| These forward-looking statements are subject to substantial risks and uncertainties that could cause our future business, financial condition or results of operations to differ materially from our historical results or currently anticipated results, including those set forth below |
| Risks Related to Our Business We face intense competition in our markets from more established CMOS and CCD image sensor manufacturers, and if we are unable to compete successfully we may not be able to maintain or grow our business |
| The image sensor market is intensely competitive, and we expect competition in this industry to continue to increase |
| This competition has resulted in rapid technological change, evolving standards, reductions in product selling prices and rapid product obsolescence |
| If we are unable to successfully meet these competitive challenges, we may be unable to maintain and grow our business |
| Any inability on our part to compete successfully would also adversely affect our results of operations and impair our financial condition |
| Our image-sensor products face competition from other companies that sell CMOS image sensors and from companies that sell CCD image sensors |
| Many of our competitors have longer operating histories, greater presence in key markets, greater name recognition, larger customer bases, more established strategic and financial relationships and significantly greater financial, sales and marketing, distribution, technical and other resources than we do |
| Many of them also have their own manufacturing facilities which may give them a competitive advantage |
| As a result, they may be able to adapt more quickly to new or emerging technologies and customer requirements or devote greater resources to the promotion and sale of their products |
| Our competitors include established CMOS image sensor manufacturers such as Avago, Cypress, ESS, Kodak, MagnaChip, Micron, Matsushita, Samsung, Sharp, Sony, STMicroelectronics and Toshiba as well as CCD image sensor manufacturers such as Fuji, Matsushita, NEC, Sanyo, Sharp, Sony and Toshiba |
| Many of these competitors own and operate their own fabrication facilities, which in certain circumstances may give them the ability to price their products more aggressively than we can or may allow them to respond more rapidly than we can to changing market opportunities |
| In addition, we compete with a large number of smaller CMOS manufacturers including Foveon, PixArt and Pixelplus |
| Competition with these and other companies may force us to reduce our prices |
| For instance, we have seen increased competition in the markets for VGA image sensor products with resulting pressures on product pricing |
| Downward pressure on pricing could result both in decreased revenues and lower gross margins, which would adversely affect our profitability |
| Our competitors may acquire or enter into strategic or commercial agreements or arrangements with foundries or providers of color filter processing, assembly or packaging services |
| These strategic arrangements between our competitors and third party service providers could involve preferential or exclusive arrangements for our competitors |
| Such strategic alliances could impair our ability to secure sufficient capacity from foundries and service providers to meet our demand for wafer manufacturing, color filter processing, assembly or packaging services, adversely affecting our ability to meet customer demand for our products |
| In addition, competitors may enter into exclusive relationships with distributors, which could reduce available distribution channels for our products and impair our ability to sell our products and grow our business |
| Further, some of our customers could also become developers of image sensors, and this could potentially adversely affect our results of operations, business and prospects |
| Sales of our image-sensor products for camera cell phones account for a large portion of our revenues from digital applications on an annual basis, and any decline in sales to the camera cell phone market or failure of this market to continue to grow as expected could adversely affect our results of operations |
| Sales to the camera cell phone market account for a large portion of our revenues from digital applications |
| Although we can only estimate the percentages of our products that are used in the camera cell phone market due to the significant number of our image-sensor products that are sold through distributors and VARs, we believe that the camera cell phone market accounted for approximately 75prca and 70prca of our revenues in fiscal 2005 and fiscal 2006, respectively |
| We expect that revenues from sales of our image-sensor products to the camera cell phone market will continue to account for a significant portion of our revenues during fiscal 2007 and beyond |
| Any factors adversely affecting the demand for our image sensors in this market could cause our business to suffer and adversely affect our 15 _________________________________________________________________ [45]Table of Contents results of operations |
| The digital image sensor market for camera cell phones is extremely competitive, and we expect to face increased competition in this market in the future |
| In addition, we believe the market for camera cell phones is also relatively concentrated and the top six producers account for more than 80prca of the annual sales of these products |
| If we do not continue to achieve design wins with key camera cell phone manufacturers, our market share or revenues could decrease |
