Item 1. Business
Overview
We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) automotive, (ii) communications, (iii) industrial, medical and military (IMM), and (iv) digital consumer. Our primary products are low and medium density DRAM in both package and Known Good Die (KGD) form and high speed and low power SRAM. In fiscal 2012, approximately 96% of our revenue was derived from our DRAM and SRAM products. We target large markets with our cost-effective, high quality semiconductor products and seek to build long-term relationships with our customers. A key part of our strategy is to offer a long-term commitment supplying many of the legacy DRAM and SRAM memories that are of less interest to many of our competitors. Our customers frequently cite our commitment to long-term supply of these memories as one reason they buy products from ISSI.
Our outsourced manufacturing model is based upon relationships with key foundries such as GlobalFoundries Inc., Hynix, IBM, Nanya Technology Corporation (Nanya), Powerchip, Taiwan Semiconductor Manufacturing Corporation (TSMC), and Semiconductor Manufacturing International Corporation (SMIC). We have an established presence in the important Asian market that includes our design groups in Shanghai, China, Xiamen, China, Hsinchu, Taiwan and Songham, Korea. These locations also have product engineering, sales and marketing, quality assurance, production control, and other operating functions. Our worldwide headquarters are in San Jose, California.
Our customers include leaders in each of our four target markets, including Continental, Delphi, Panasonic and Sirius XM in automotive electronics; Cisco, Ericsson and Huawei Technologies in communications; Honeywell, Schneider, and Siemens in industrial, military and medical applications; and Samsung, Sharp, and Toshiba in digital consumer electronics. Due to their significant size and market influence, we believe these types of customers generally drive memory volumes in their market segments and help define the direction of future memory needs.
On September 14, 2012, we acquired Chingis Technology Corporation (Chingis), a public company in Taiwan, which provides a variety of NOR flash memory technologies used in standalone and embedded applications. Chingis targets the personal computer peripheral markets including hard disc drive markets. Chingis's current products include low density serial flash products.
On January 31, 2011, we acquired Si En Integration Holdings Limited (Si En), a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Si En targets the communications, digital consumer and automotive markets with high quality analog products.
In January 2010, we formed a separate business unit, Giantec Semiconductor, Inc. (Giantec). As part of this formation, Giantec raised approximately $3.8 million from an outside investor. On December 30, 2010, Giantec received an additional direct investment of $4.0 million from outside investors, and as a result our ownership interest was reduced to approximately 44% and we were required to deconsolidate Giantec. In August 2011, we sold approximately 37% of our shares in Giantec and on August 31, 2011, Giantec merged with Maxllent Corp. thereby reducing our ownership interest in Giantec to approximately 19.85%. Giantec designs and markets application specific standard products (ASSP) primarily EEPROMs and SmartCards. Our consolidated financial statements reflect accounting for Giantec on a consolidated basis from January 1, 2010 through December 30, 2010. For the period from December 31, 2010 through August 31, 2011, we accounted for Giantec on the equity method and our results included our percentage share of Giantec’s results of operations. Effective September 1, 2011, we account for Giantec on the cost basis.
Company Background
We were incorporated in California in October 1988 and changed our state of incorporation to Delaware in August 1993. We have one operating segment which is to design, develop and market high performance DRAM and SRAM and other memory and non-memory semiconductor products. Our principal executive offices are located at 1940 Zanker Road, San Jose, California 95112, and our telephone number is (408) 969-6600. On our Investor Relations web site, located at
www.issi.com
, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such documents on our Investor Relations web site are available free of charge.
Market Background
In recent years, the need for sophisticated semiconductor memory architecture has expanded beyond the PC market and into electronic systems in a wide variety of markets, including automotive electronics, communications, industrial, medical and military applications and digital consumer electronics. Advances in technology have allowed for increasingly complex digital consumer products such as set-top boxes, digital cameras and HDTVs. Significant memory content is often required in these products to manage large amounts of data that create images and sounds in a digital format. As a result, virtually all electronic systems incorporate semiconductor memory devices to enable and enhance system performance.
The complexity of automobile electronics is also increasing rapidly. The significant increase in automotive electronic applications has resulted in an increase in microcontrollers and memory responsible for delivering control and command functionality. Automobile designers are increasing semiconductor content in automobiles to allow for improved telematics, digital audio and video entertainment systems, advanced safety features such as backup cameras and lane departure warning systems and powertrain functions such as engine control and fuel efficiency management systems. These systems require memory devices that meet the automotive industry’s high quality and reliability standards.
Mobile communication products have gained broad acceptance among consumers. Applications for cellular communications, wireless local area networks (WLAN) and global positioning systems (GPS) are increasingly able to access a wide range of data services, from internet connectivity to location detection, and are delivering information to consumers through sophisticated mobile products. Mobile products connect without wires to a base station that receives and sends data or voice to the mobile device. As more data and user content is accessed and stored on the mobile devices, advanced memory is required to store and access this information. As 3G and 4G mobile broadband services proliferate, the volume of data is expected to increase significantly, and memory will play a crucial role in ensuring quality of service in the mobile infrastructure market.
The needs of the industrial memory market match our strategy of providing long-term customer support. Memory products are used in various industrial applications such as power management, imaging, point of sale terminals, bar code scanners, smart meters, instrumentation and data acquisition systems. We have a wide range of DRAM, SRAM, flash and analog products that meet the needs of the industrial market segment.
