to shortages may result in significant fluctuations in our quarterly or annual operating results. These shifts in industry conditions can occur quickly with little or no advance notice to us. Adverse changes in industry
conditions are likely to result in a decline in average selling prices and the stated value of inventory. In the first quarter of fiscal 2008, in fiscal 2007 and in fiscal 2006, we recorded inventory write-downs of $2.5 million, $10.3 million,
and $16.5 million, respectively. The inventory write-downs related to valuing our inventory at the lower-of-cost-or-market, and adjusting our inventory valuation for certain excess and obsolete products.
We write down to zero dollars the carrying value of inventory on hand that has aged over one year to cover estimated excess and obsolete exposures,
unless adjustments are made based on managements judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, management takes into account the
product life cycles which can range from six to 30 months, the stage in the life cycle of the product, the impact of competitors announcements and product introductions on our products. Future additional inventory write-downs may occur due to
lower of cost or market accounting, excess inventory or inventory obsolescence.
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Our transition to lead-free parts may result in excess inventory of products packaged using traditional methods.
Customers are requiring that we offer our products in lead-free packages. Governmental regulations in certain countries and customers
intention to produce products that are less harmful to the environment has resulted in a requirement from many of our customers to purchase integrated circuits that do not contain lead. We have responded by offering our products in lead-free
versions. While the lead-free versions of our products are expected to be more friendly to the environment, the ultimate impact is uncertain. The transition to lead-free products may produce sudden changes in demand depending on the packaging method
used, which may result in excess inventory of products packaged using traditional methods. This may have an adverse effect on our results of operations. In addition, the quality, cost and manufacturing yields of the lead-free parts may be less
favorable to us than the products packaged using more traditional materials which may result in higher product costs.
If we are unable to obtain an
adequate supply of wafers, our business will be harmed.
If we are unable to obtain an adequate supply of wafers from our current
suppliers or any alternative sources in a timely manner, our business will be harmed. Our principal manufacturing relationships are with Powerchip Semiconductor, SMIC, TSMC, and Chartered Semiconductor Manufacturing. Each of our wafer foundries also
supplies wafers to other semiconductor companies, including certain of our competitors or for their own account. Although we are allocated specific wafer capacity from our suppliers, we may not be able to obtain such capacity in periods of tight
supply. If any of our suppliers experience manufacturing failures or yield shortfalls, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us, we may not be able to obtain enough wafers to meet the market demand for
our products which would adversely affect our revenues. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. In addition, we may not be able to qualify
additional manufacturing sources for existing or new products in a timely manner and we cannot be certain that other manufacturing sources would be able to deliver an adequate supply of wafers to us or at the same cost.
Our gross margins may decline even in periods of increasing revenue.
Our gross margin is affected by a variety of factors, including our mix of products sold, average selling prices for our products and cost of wafers. Even when our revenues are increasing, our gross margin may be
adversely affected if such increased revenue is from products with lower margins or declining average selling prices. During periods of strong demand, wafer capacity is likely to be in short supply and we will likely have to pay higher prices for
wafers, which would adversely affect our gross margin unless we are able to increase our product prices to offset such costs. To maintain our gross margins when average selling prices are declining, we must introduce new products with higher margins
or reduce our cost per unit. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit.
We may encounter difficulties in effectively integrating newly acquired businesses.
From time to
time, we may acquire other companies or assets that we believe to be complementary to our business. Acquisitions may result in use of our cash resources, potentially dilutive issuances of equity securities, incurrence of debt and contingent
liabilities, amortization expenses related to intangible assets, and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including:
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higher than estimated acquisition expenses;
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difficulties in successfully assimilating the operations, technologies and personnel of the acquired company;
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difficulties in continuing to develop the new technologies and deliver products to market on time;
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diversion of managements attention from other business concerns;
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risks of entering markets in which we have no, or limited, direct prior experience;
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the risk that the markets for acquired products do not develop as expected; and
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the potential loss of key employees and customers as a result of the acquisition.
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There is no assurance that any future acquisitions will contribute positively to our business or operating results.
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We rely on third-party contractors to assemble and test our products and our failure to successfully manage our
relationships with these contractors could damage our relationships with our customers, decrease our sales and limit our growth.
We
rely on third-party contractors located in Asia to assemble and test our products. There are significant risks associated with our reliance on these third-party contractors, including:
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reduced control over product quality;
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potential price increases;
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reduced control over delivery schedules;
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possible capacity shortages;
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their inability to increase production and achieve acceptable yields on a timely basis;
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absence of long-term agreements;
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limited warranties on products supplied to us; and
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general risks related to conducting business internationally.