| The camera cell phone image sensor market is also subject to rapid technological change |
| In order to compete successfully in this market, we will have to correctly forecast customer demand for technological improvements and be able to deliver such products on a timely basis at competitive prices |
| If we fail to do this, our results of operations, business and prospects would be materially and adversely affected |
| In the past, we have experienced problems accurately forecasting customer demand in other markets |
| If sales to the camera cell phone market do not increase, our results of operations, business and prospects would be materially adversely affected |
| Our future success depends on the timely development, introduction, marketing and selling of new CMOS image sensors, which we might not be able to achieve |
| Our failure to successfully develop new products that achieve market acceptance in a timely fashion would adversely affect our ability to grow our business and our operating results |
| The development, introduction and market acceptance of new products is critical to our ability to sustain and grow our business |
| Any failure to successfully develop, introduce, market and sell new products could materially adversely affect our business and operating results |
| The development of new products is highly complex, and we have in the past experienced delays in completing the development and introduction of new products |
| From time to time, we have also encountered unexpected manufacturing problems as we increase the production of new products |
| For example, in the fourth quarter of fiscal 2005, and again in the first quarter of fiscal 2006, the back-end yields on two of our advanced products were significantly below where we planned, and our gross margins were adversely impacted |
| As our products integrate new and more advanced functions, they become more complex and increasingly difficult to design and debug |
| Successful product development and introduction depends on a number of factors, including: • accurate prediction of market requirements and evolving standards, including pixel resolution, output interface standards, power requirements, optical lens size, input standards and operating systems for personal computers and other platforms; • development of advanced technologies and capabilities; • definition, timely completion and introduction of new CMOS image sensors that satisfy customer requirements; • development of products that maintain a technological advantage over the products of our competitors, including our advantages with respect to the functionality and pixel capability of our image-sensor products and our proprietary testing processes; and • market acceptance of the new products |
| Accomplishing all of this is time consuming and expensive |
| We may be unable to develop new products or product enhancements in time to capture market opportunities or achieve significant or sustainable acceptance in new and existing markets |
| In addition, our products could become obsolete sooner than anticipated because of a rapid change in one or more of the technologies related to our products or the reduced life cycles of consumer products |
| Our future success is dependent upon manufacturers designing our image-sensor products into their products |
| To achieve design wins, which are decisions by manufacturers to design our products into their systems, we must define and deliver cost effective and innovative image-sensor solutions |
| Our ability to achieve design wins is subject to numerous risks including competitive pressures as well as technological risks |
| If we do not achieve a design win with a prospective customer, it may be difficult to sell our image-sensor products to such prospective customer in the future because once a manufacturer has designed a supplier’s products into its systems, the manufacturer may be reluctant to change its source of components due to the significant costs, time, effort and risk associated with qualifying a new supplier |
| Accordingly, if we fail to achieve design wins with key device manufacturers that embed image sensors in their products, our market share or revenues could decrease |
| Furthermore, to the extent that our competitors secure design wins, our ability to expand our business in the future will be impaired |
| 16 _________________________________________________________________ [46]Table of Contents We depend on a limited number of third party wafer foundries, which reduces our ability to control our manufacturing process |
| Unlike some of our larger competitors, we do not own or operate a semiconductor fabrication facility |
| Instead, we rely on TSMC, PSC and other subcontract foundries to produce all of our wafers |
| Historically, we have relied on TSMC to provide us with a substantial majority of our wafers |
| As a part of our joint venture agreement with TSMC, TSMC has agreed to commit substantial wafer manufacturing capacity to us in exchange for our commitment to purchase a substantial portion of our wafers from TSMC, subject to pricing and technology requirements |
| We do not have long-term supply agreements with any other foundries |
| As a result, we have to secure manufacturing availability on a purchase order basis |
| These foundries have no obligation to supply products to us for any specific period, in any specific quantity or at any specific price, except as set forth in a particular purchase order |