As more consumers and businesses utilize the internet and broadband communications networks, the demand for networking products has accelerated. Consumers and businesses require high speed access to internet content and other services to transmit and receive large amounts of data, such as highly graphical web sites, MP3 audio files, HD video and streaming multimedia applications. The numerous and complex applications that facilitate connections within networking and broadband products, such as cable and DSL modems, switches and routers, require optimized high speed memory architectures to maximize bus bandwidth and reduce latency.
Integrated circuits that address the semiconductor memory market can be segmented into volatile memory, such as DRAM and SRAM, and non-volatile memory, such as Flash and EEPROM. Volatile memory loses its data if the power is turned off, while non-volatile memory retains its data when the power is turned off. SRAM is used for applications that require very high speed access to stored data and it typically requires four to six transistors to store each bit of data. DRAM uses only a single transistor to store each bit of data. As a result, the storage capacity of DRAM tends to be much greater than that of SRAM. SRAM is faster than DRAM, but more expensive on a cost per bit basis. The same equipment manufacturers that use high performance SRAM may also use low and medium density DRAM and such products can be sold through the same channels.
System designers use SRAM in the most performance sensitive portions of their memory architecture. High performance SRAM operates at either very high speed or very low power or both. High speed SRAM is used in applications such as base stations, aggregators, routers, switches, modems and peripherals. Low power SRAM is used in applications such as industrial applications, wireless handheld devices and mobile phones.
The DRAM market can be segmented into high density devices (currently 4 Gb and above) and low and medium density devices (currently 2 Gb and below). High density DRAM is used in applications that require high capacity storage, such as PCs, servers and other high-end computing devices. Currently, DRAM in PCs is migrating from 4 Gb to 8 Gb and above. Low and medium density DRAM is used in applications such as digital consumer electronics, networking, mobile communications, and automotive electronics, which require less memory capacity than PCs and high end computing applications. Large captive memory manufacturers tend to focus production on higher density DRAM devices, where the volumes are greater and manufacturing economies of scale can be optimized. As a result, to the extent the large, captive memory manufacturers limit or cease production of low and medium density DRAM, customers will seek long-term, steady supply of these products. We do not participate in the PC and high end computing applications market, rather we focus on providing long-term support for low and medium density DRAM products.
The Flash market can be segmented into Serial NOR, Parallel NOR and NAND Flash products. We are currently focusing on Serial NOR products. Our Serial NOR family of products are used in personnel computer peripherals, communications, automotive and industrial applications.
Memory suppliers compete on the basis of speed, power consumption, density, reliability, and cost, all of which are a function of process technology and design expertise. Success in the memory market is determined not only by the quality of the device design, but also by the process through which the device is fabricated. Process technology improvements allow design line widths to be reduced, which in turn allow the integrated circuit design to operate at faster speeds and increased memory density. To meet the demands for high performance memories, a memory supplier must also have a wafer fabrication strategy allowing it to migrate to the newest generations of process technology on a timely basis. Process technology shifts occur frequently and are developed in high end wafer fabrication facilities that typically cost over $1.0 billion. Although most of the large multinational memory companies fabricate their own semiconductor wafers, fabless suppliers rely on third-party wafer foundries. The fabless model is much less capital intensive, but requires strong relationships with foundries to secure wafer supply and access to advanced process technology.
We believe the demand for high performance memory products across a variety of end markets provides a substantial opportunity for a focused supplier of high performance memory integrated circuits to penetrate these markets and support customers’ long-term needs.
Strategy
Since our inception in 1988, we have developed a broad range of SRAM products that enable designers to meet the demanding density, speed, cost, reliability and power consumption requirements of semiconductors used in high technology products. In the late 1990’s, we began to establish ourselves as a supplier of low and medium density DRAM products, which are complementary to our SRAM products. For both product lines, we emphasize our commitment to be a long-term provider of legacy, small to medium density memories that are of less interest to some of our larger competitors. Our customers are among the largest manufacturers in the automotive electronic, communications, industrial, medical and military and digital consumer electronic markets. Unlike many other fabless semiconductor companies, we employ our own process development team to work collaboratively with our key foundry suppliers, which are primarily located in Asia. Our management has extensive experience working with Asian foundries. We believe these factors allow us to build strong relationships with our foundry suppliers and facilitate access to leading edge process technology and wafer capacity. The key elements of our strategy are:
Target Specific Memory Market Segments
. The memory markets are large and diverse, but also prone to the economics of demand and supply imbalances which can cause fluctuations in product prices. We work to market and sell our DRAM and SRAM products into certain specific markets that provide sufficient volume for sales, but which also may provide better stability in prices over time. Examples of the market segments that we target are automotive, communications, industrial applications, medical equipment, die sales and specialty consumer.
Commit to Being a Long-Term Supplier of our Products
. We are a long-term supplier of products to many of our customers. Our fabless model provides us the flexibility to accommodate small volume production runs for products such as low and medium density memories. In contrast, many large captive suppliers may reduce or cease production of lower density products in periods of tight capacity, as manufacturing such products is less attractive to them than making higher density memories, which typically have higher volumes and greater economies of scale. As an example, we still supply low density 4 Mb EDO 3.3 volt DRAM and 64K SRAM, while most large captive memory companies ceased production of such devices many years ago.
Continue to Develop and Offer High Performance Products
. We provide cost effective, high performance products, including a complete family of SRAM products and a broad range of low and medium density DRAM products. We work with our customers to identify the memory requirements of their next generation products and then focus our development efforts on achieving high performance standards through advanced process technology, circuit density, high speed, reliability and optimized power consumption. Examples of our high performance product offerings include a 72 Mb synchronous high speed SRAM product and RLDRAM
®
2 and RLDRAM
®
3 products targeting high-end networking applications and a 2 Gb DDR2 DRAM and various densities of DDR3 DRAM products targeting the automotive and communication markets.