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If any of these risks are realized, our business and results of operations could be adversely affected until our subcontractor is able to remedy the problem or until we are able to secure an alternative subcontractor.
The loss of a significant customer or a reduction in orders from one or more large customers could adversely affect our operating results.
As sales to our customers are executed pursuant to purchase orders and no purchasing contracts typically exist, our customers can cease
doing business with us at any time. We may not be able to retain our key customers, such customers may cancel or reschedule orders, and in the event of canceled orders, such orders may not be replaced by other sales. In addition, sales to any
particular customer may fluctuate significantly from quarter to quarter, and such fluctuating sales could harm our business and financial results.
We
have significant international sales and operations and risks related to our international activities could harm our operating results.
In the three months ended December 31, 2007, approximately 14% of our net sales was attributable to customers located in the U.S., 16% was attributable to customers located in Europe and 70% was attributable to customers located in
Asia. In fiscal 2007, approximately 18% of our net sales was attributable to customers located in the U.S., 15% was attributable to customers located in Europe and 67% was attributable to customers located in Asia. In fiscal 2006, approximately 17%
of our net sales was attributable to customers located in the U.S., 10% was attributable to customers located in Europe and 73% was attributable to customers located in Asia. We anticipate that sales to international sites will continue to represent
a significant percentage of our net sales. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese Renminbi. In addition, our wafer foundries
and assembly and test subcontractors are in primarily located in Taiwan and China. A substantial majority of our employees are located outside of the U.S and the expenses for our foreign operations are generally denominated in local currency. As a
result, a devaluation of the New Taiwan dollar or Chinese Renminbi could substantially increase the cost of our operations in Taiwan or China.
We are subject to the risks of conducting business internationally, including:
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global economic conditions, particularly in Taiwan and China;
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duties, tariffs and other trade barriers and restrictions;
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foreign currency fluctuations;
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changes in trade policy and regulatory requirements;
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the burdens of complying with foreign laws;
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imposition of foreign currency controls;
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difficulties in hiring and retaining experienced engineers in countries such as China and Taiwan;
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difficulties in collecting foreign accounts receivable;
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political instability, including any changes in relations between China and Taiwan;
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public health outbreaks such as SARS or avian flu; and
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earthquakes and other natural disasters.
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Strong
competition in the semiconductor memory market may harm our business.
The semiconductor memory market is intensely competitive and has
been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns, and heightened foreign and domestic competition. Many of our competitors offer broader product lines and
have greater financial, technical, marketing, distribution and other resources than us. We may not be able to compete successfully against any of these competitors. Our ability to compete successfully in the memory market depends on factors both
within and outside of our control, including:
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the pricing of our products;
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the supply and cost of wafers;
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product design, functionality, performance and reliability;
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successful and timely product development;
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the performance of our competitors and their pricing policies;
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wafer manufacturing over or under capacity;
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real or perceived imbalances in supply and demand for our products;
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the rate at which OEM customers incorporate our products into their systems;
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the success of our customers products and end-user demand;
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access to advanced process technologies at competitive prices;
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achievement of acceptable yields of functional die;
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the capacity of our third-party contractors to assemble and test our products;
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the gain or loss of significant customers;
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the nature of our competitors; and
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general economic conditions.
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addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. In particular, a competitor with a materially smaller die size and lower cost could dramatically gain market share
in a short period of time. We may not be able to compete successfully in the future as to any of these factors. Our failure to compete successfully in these or other areas could harm our business and financial results.
Our revenues and business would be harmed if we are not able to successfully develop, introduce and sell new products and develop and implement new manufacturing
technologies in a timely manner. Our research and development expenses could increase and our business could be harmed if the implementation of these new manufacturing technologies is unsuccessful.
We operate in highly competitive, quickly changing markets which are characterized by rapid obsolescence of existing products. As a result, our future
success depends on our ability to develop and introduce new products that our customers choose to buy in significant quantities. If we fail to introduce new products in a timely manner or if our customers products do not achieve commercial
success, our business and results of operations could be seriously harmed. The design and introduction of new products is challenging as such products typically incorporate more functions and operate at faster speeds than prior products. Increasing
complexity generally requires smaller features on a chip. This makes developing new generations of products substantially more difficult than prior generations. The cost to develop products utilizing these new technologies is expensive and requires
significant research and development spending and, as a result, our research and
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development expenses could increase in the future. Further, new products may not work properly in our customers applications. If we are unable to
design, introduce, market and sell new products successfully, our business and financial results would be seriously harmed.
Our products are complex
and could contain defects, which could reduce sales of those products or result in claims against us.