| In general, our reliance on third party foundries involves a number of significant risks, including: • reduced control over delivery schedules, quality assurance, manufacturing yields and production costs; • lack of guaranteed production capacity or product supply; • unavailability of, or delayed access to, next generation or key process technologies; and • financial difficulties or disruptions in the operations of third party foundries due to causes beyond our control |
| If TSMC or any of our other foundries were unable to continue manufacturing our wafers in the required volumes, at acceptable quality, yields and costs, or in a timely manner, we would have to identify and qualify substitute foundries, which would be time consuming and difficult, and could increase our costs or result in unforeseen manufacturing problems |
| In addition, if competition for foundry capacity increases we may be required to pay increased amounts for manufacturing services |
| We are also exposed to additional risks if we transfer our production of semiconductors from one foundry to another, as such transfer could interrupt our manufacturing process |
| Further, some of our foundries may also be developers of image sensor products and if one or more of our other foundries were to decide not to fabricate our companion DSP chips for competitive or other reasons, we would have to identify and qualify other sources for these products |
| We rely on a joint venture company for color filter application and on third party service providers for packaging services, which reduces our control over delivery schedules, product quality and cost, and could adversely affect our ability to deliver products to customers |
| We rely on VisEra, our joint venture with TSMC, for the color filter processing of our completed wafers |
| In addition, we rely on Advanced Semiconductor Engineering Inc, or ASE, ImPac, and Kyocera for substantially all of our ceramic chip packages |
| We also rely on ImPac, our equity investee, for our plastic chip packages |
| We rely on XinTec, another investee company, for chip scale packages, which are generally used in our products designed for the smallest form factor applications |
| We do not have long-term agreements with any of these service providers and typically obtain services on a purchase order basis |
| If for any reason one or more of these service providers becomes unable or unwilling to continue to provide color filter processing or packaging services of acceptable quality, at acceptable costs and in a timely manner, our ability to deliver our products to our customers could be severely impaired |
| We would have to identify and qualify substitute service providers, which could be time consuming and difficult and could result in unforeseen operational problems |
| Substitute service providers might not be available or, if available, might be unwilling or unable to offer services on acceptable terms |
| In addition, if competition for color filter processing or packaging capacity increases, we may be required to pay or invest significant amounts to secure access to these services, which could adversely impact our operating results |
| The number of companies that provide these services is limited and some of them have limited operating histories and financial resources |
| Furthermore, if customer demand for our products increases, we may be unable to secure sufficient additional capacity from our current service providers on commercially reasonable terms, if at all |
| Moreover, our reliance on a limited number of third party service providers to provide color filter processing services subjects us to reduced control over delivery schedules, quality assurance and costs |
| This lack of control may cause unforeseen product shortages or may increase 17 _________________________________________________________________ [47]Table of Contents our costs of manufacturing, assembling or testing of our products, which would adversely affect our operating results |
| Declines in our average selling prices may result in declines in our revenues and gross margins |
| We have experienced and expect to continue to experience pressure to reduce the selling prices of our products, and our average selling prices have declined as a result |
| Competition in our product markets is intense and as this competition continues to intensify, we anticipate that these pricing pressures will increase |
| We expect that the average selling prices for many of our products will continue to decline over time |
| Unless we can increase unit sales sufficiently to offset these declines in our average selling prices, our revenues will decline |
| If we cannot reduce manufacturing costs to compensate, reductions in our selling prices will cause a decline in our gross margins and could materially and adversely affect our operating results and impair our financial condition |
| We have increased and intend to continue to increase our research, development and related expenses to continue the development of new image sensor products in fiscal years 2007 and 2008 that can be sold at higher selling prices and/or manufactured at lower cost |
| However, if we are unable to timely introduce new products that incorporate more advanced technology and include more advanced features that can be sold at higher average selling prices, or if we are unable to reduce manufacturing costs, our financial results could be adversely affected |
| Changes in accounting rules for stock-based compensation will adversely affect our reported operating results, and may adversely affect our stock price and our competitiveness in the employee marketplace |
| Since our founding, we have used employee stock options and other stock-based compensation to hire, motivate and retain our employees |