Expand our Cost Effective Asian-Based Development Teams Close to our Customers
. We intend to continue to capitalize on our extensive experience in Asia. We have established cost effective engineering development teams close to our customers through our subsidiaries in Taiwan, China and Korea and have a full complement of research and development and sales and marketing capability in these Asian locations.
Further Penetrate Industry Leading Customers
. We leverage our expertise in producing high quality memory products to penetrate our target markets through industry leading accounts, such as Continental, Delphi and Panasonic in automotive electronics; Cisco, Ericsson and Huawei Technologies in communications; Honeywell, Schneider, and Siemens in industrial, military and
medical applications; and Samsung, Sharp, and Toshiba in digital consumer electronics. We target these customers because we believe they drive high volumes in their markets, have long life cycle products and define the direction of future memory requirements. We believe our success with these market leaders enables us to attract other customers and broaden our customer base.
NOR Flash Product Line Addition.
With our acquisition of Chingis, we offer a NOR Flash product line which is synergistic with our SRAM and DRAM customer base. Our goal is to expand our presence with the current Chingis customers and to promote the Flash portfolio to our current customer base specifically focused on the automotive and industrial markets.
Analog Market Expansion.
We develop analog products for use in our key markets. Our goal is to expand key customer relationships with additional products in core end markets, increase market share in China, and expand into high volume emerging markets. Currently, our analog products include audio amplifiers, LED drivers, power management and temperature sensors.
Customers and Marketing
Over the years, we have established a strong customer base, including industry leading accounts. Our key customers in each of our target markets are presented in the following table:
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Automotive
Electronics
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Communications
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Industrial/Military/Medical
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Digital Consumer - Memory
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Bosch
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Alcatel-Lucent
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General Electric
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Garmin
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Continental
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Cisco
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Honeywell
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LG Electronics
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Delphi
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Ericsson
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Hypercom
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NEC
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Harman Becker
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Huawei Technologies
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Philips
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Panasonic
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Hyundai Mobis
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Motorola
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Raytheon
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Samsung
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Johnson Controls
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Nokia Siemens Networks
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Schneider Electric
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Sharp
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Panasonic
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Tellabs
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Siemens
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Sony
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Philips
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ZTE
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Tyco
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Toshiba
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SiriusXM
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Western Digital
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TRW
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Digital Consumer - Analog
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Inventec
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Lenovo
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Motorola
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Oppo
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Samsung
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TCL
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We have sales and marketing teams in the U.S. and Asia and a sales team in Europe. We market and sell our products in Asia, the U.S. and Europe through our direct sales force, independent sales representatives and distributors. We have distributors in North America and in many countries in Europe, including a Pan-European distributor. In Asia, we sell primarily through distributors who work closely with our Asian resident direct sales force. We have sales offices in the U.S., U.K., Germany, Taiwan, China, Hong Kong, Japan, India, Korea, and Singapore. Our marketing group focuses on product strategy, product development road maps, new product introduction, demand assessment and competitive analysis. The group also helps ensure that product launches, channel marketing programs, and ongoing demand and supply planning occur on a well-managed, timely basis.
In fiscal 2012, revenue from our largest and second largest distributor accounted for approximately 14% and 13%, respectively, of our total net sales. In fiscal 2011, revenue from our largest and second largest distributor accounted for approximately 15% and 12%, respectively, of our total net sales. In fiscal 2010, revenue from our largest and second largest distributor accounted for approximately 15% and 10%, respectively, of our total net sales. The percentage of our sales from customers located outside the U.S. was approximately 84%, 85%, and 85% in fiscal 2012, 2011 and 2010, respectively. We measure sales location by the shipping destination, even if the customer is headquartered in the U.S. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our sales by region are set forth in the following table:
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Fiscal Year Ended
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September 30,
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2012
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2011
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2010
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Asia
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62
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%
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64
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%
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66
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%
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Europe
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21
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20
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18
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U.S.
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16
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15
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15
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Other
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1
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1
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1
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Total
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100
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%
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100
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%
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100
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%
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Information regarding our long-lived assets is contained in Note 15 to our Consolidated Financial Statements.
Our sales are generally made pursuant to standard purchase orders, which can be revised by our customers to reflect changes in the customer’s requirements. Generally, our purchase orders and OEM agreements allow customers to reschedule delivery dates and cancel purchase orders without significant penalties. For these reasons, we believe that our backlog, while useful for scheduling production, is not necessarily a reliable indicator of future revenues. To meet customer requirements, we often must deliver products on relatively short notice. Accordingly, we must maintain a significant inventory of certain items to be able to meet these requirements.
See page
24 o
f this Report on Form 10-K for a discussion of the impact of seasonality on our business. See “Risk Factors” for information regarding risks related to our international operations.
Markets and Products
Our memory products are used in a variety of specific applications within the automotive, communications, industrial, military and medical markets, and digital consumer electronics. In particular, our SRAM products are used in WLANs, cell phones, base stations, networking switches and routers, fiber to the home (FTTH), DSL modems, LCD TVs, set-top boxes, GPS systems, instrumentation, engine control systems, medical equipment, telematics, audio and video equipment, satellite radio, POS terminals, fax machines, copiers, tape drives, and other applications. Our low and medium density DRAM products are used in WLANs, base stations, networking switches and routers, FTTH, DSL and cable modems, set top boxes, digital cameras, MP3, flat panel TVs, LCD TVs, HDTVs, video phones, voice over internet protocol (VOIP), printers, disk drives, tape drives, audio/video equipment, instrumentation, GPS, telematics, infotainment, smart meters and other applications. Many of the same customers that purchase our SRAM products also purchase our DRAM products.