We develop complex and evolving
products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance. The occurrence of
defects could also cause us to incur significant warranty, support and repair costs, could divert the attention of our engineering personnel from our product development efforts, and could harm our relationships with our customers. The occurrence of
these problems could result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our
customers. Our customers could also seek and obtain damages from us for their losses. From time to time, we have been involved in disputes regarding product warranty issues. Although we seek to limit our liability, a product liability claim brought
against us, even if unsuccessful, would likely be time consuming and could be costly to defend.
Potential intellectual property claims and litigation
could subject us to significant liability for damages and could invalidate our proprietary rights.
In the semiconductor industry, it is
not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights. We have been, and from time-to-time expect to be, notified of claims that we may be infringing patents, maskwork rights or
copyrights owned by third-parties. If it appears necessary or desirable, we may seek licenses under patents that we are alleged to be infringing. However, licenses may not be offered and the terms of any offered licenses may not be acceptable to us.
The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by us could cause
us to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could harm our business. Furthermore, we may become involved in protracted
litigation regarding the alleged infringement by us of third-party intellectual property rights or litigation to assert and protect our patents or other intellectual property rights. Any litigation relating to patent infringement or other
intellectual property matters could result in substantial cost and diversion of our resources, which could harm our business.
We may be unable to
effectively protect our intellectual property, which would negatively impact our ability to compete.
We believe that the protection of
our intellectual proprietary rights will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property
rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts,
unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries
in which we design and sell our products. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from
competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies
on their own.
We have acquired equity positions for strategic reasons in other companies which may significantly decrease in value.
Over the last several years, we have acquired equity positions for strategic reasons in other technology companies and we may make similar equity
purchases in the future. In this regard, we own shares in SMIC with a cost basis of approximately $3.4 million and a market value at December 31, 2007 of approximately $3.1 million. The market value of SMIC shares is subject to fluctuation and
our carrying value will be subject to adjustments to reflect the current market value. In the event the
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decline in the market value of our SMIC shares below our cost basis, is determined to be other-than-temporary, we may be required to recognize a loss on our
investment through operating results. At December 31, 2007, our strategic investments in non-marketable securities totaled $0.6 million. These equity investments may not increase in value and there is the possibility that they could decrease in
value over time, even to the point of becoming completely worthless. These equity securities are evaluated for impairment on a recurring basis and any reductions in the carrying value would lower our profitability. For example, we recorded
approximately a $0.4 million impairment loss on one of our equity positions in fiscal 2006.
Changes in securities laws and regulations are increasing
our costs.
The Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as rules subsequently implemented by the Securities and
Exchange Commission and the Nasdaq Stock Market, have required changes to some of our accounting and corporate governance practices, including the report on our internal controls as required by Section 404 of the Sarbanes-Oxley Act of 2002.
These rules and regulations have increased our accounting, legal and other costs, and have made some activities more difficult, time consuming and/or costly. In particular, complying with the internal control requirements of Section 404 of the
Sarbanes-Oxley Act has resulted in increased internal efforts, significantly higher fees from our independent registered public accounting firm and significantly higher fees from third party contractors. These rules and regulations could also make
it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee.
We may experience difficulties in complying with Sarbanes-Oxley Section 404 in future periods.
We concluded that our internal control over financial reporting was effective at September 30, 2007. A key element of Section 404 compliance involves an analysis of management information systems (MIS). We are in the process of
implementing a new worldwide MIS system and we are continuing to use our current systems until the new system is fully implemented. If in the future we are unable to assert that our internal control over financial reporting is effective (or if our
auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.
We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to
interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in
these policies or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, beginning in the first quarter of fiscal
2006, with the adoption of SFAS 123R, we now record a charge to earnings for employee stock option grants for all stock options unvested at and granted after October 1, 2005. This accounting pronouncement has and is expected to continue to
negatively impact our financial results. Technology companies generally, and our company specifically, rely on stock options as a major component of our employee compensation packages. Because we are required to expense options, we may be less
likely to sustain profitability or we may have to decrease or eliminate option grants. Decreasing or eliminating option grants may negatively impact our ability to attract and retain qualified employees.
Our results of operations could vary as a result of the methods, estimates, and judgments we use in applying our accounting policies.
The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations (see
Critical Accounting Policies in Part I, Item 2 of this Form 10-Q). Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead
us to change our methods, estimates, and judgments. Changes in those methods, estimates, and judgments could significantly affect our results of operations. In particular, the calculation of share-based compensation expense under SFAS 123R, requires
us to use valuation methodologies (which were not developed for use in valuing employee stock options and restricted stock units) and a number of assumptions, estimates, and conclusions regarding matters such as expected forfeitures, expected
volatility of our share price, the expected dividend rate with respect to our common stock, and the exercise behavior of our employees. Furthermore, there are no means, under applicable accounting principles, to compare and adjust our expense if and
when we learn about additional information that may affect the estimates that we previously made, with the
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exception of changes in expected forfeitures of share-based awards. Factors may arise over time that lead us to change our estimates and assumptions with
respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our gross margin percentage; research and
development expenses; and selling, general and administrative expenses.