| In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Nodtta 123R, “Share-Based Payment,” which will require that, beginning in the first quarter of fiscal 2007, the quarter ending July 31, 2006, we measure compensation costs for all stock-based compensation (including stock options) at fair value and recognize these costs as expenses in our consolidated statements of income |
| The recognition of these expenses in our statements of income will have a negative affect on our earnings per share, which could negatively impact our future stock price |
| In addition, if we reduce or alter our use of stock-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace |
| Problems with wafer manufacturing and/or back-end processing yields could result in higher product costs and could impair our ability to meet customer demand for our products |
| If the foundries manufacturing the wafers used in our products cannot achieve the yields we expect, we will incur higher per unit costs and reduced product availability |
| Foundries that supply our wafers have experienced problems in the past achieving acceptable wafer manufacturing yields |
| Wafer yields are a function of both of our design technology and the particular foundry’s manufacturing process technology |
| Certain risks are inherent in the introduction of such new products and technology |
| Low yields may result from design errors or manufacturing failures in new or existing products |
| Unlike many other semiconductor products, optical products can be effectively tested only when they are complete |
| Accordingly, we perform final testing of our products only after they are assembled |
| The risks associated with low yields could be increased because we rely on third party offshore foundries for our wafers, which can increase the effort and time required to identify, communicate and resolve manufacturing yield problems |
| In addition to wafer manufacturing yields, our products are subject to yield loss in subsequent manufacturing steps, often referred to as back-end processing, such as the application of color filters and micro-lenses, dicing (cutting the wafer into individual devices, or die) and packaging |
| Any of these potential problems with wafer manufacturing and/or back-end processing yields could result in a reduction in our gross margins and/or our ability to timely deliver products to customers, which could adversely affect our customer relations and make it more difficult to sustain and grow our business |
| For example, lower back-end yields on two of our products adversely impacted our gross margins for the fiscal quarters ended April 30, 2005, July 31, 2005 and October 31, 2005 |
| If we do not forecast customer demand correctly, our business could be impaired and our stock price may decline |
| Our sales are generally made on the basis of purchase orders rather than long-term purchase commitments; however, we manufacture products and build inventory based on our estimates of customer demand |
| Accordingly, we must rely on multiple assumptions about forecasted customer demand |
| We are continually working to improve 18 _________________________________________________________________ [48]Table of Contents our sales forecasting procedures |
| If we overestimate customer demand, we may manufacture products that we may be unable to sell, or we may have to sell to other customers at lower prices |
| This could materially and adversely affect our results of operations and financial condition |
| In addition, our customers may cancel or defer orders at any time |
| We have experienced problems with accurately forecasting customer demand in the past |
| For example, beginning in the third quarter of fiscal 2001, major demand for our image-sensor products for use in PC cameras decreased significantly and one of our OEM customers unexpectedly canceled its purchase orders |
| We are required to accurately predict customer demand because we must often make commitments to have products manufactured before we receive firm purchase orders from our customers |
| If we underestimate customer demand, we may be unable to manufacture sufficient products quickly enough to meet actual demand, causing us to lose customers and impairing our ability to grow our business |
| In preparation for new product introductions, we gradually ramp down production of established products |
| With our 12-14 week production cycle, it is extremely difficult to predict precisely how many units of established products we will need |
| The length of our production cycle required that we increase work-in-process inventory during the second quarter of fiscal 2006 in anticipation of increased sales activity during and following the third quarter of fiscal 2006 |
| It is also difficult to accurately predict the speed of the ramp of our new products and the impact on inventory levels presented by the shorter life cycles of end-user products |
| The shorter product life cycle is a result of an increase in competition and the growth of various consumer-product applications for image sensors |
| For example, although in the security and surveillance market we continue to sell image-sensor products introduced more than four years ago, in the camera cell phone market, the product life cycle of image sensors can be as little as six months |
| Under these circumstances, it is possible that we could suffer from shortages for certain products and, if we underestimate market demand, we face the risk of being unable to fulfill customer orders |
| We also face the risk of excess inventory and product obsolescence if we overestimate market demand for our products and build inventories in excess of demand |