DRAM.
Our DRAM strategy is to be a long-term supplier of low and medium density DRAM products. Our DRAM products are not targeted at the largest DRAM markets requiring the highest density DRAM products used in PCs and workstations. Instead, we provide 4, 16, 64, 128, 256 and 512 Mb and 1 Gb and 2 Gb DRAM products, including a 1.8 volt low power version of our 16, 64, 128, 256 and 512 Mb synchronous DRAM (SDRAM) products. We also provide EDO, SDRAM, DDR and DDR II memory solutions in both x 32 and x 16 configurations to meet our customers’ memory requirements. We provide 288 Mb and 576 Mb densities of the RLDRAM
®
family. RLDRAM
®
memory is a reduced latency DRAM product targeting high speed communication applications. We are now ramping various densities of DDR3 DRAM products.
We also offer both high performance and lower memory solutions. Applications for our low and medium density DRAM products include products such as WLANs, base stations, networking switches and routers, FTTH, DSL and cable modems, set top boxes, digital cameras, MP3, flat panel TVs, LCD TVs, HDTVs, video phones, VOIP, printers, disk drives, tape drives, audio/video equipment, instrumentation, GPS, telematics, infotainment, backup cameras, lane departure warning systems and other applications. Most of these applications do not require high density products, and our customers’ memory component strategy typically follows one or more generations behind the high density DRAM market. Additional DRAM products are under development. For most SDRAM products, we offer both packaged and known good die (KGD) only solutions. We also offer FBGA packages, which are very small and thin, for all of our synchronous and low power DRAM products.
SRAM.
Our SRAM strategy is to offer a broad range of devices and to be a complete supplier of our customers’ SRAM requirements. We offer advanced, leading-edge products, such as our 72 Mb synchronous SRAM, and we also make long-term supply commitments on established SRAM products, such as a 32K x 8, 5 volt asynchronous SRAM. Our high performance SRAM products generally focus on either high speed or low power applications.
We offer both asynchronous and synchronous high speed SRAM products. Our high speed asynchronous SRAM products are used in applications such as LANs, telecommunication equipment such as base stations, routers, modems, automotive electronics, multimedia products, peripherals, and industrial instrumentation. We have also developed a low power family of SRAM products for wireless applications. Our high speed synchronous SRAM products are used in a variety of networking and
telecommunications applications, such as high performance switches and routers, as well as in automotive applications. Additional SRAM products under development are expected to include performance-leading features in speed, configuration, power levels, density and packaging. We are also developing certain Psuedo SRAM products as a cost effective replacement for ultra low power SRAMs.
NOR Flash.
Through our acquisition of Chingis in September 2012, we are now offering serial NOR Flash products targeting the personal computer peripheral, automotive, IMM and communication markets. Current products in production include 256Kb, 512Kb, 1Mb, 2Mb, 4Mb and 32Mb. We have a number of products that are in the engineering validation stage including 16Mb and 8Mb. Our goal is to provide a complete portfolio of serial NOR Flash products ranging from 256Kb to 256Mb.
Analog and Other Products.
Through our acquisition of Si En in January 2011, we added high performance analog and mixed signal integrated circuits targeting the communications, digital consumer and automotive markets. Our primary products are audio amplifiers, LED drivers, power management and temperature sensors. Applications for our audio power amplifiers include cell phones, GPS devices, MP3 players and conference phones. Applications for our LED drivers for backlighting and panel display include cell phones, digital cameras, notebook computers and other computing and consumer devices as well as voltage converters used in industrial applications. In addition, we currently sell temperature sensors for computing, networking and industrial applications.
Through our former Giantec business unit, our ASSP products included high performance serial EEPROM, SmartCard and selected other products. Since December 31, 2010, we no longer consolidate Giantec's results with our results.
Product Warranty.
Consistent with semiconductor memory industry practice, we generally provide a limited warranty that our semiconductor memory devices are in compliance with specifications existing at the time of delivery. Liability for a stated warranty period is usually limited to replacement of defective items or return of amounts paid.
Manufacturing
We outsource our manufacturing operations, including wafer fabrication, assembly and testing. Since memory products are particularly well suited for the development of advanced process technology, we seek to participate in developing and refining the process technology used to manufacture many of our products. We believe that this strategy enables us to achieve earlier introduction of smaller geometries for our memory products, which results in increased performance and lower manufacturing costs, as well as facilitates access to needed capacity. Our principal manufacturing relationships are with GlobalFoundries, Hynix, IBM, Nanya, Powerchip, SMIC, and TSMC.
The manufacturing of our products begins at independent wafer foundries. Once the foundry has completed wafer processing, the wafers are shipped to subcontractors for wafer testing. They are then cut into individual memory chips, assembled into final packages and tested at our third-party subcontractors in Taiwan, China and the Philippines. Our operations groups in the U.S., China and Taiwan perform subcontractor management. We are certified to ISO 9001/2000 standards and ISO 14001, the environmental standard, and our quality system is periodically reviewed and approved by both ISO registrars and our customers. We are compliant to ISO/TS 16949:2002, the automotive standard.