We depend on our ability to attract and retain our key technical and management
personnel.
Our success depends upon the continued service of our key technical and management personnel. Several of our important
manufacturing and other subcontractor relationships are based on personal relationships between our senior executive officers and such parties. In particular, our Chairman and Chief Executive Officer has long-term relationships with our key
foundries. If we were to lose the services of any key executives, it may negatively impact the related business relationships since we have no long-term contractual agreements with such parties. Our success also depends on our ability to continue to
attract, retain and motivate qualified technical personnel, particularly experienced circuit designers and process engineers. The competition for such employees is intense. We have no employment contracts or key person life insurance policies with
or for any of our employees. The loss of the service of one or more of our key personnel could harm our business.
Our stock price is expected to
continue to be volatile.
The trading price of our common stock has been and is expected to be subject to wide fluctuations in response
to:
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quarter-to-quarter variations in our operating results;
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general conditions or cyclicality in the semiconductor industry or the end markets that we serve;
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new or revised earnings estimates or guidance by us or industry analysts;
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comments or recommendations issued by analysts who follow us, our competitors or the semiconductor industry;
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aggregate valuations and movement of stocks in the broader semiconductor industry;
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announcements regarding our share repurchase program and the timing and amount of shares we purchase under such program;
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announcements of new products, strategic relationships or acquisitions by us or our competitors;
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increases or decreases in available wafer capacity;
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governmental regulations, trade laws and import duties;
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announcements related to future or existing litigation involving us or any of our competitors;
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announcements of technological innovations by us or our competitors;
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additions or departures of senior management; and
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other events or factors, many of which are beyond our control.
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In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many technology companies for
reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
Foundry capacity can be limited, and we may be required to enter into costly arrangements to secure foundry capacity.
If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and our future sales would be adversely impacted. In order to secure foundry capacity, we have
entered into in the past, and may enter into in the future, various arrangements with suppliers, which could include:
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purchases of equity or debt securities in foundries;
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process development relationships with foundries;
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contracts that commit us to purchase specified quantities of wafers over extended periods;
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increased price for wafers;
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option payments or other prepayments to foundries; and
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nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments.
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We may not be able to make any such arrangements in a timely fashion or at all, and such arrangements, if any, may not be on terms favorable to us. Once
we make commitments to secure foundry capacity, we may incur significant financial penalties if we subsequently determine that we are not able to utilize all of that capacity. Such penalties may be substantial and could harm our financial results.
Our foundries may experience lower than expected yields which could adversely affect our business.
The manufacture of integrated circuits is a highly complex and technically demanding process. Production yields and device reliability can be affected by
a large number of factors. As is typical in the semiconductor industry, our outside foundries have from time to time experienced lower than anticipated manufacturing yields and device reliability problems, particularly in connection with the
introduction of new products and changes in such foundrys processing steps. There can be no assurance that our foundries will not experience lower than expected manufacturing yields or device reliability problems in the future, which could
materially and adversely affect our business and operating results.
Business disruptions could seriously harm our future revenue and financial
condition and increase our costs and expenses.
Our worldwide operations could be subject to natural disasters and other business
disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters, and a portion of our research and development activities, are located in California, and our other critical
business operations and many of our suppliers are located in Asia, near major earthquake faults. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults is unknown, but our
revenue, profitability and financial condition could suffer in the event of a major earthquake or other natural disaster. Losses and interruptions could also be caused by earthquakes, power shortages, telecommunications failures, water shortages,
tsunamis, floods, typhoons, fires, extreme weather conditions, medical epidemics and other natural or manmade disasters.
Terrorist attacks, threats of
further attacks, acts of war and threats of war may negatively impact all aspects of our operations, revenues, costs and stock price.
Terrorist acts, conflicts or wars, as well as future events occurring in response or connection to them, including future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the U.S. or its allies
(such as the war in Iraq), conflict between China and Taiwan, or trade disruptions impacting our domestic or foreign suppliers or our customers, may impact our operations and may, among other things, cause delays or losses in the delivery of wafers
or other products to us and decreased sales of our products. More generally, these events have affected, and are expected to continue to affect, the general economy and customer demand for products sold by our customers. Any of these occurrences
could have a significant impact on our operating results, revenues and costs, which in turn may result in increased volatility in our common stock price and a decline in the price of our common stock.
Item 1B.
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Unresolved Staff Matters
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None.
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