| Our ability to accurately forecast sales is also a critical factor in our ability to meet analyst expectations for our quarterly and annual operating results |
| Any failure to meet these expectations would likely lead to a substantial decline in our stock price |
| We depend on the increased acceptance of mass-market image sensor applications to grow our business and increase our revenues |
| Our business strategy depends in large part on the continued growth of various markets into which we sell our image-sensor products, including the markets for camera cell phones, digital still and video cameras, commercial and security and surveillance applications and toys and games, including interactive video games |
| Our ability to sustain and grow our business also depends on the continued development of new markets for our products such as cameras for embedded applications for personal computers, automotive applications and medical imaging devices |
| If these current and new markets do not grow and develop as anticipated, we may be unable to sustain or grow the sales of our products |
| In addition, the market price of our common stock may be adversely affected if certain of these new markets do not emerge or develop as expected |
| Securities analysts may already factor revenue from such new markets into their future estimates of our financial performance and should such markets not develop as expected by such securities analysts the trading price of our common stock could be adversely affected |
| Our lengthy manufacturing, packaging and assembly cycle, in addition to our customers’ design cycle, may result in uncertainty and delays in generating revenues |
| The production of our image sensors requires a lengthy manufacturing, packaging and assembly process, typically lasting approximately 12-14 weeks |
| Additional time may pass before a customer commences volume shipments of products that incorporate our image sensors |
| Even when a manufacturer decides to design our image sensors into its products, the manufacturer may never ship final products incorporating our image sensors |
| Given this lengthy cycle, we experience a delay between the time we incur expenditures for research and development and sales and marketing efforts and the time we generate revenue, if any, from these expenditures |
| This delay makes it more difficult to forecast customer demand, which adds uncertainty to the manufacturing planning process and could adversely affect our operating results |
| In addition, the product life cycle for certain of our image-sensor products designed for use in certain applications can be relatively short |
| If we fail to appropriately manage the manufacturing, packaging and assembly process, our products may become obsolete before they can be incorporated into our customers’ products and we may never realize a return on investment for the expenditures we incur in developing and producing these products |
| 19 _________________________________________________________________ [49]Table of Contents Our ability to deliver products that meet customer demand is dependent upon our ability to meet new and changing requirements for color filter application and sensor packaging |
| We expect that as we develop new products to meet technological advances and new and changing industry and customer demands, our color filter application and ceramic, plastic and chip-scale packaging requirements will also evolve |
| Our ability to continue to profitably deliver products that meet customer demand is dependent upon our ability to obtain third party services that meet these new requirements on a cost-effective basis |
| We have historically relied exclusively on third parties, and more recently, on one of our joint ventures, to provide these services |
| There can be no assurances that any of these parties will be able to develop enhancements to the services they provide to us to meet these new and changing industry and customer requirements |
| Furthermore, even if these service providers are able to develop their services to meet new and evolving requirements, these services may not be available at a cost that enables us to sustain our profitability |
| The high level of complexity and integration of our products increases the risk of latent defects, which could damage customer relationships and increase our costs |
| Because we integrate many functions on a single chip, our products are complex and are based upon evolving technology |
| The integration of additional functions into the complex operations of our products could result in a greater risk that customers or end users could discover latent defects or subtle faults after volumes of product have already been shipped |
| Although we test our products, we have in the past and may in the future encounter defects or errors |
| For example, in the third quarter of fiscal 2005, we made a provision of dlra2dtta7 million related to the possible replacement of products that did not meet a particular customer’s specifications |
| Delivery of products with defects or reliability, quality or compatibility problems may damage our reputation and ability to retain existing customers and attract new customers |
| In addition, product defects and errors could result in additional development costs, diversion of technical resources, delayed product shipments, increased product returns, product warranty costs for recall and replacement and product liability claims against us which may not be fully covered by insurance |