Each of our wafer suppliers also fabricates for other integrated circuit companies, including certain of our competitors. In addition, some of our wafer suppliers manufacture memories 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. There can be no assurance that the foundries we use will not encounter construction or production difficulties or that they will allocate sufficient wafer capacity to satisfy our wafer requirements, especially in times of wafer capacity shortages. Moreover, there can be no assurance that we would be able to qualify additional manufacturing sources for existing or new products in a timely manner or that such additional manufacturing sources would be able to produce an adequate supply of wafers. If we were unable to obtain an adequate supply of wafers from our current or any alternative sources in a timely manner, our business and operating results would be harmed.
Our suppliers for wafer testing, assembly, and final test also provide services to other companies. There can be no assurance that these suppliers will not encounter production difficulties or that they will allocate sufficient capacity to satisfy our requirements. If we were unable to obtain an adequate supply of wafer testing, assembly, or final test services, our business and operating results would be harmed.
Competition
The semiconductor market is intensely competitive and has been characterized by cyclical market conditions, an oversupply of product, price erosion, rapid technological change and short product life cycles. Key factors impacting our competitive capabilities include:
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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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wafer manufacturing over or under capacity;
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access to advanced process technologies at competitive prices;
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access to assembly and test capacity; and
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Adverse developments with respect to any of these factors could impact our ability to compete successfully in the future and our failure to do so could harm our business. We currently believe that we compete favorably with respect to each of the foregoing factors.
In the low to medium density DRAM area, we generally compete with Elpida, Hynix, Micron, Nanya, Oki, Samsung and Winbond. In addition, there are several fabless Taiwanese companies that are competitors, including ESMT and Etron. Other large DRAM manufacturers could address the low and medium density DRAM market in the future.
In the market for SRAM products we compete with several domestic and international semiconductor companies including Cypress, Etron, GSI Technology, Integrated Device Technology, Renesas Electronics and Samsung. We also may face significant competition from other domestic and foreign integrated circuit manufacturers which have advanced technological capabilities but are not currently participating in the SRAM market sector.
In the NOR Flash area our main competitors are Macronix, Micron, Spansion, Winbond and others.
In the analog market, our primary competitors are AMS, IWatt, Linear Technology, Maxim Integrated Products, Microsemi, NXP Semiconductors, Richtek and Texas Instruments. We also compete with many small to medium-sized companies in one or more segments of the market.
Certain of our competitors offer broader product lines and have greater financial, technical, marketing, distribution and other resources than us. In industry down cycles, they may be willing to sell below fully absorbed costs at prices we cannot match. We may not be able to compete successfully against any of these competitors.
The process technology used by our manufacturing sources, including process technology that we have developed jointly with our foundries, can be used by such foundries to produce products for other companies, including our competitors. Although we believe that our participation in the development of the processes provides us the advantage of early access to such processes, the knowledge of the wafer manufacturer may be used to benefit our competitors.
Research and Development
Rapid technological change and continuing price competition require research and development efforts on both new products and advanced processes employing smaller geometries. Our research and development activities are focused primarily on the development of new memory circuit designs at the smallest die size and utilization of advanced process technologies. We currently have design teams in California, Taiwan, China and Korea. Our research and development expenditures in fiscal 2012, 2011, and 2010 were $30.9 million, $27.6 million, and $24.1 million, respectively.
New SRAM products in development include a die shrink on our 8Mb Asynchronous SRAM, a 4Mb Synchronous SRAM, a 16Mb ultra low power Asynchronous SRAM, a 36Mb Synchronous SRAM, and a 72Mb Synchronous SRAM. New DRAM products in development include 1.8 volt, low power 256Mb, 512Mb and 1Gb SDRAMs and various densities of DDR/DDR2/DDR3 DRAMs. We are also enhancing our portfolio of RLDRAM
®
2 and RLDRAM
®
3 products
. We are developing new products on advanced 45, 63 and 65 nanometer process technology as well as 72nm and 0.13 micron process technology.
Patents and Intellectual Property
As of September 30, 2012, we held 125 U.S. patents which expire between 2012 and 2028 and have five U.S. patent applications pending. We do not believe that the expiration of any particular patent in the short-term will have a material impact on our business. We expect to continue to file patent applications where appropriate to protect our proprietary technologies. In addition, we hold 42 patents in foreign jurisdictions which expire between 2018 and 2032 and have 20 patent applications in foreign jurisdictions which are pending. Although patents are an important element of our intellectual property, we believe that our continued success depends primarily on factors such as the technological skills and innovation of our personnel rather than on our patents. The process of seeking patent protection can be expensive and time consuming. There can be no assurance that patents will be issued from pending or future applications or that, if patents are issued, they will not be challenged, invalidated or circumvented, or that any rights granted thereunder will provide meaningful protection or other commercial advantage to us. Moreover, there can be no assurance that any patent rights will be upheld in the future or that we will be able to preserve any of our other intellectual property rights.
In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights of others. 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. Although patent holders commonly offer such licenses, 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 harm our business.
Part of our outsourcing strategy includes licensing product designs. To help control our research and development expenses, we license some of our DRAM and SRAM designs from other companies or our foundries. We also license our own designs to other companies.
Employees
As of September 30, 2012, we had 552 employees worldwide, including 69 employees in the U.S., 148 in China, 289 in Taiwan, 8 in Hong Kong, 3 in Europe, 4 in India, 10 in Japan, 19 in Korea, and 2 in Singapore. Our future success will be dependent on our ability to attract, retain and motivate highly qualified technical and management personnel. The employment market for such personnel can be very competitive and there can be no assurance that we will successfully staff all necessary positions. Our employees are not represented by any collective bargaining agreements, we have never experienced a work stoppage and we believe our employee relations are good.
Executive Officers of the Registrant
Our executive officers and their ages as of December 1, 2012 are as follows:
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Name
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Age
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Position
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Jimmy S.M. Lee
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57
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Executive Chairman of the Board of Directors
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Scott D. Howarth
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52
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President and Chief Executive Officer
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John M. Cobb
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56
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Vice President and Chief Financial Officer
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Kong Yeu Han
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Vice Chairman
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Chang-Chaio (James) Han
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Executive Vice President, GM ISSI-Taiwan and SRAM/DRAM Business Division
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Set forth below is certain information relating to our executive officers.
Jimmy S.M. Lee
has served as our Executive Chairman since April 2008 and as Chairman, Chief Executive Officer and a director from October 1988, when he co-founded ISSI, until March 2008. He also served as President from November 2005 until December 2007. From 1985 to 1988, Mr. Lee was engineering manager at International CMOS Technology, a semiconductor company, and from 1983 to 1985, he was a design manager at Signetics Corporation, a semiconductor company. He has served as a director of Chrontel, a video optics company, since July 1995 and as a director of Alpha & Omega Semiconductor, Inc., a developer of advanced power semiconductor solutions, from March 2006 through January 2010. Mr. Lee holds an M.S. degree in electrical engineering from Texas Tech University and a B.S. degree in electrical engineering from National Taiwan University.
Scott D. Howarth
has served as our Chief Executive Officer since April 2008, as a director since October 2008 and as our President since December 2007. He also served as our Chief Financial Officer from February 2006 until May 2008. From September 2001 to February 2006, Mr. Howarth was the Vice President of Finance and Administration and Chief Financial Officer of Chrontel, Inc., a fabless video optics company. Prior to joining Chrontel, Mr. Howarth was acting Chief Financial Officer at Securecom
Networks, a start-up that was acquired. From 1984 to 2000, he was employed with Intel Corporation in both finance and operation positions, and held several group controller positions in the company. Mr. Howarth holds an MBA degree in finance and a B.S. degree in mining engineering from the University of Idaho.
John M. Cobb
has served as our Vice President of Finance and Administration and Chief Financial Officer since May 2008. He served as Vice President Finance and Administration and Chief Financial Officer of Power Integrations, Inc., a power conversion semiconductor company, from 2001 through 2006. From 1990 to 2000, Mr. Cobb held various senior level financial positions at Quantum Corporation, a computer storage company, most recently as Vice President Finance and Chief Financial Officer of the company’s hard disk drive group. Mr. Cobb holds a B.S. degree in accounting from Villanova University.
Kong Yeu Han
has served as our Vice Chairman since May 2005 and as a director since August 2005. He served as Chief Executive Officer of Integrated Circuit Solution, Inc. (ICSI) from January 1999 to May 2005. Mr. Han was a co-founder of ISSI and served as the Company’s Executive Vice President from April 1995 to December 1998, as Vice President from December 1988 to March 1995, and as General Manager, ISSI-Taiwan from September 1990 to December 1998. Mr. Han holds an M.S. degree in electrical engineering from the University of California, Santa Barbara and a B.S. degree in electrical engineering from National Taiwan University.
Chang-Chaio (James) Han
has served as the Company’s Executive Vice President and as General Manager, ISSI-Taiwan and SRAM/DRAM Business Division since May 2005. He served as President of ICSI from October 2003 to April 2005, and as Vice President of Design of ICSI from July 1998 to October 2003. He has served as a director of Win Win Precision Technology Co., a solar energy and semiconductor equipment company, since August 2010. Mr. Han holds a PhD degree in electrical engineering from Case Western Reserve University and M.S. and B.S. degrees in electrical engineering from National Taiwan University.
Officers serve at the discretion of the Board and are appointed annually. There are no family relationships among the directors or officers of ISSI.
Item 1A. Risk Factors
Uncertain general economic conditions and any future downturn in the markets we serve are expected to adversely affect our business and financial results.
Substantially all of our products are incorporated into products for the automotive, communications, industrial, medical and military, and digital consumer electronics markets. In particular, in the three months and fiscal year ended September 30, 2012, approximately 46% and 41%, respectively, of our sales were to the automotive market and any future downturn in this market would have a material adverse effect on our revenue and profitability. Historically, the automotive, communications, industrial, medical and military, and digital consumer electronics 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. During uncertain economic conditions, our current or potential customers may delay or reduce purchases of our products which would adversely affect our revenues and harm our business and financial results. In addition, any uncertainty in the economy may negatively impact the spending patterns of businesses including our current and potential customers. We expect our business to be adversely impacted by any further downturn in the U.S. or global economies.
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 fiscal 2012, fiscal 2011 and fiscal 2010, approximately 96%, 92% and 90%, 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. We experienced a sequential decline in revenue from $66.2 million in the December 2011 quarter to $62.5 million in the March 2012 quarter primarily as a result of a decrease in unit shipments of our DRAM products. We experienced a sequential decline in revenue from $71.3 million in our September 2011 quarter to $66.2 million in our December 2011 quarter which was partially a result of a decrease in unit shipments of our SRAM products. We experienced a sequential decline in revenue from $73.6 million in our September 2010 quarter to $66.1 million in our December 2010 quarter primarily as a result of a decrease in unit shipments of both our DRAM and SRAM products. We may not be able to offset any future price declines for our products by higher volumes or by higher prices on newer products. While we experienced increases in the average selling prices for certain of our products in fiscal 2010, fiscal 2011 and in fiscal 2012, 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.
If we are unable to obtain an adequate supply of wafers due to industry consolidation involving foundries, financial difficulties at foundries or other reasons, our business will be harmed unless we are able to secure alternative capacity in a timely manner and on reasonable terms.
If we are unable to obtain an adequate supply of wafers from our current suppliers or any alternative sources in a timely manner and on reasonable terms, our business will be harmed. Our principal manufacturing relationships are with Nanya, Powerchip Semiconductor, SMIC, TSMC, Global Foundries, Hynix and IBM. 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 wafer capacity from our key 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, severe financial or operational difficulties, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us for any other reason, we may not be able to obtain enough wafers to meet the market demand for our products which would adversely affect our revenues. In recent years, it has been more difficult for us to secure long-term foundry capacity (particularly for our DRAM products) due to industry consolidation affecting foundries and adverse financial conditions at foundries. From time to time, certain of our wafer foundries announce that they will no longer produce a specific type of wafer we may need (especially certain types of DRAM wafers). In such event, we have had to and expect in the future to have to place large last time buy orders which expose us to the risk of inventory obsolescence. In this regard, in the September 2012 quarter, we took delivery of a large quantity of DRAM wafers as the result of a last time buy with one of our foundries. 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.
Foundry capacity can be limited, resulting in higher wafer prices, and we have had to enter into special arrangements to secure foundry capacity.
If we are not able to obtain sufficient 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 will likely enter into in the future, various arrangements with suppliers, which could include:
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option payments or other prepayments to foundries;
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increased prices for wafers;
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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; and
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nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments.
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In this regard, in September 2012, we invested approximately $27.1 million in Nanya and entered into an agreement with Nanya to provide us with access to leading edge process technologies and certain wafer volume guarantees.
In the future, we may not be able to make any such other 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. In addition, we must be able to secure sufficient assembly and test capacity from third-party contractors. In order to secure such capacity, we are exposed to some of the same risks we face when securing foundry capacity. In the past, we have purchased testing equipment for use by our contractors to satisfy a portion of our capacity needs. If we are not able to secure required assembly and test capacity, our business and customer relationships would be harmed.
We rely on third-party contractors to fabricate, assemble and test our products. Our business is highly dependent on the continued operations of such contractors 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 fabricate, assemble and test our products. Any uncertain economic conditions or uncertainty in the U.S. and global credit markets could materially impact the financial condition or operations of our third-party contractors such as our wafer foundries, test contractors and assembly contractors. Our business is highly dependent on the continued operations of such contractors. Any deterioration in the financial condition of our contractors or any disruption in the operations of our contractors could adversely impact the flow of our products to our end customers and materially adversely impact our business and results of operation. In recent years, several foundries have experienced financial difficulties and have filed for bankruptcy protection, substantially reduced their operations or been acquired by competing companies. There are significant risks associated with our reliance on these third-party contractors, including:
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potential price increases;
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possible capacity shortages;
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foundries ceasing production of wafer types that we need;
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financial viability of our contractors;
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reduced control over product quality;
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reduced control over delivery schedules;
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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;
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impact of foreign exchange rates on our product costs; 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.
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 foundry’s 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.
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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changes in the global economy;
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changes in business conditions in our key markets especially the automotive market;
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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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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 the pricing for wafers or assembly or test services;
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oversupply of memory or analog products in the market;
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inventory write-downs for lower of cost or market or excess and obsolete;
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cancellation of existing orders or the failure to secure new orders;
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excess inventory levels at our customers;
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decreases in the demand for our memory or analog products;
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our ability to control or reduce our operating expenses;
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fluctuations in foreign currencies relative to the U.S. dollar
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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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changes in our product mix which could reduce our gross margins;
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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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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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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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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 our inventory. In fiscal 2012, fiscal 2011, and fiscal 2010, we recorded inventory write-downs of $5.7 million, $3.5 million, and $2.9 million, respectively. These 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.
Differences in forecasted average selling prices used in calculating lower of cost or market adjustments can result in significant changes in the estimated net realizable value of inventory and accordingly the amount of write-down recorded. If the estimated market value of products in inventory at quarter-end is below the manufacturing cost of these products, we will recognize charges to write down the carrying value of our inventories to market value. In addition, we write down to zero dollars the carrying value of inventory on hand that has aged over one year (two years for wafer and die bank) to cover estimated excess and obsolete exposures, unless adjustments are made based on management’s 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.
Strong competition in the semiconductor market may harm our business.
The semiconductor 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 our markets 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;
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our financial strength and the financial strength of our competitors; and
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general economic conditions.
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In addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. 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.
We may encounter difficulties in effectively integrating newly acquired businesses.
From time to time, we have acquired and expect in the future to acquire other companies or assets that we believe to be complementary to our business. In this regard, in September 2012, we acquired Chingis Technology Corporation (Chingis), a provider of NOR flash memory technologies used in standalone and embedded applications headquartered in Taiwan. In addition, in January 2011, we acquired Si En Integration Holding Limited (Si En), a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Acquisitions may result in the 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 (including our acquisition of Chingis) involve numerous risks, including:
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lower than expected sales of any acquired products;
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the risk that the markets for acquired products do not develop as expected;
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difficulties in continuing to develop new technologies and deliver products to market on time;
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the potential loss of key employees and customers as a result of the acquisition;
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difficulties in successfully assimilating the operations, technologies and personnel of the acquired company;
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diversion of management’s attention from other business concerns;
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risks of entering markets in which we have no, or limited, direct prior experience; and
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higher than estimated acquisition expenses.
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There is no assurance that any of our recent or future acquisitions will contribute positively to our business or operating results.
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 fiscal 2012, approximately 16% of our net sales was attributable to customers located in the U.S., 21% was attributable to customers located in Europe and 62% was attributable to customers located in Asia. In fiscal 2011, approximately 15% of our net sales was attributable to customers located in the U.S., 20% was attributable to customers located in Europe and 64% was attributable to customers located in Asia. In fiscal 2010, approximately 15% of our net sales was attributable to customers located in the U.S., 18% was attributable to customers located in Europe and 66% 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 primarily located in Taiwan and China and, while our wafer purchases are denominated in U.S. dollars, most of our assembly and test costs are denominated in New Taiwan dollars. 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 U.S. dollar compared to the New Taiwan dollar or Chinese renminbi could substantially increase the cost of our products and 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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foreign currency fluctuations;
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duties, tariffs and other trade barriers and restrictions;
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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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difficulties in protecting our intellectual property rights;
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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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Adverse changes in our effective tax rate will harm our results of operations.
A number of factors may increase our future effective tax rates, including:
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changes in the valuation of our deferred tax assets and liabilities, and changes in deferred tax valuation allowances;
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exhaustion of our existing federal and foreign net operating loss carryforwards and credits;
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increases in expenses not deductible for tax purposes, including impairments of goodwill in connection with acquisitions;
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the jurisdictions in which profits are determined to be earned and taxed;
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limitations on the utilization of federal net operating loss carryforwards and credits;
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the resolution of issues arising from tax audits with various tax authorities;
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adjustments to income taxes upon finalization of various tax returns;
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changes in available tax credits;
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changes in tax laws or the interpretation of such tax laws;
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changes in U.S. generally accepted accounting principles; and
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our decision to repatriate non-U.S. earnings for which we have not previously provided for U.S. taxes.
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Any significant increase in our future effective tax rates will reduce our net income for future periods.
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 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, manufacture, 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 also 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 costs 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 take actions to 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 develop competing technologies on their own.
We have incurred significant losses in certain recent periods, and there can be no assurance that we will be able to sustain profitability in the future.
Though we had been profitable for twelve consecutive quarters beginning with the September 2009 quarter through the June 2012 quarter, we incurred a loss of $13.2 in the September 2012 quarter and a loss of $2.7 million for fiscal 2012, which included a $14.3 million write-down for certain tangible and intangible net assets related to our acquisition of Si En and a charge of $2.3 million to write-down our investment in Semiconductor Manufacturing International Corporation (SMIC) due to the decline in fair market value being considered other than temporary. We incurred a loss of $5.1 million in fiscal 2009, which included a $0.7 million charge for acquired in-process technology. Though we were profitable in each of the first three quarters of fiscal 2008, we incurred a loss of $17.8 million in fiscal 2008, which included charges for the impairment of goodwill of $25.3 million. There can be 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 and assembly and test capacity and control operating expenses, including stock-based compensation. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.
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 II, Item 7 of this Form 10-K). 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 requires us to use valuation methodologies (which were not developed for use in valuing employee stock options) 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 option 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 exception of changes in expected forfeitures of share-based awards. In the future, factors may arise 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 Executive Chairman 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 depends on general economic and industry conditions but such competition has been intense in prior periods of industry growth. 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 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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announcements regarding our share repurchase program and the timing and amount of shares we purchase under such program;
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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 from time to time experienced extreme price and trading volume volatility. This volatility has had a substantial effect on the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations have adversely affected the market price of our common stock in the past and are likely to continue to do so in the future.
We have used and may in the future use a significant amount of our cash resources to repurchase shares of our common stock and such repurchases present potential risks and disadvantages to us and our continuing stockholders.
While we did not repurchase any shares in fiscal 2012, from September 2007 through September 2011, we repurchased and retired an aggregate of 14,179,711 shares of our common stock in the open market under Rule 10b-18 and pursuant to our tender offers at a cost of approximately $88.5 million. At September 30, 2012, we had outstanding authorization from our Board to purchase up to an additional $19.8 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 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 have reduced our “public float,” which is the number of our shares owned by non-affiliate stockholders and available for trading in the securities markets, and likely reduced the number of our
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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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Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.
Our worldwide operations, including the operations of our foundries and other suppliers, 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 San Jose, 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, volcanic eruptions, fires, extreme weather conditions, medical epidemics such as a flu outbreak and other natural or manmade disasters.
Our operations involve the use of hazardous and toxic materials, and we must comply with environmental laws and regulations, which can be expensive, and may adversely affect our business and operating results.
We are subject to federal, state and local regulations relating to the use, handling, storage, disposal and human exposure to hazardous and toxic materials. If we were to violate or become liable under environmental laws in the future as a result of our inability to obtain permits, human error, accident, equipment failure or other causes, we could be subject to fines, costs, or civil or criminal sanctions, face property damage or personal injury claims or be required to incur substantial investigation or remediation costs or experience disruptions in our operations, any of which could have a material adverse effect on our business. In addition, environmental laws could become more stringent over time, imposing greater compliance costs and increasing the risks and penalties associated with violations, which could harm our business.
We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances applicable to specified electronic products placed on the market in the European Union (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the RoHS Directive). We also expect that our operations will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs, and could require that we change the design or manufacturing of our products, any of which could have a material adverse effect on our business.
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, 2012. If in the future, we are unable to conclude that our internal control over financial reporting is effective or we are unable to conclude that our disclosure controls and procedures are effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.