| Historically, our revenues have been dependent upon a few key customers, the loss of one or more of which could significantly reduce our revenues |
| Historically, a relatively small number of OEMs, VARs and distributors have accounted for a significant portion of our revenues |
| Any material delay, cancellation or reduction of purchase orders from one of our major customers or distributors could result in our failure to achieve anticipated revenue for a particular period |
| If we are unable to retain one or more of our largest OEM, distributor or VAR customers, or if we are unable to maintain our current level of revenues from one or more of these significant customers, our business and results of operation would be impaired and our stock price could decrease, potentially significantly |
| In fiscal 2006, two OEM customers accounted for approximately 14dtta6prca and 11dtta6prca of our revenues |
| In fiscal 2006, one distributor accounted for approximately 13dtta7prca of our revenues |
| Our business, financial condition, results of operations and cash flows will continue to depend significantly on our ability to retain our current key customers and attract new customers, as well as on the financial condition and success of our OEMs, VARs and distributors |
| Our customers experience fluctuating product cycles and seasonality, which could cause our results of operations to fluctuate from period to period |
| Many of the products using our image sensors, such as digital still cameras, camera cell phones and cameras for toys and games, are consumer electronics goods |
| These mass-market camera devices generally have seasonal cycles which historically have caused the sales of our customers to fluctuate quarter-to-quarter |
| These seasonal demand patterns could, in turn, cause our results of operations to fluctuate from period to period |
| Historically, demand from OEMs and distributors that serve such consumer product markets has been stronger in the second and third quarters of our fiscal year and weaker in the first and fourth quarters of our fiscal year |
| If we fail to predict accurately and respond appropriately on a timely basis to meet seasonal fluctuations, or if there is any disruption of consumer buying habits during these key periods, our business and operating results would be harmed |
| Fluctuations in our quarterly operating results make it difficult to predict our future performance and may result in volatility in the market price of our common stock |
| Our quarterly operating results have varied significantly from quarter-to-quarter in the past and are likely to vary significantly in the future based on a number of factors, many of which are beyond our control |
| These factors and other industry risks, many of which are more fully discussed in our other risk factors, include: • the volume and mix of our product sales; 20 _________________________________________________________________ [50]Table of Contents • competitive pricing pressures; • our ability to accurately forecast demand for our products; • our ability to achieve acceptable wafer manufacturing or back-end processing yields; • our gain or loss of a large customer; • our ability to manage our product transitions; • the availability of production capacities at the semiconductor foundries that manufacture our products or components of our products; • the growth of the market for products and applications using CMOS image sensors; • the timing and size of orders from our customers; • the volume of our product returns; • the seasonal nature of customer demand for our products; • the deferral of customer orders in anticipation of new products, product designs or enhancements; • the announcement and introduction of products and technologies by our competitors; and • the level of our operating expenses |
| Our introduction of new products and our product mix have affected and may continue to affect our quarterly operating results |
| Changes in our product mix could adversely affect our operating results, because some products provide higher margins than others |
| We typically experience lower yields when manufacturing new products through the initial production phase, and consequently our gross margins on new products have historically been lower than our gross margins on our more established products |
| We also anticipate that the rate of orders from our customers may vary significantly from quarter to quarter |
| Our operating expenses are relatively fixed, and our inventory levels are based on our expectations of future revenues |
| Consequently, if we do not achieve the revenues we expect in any quarter, expenses and inventory levels could be disproportionately high, and our operating results for that quarter, and potentially future quarters, may be harmed |
| All of these factors are difficult to forecast and could result in fluctuations in our quarterly operating results |
| Our operating results in a given quarter could be substantially less than anticipated, and, if we fail to meet market analysts’ expectations, a substantial decline in our stock price could result |
| Fluctuations in our quarterly operating results could adversely affect the price of our common stock in a manner unrelated to our long-term operating performance |
| We may be required to record a significant charge to earnings if our goodwill or amortizable intangible assets become impaired |
| Under generally accepted accounting principles, we are required to review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable |
| We are required to test goodwill for impairment at least annually |
| Factors that may be considered a change in circumstances indicating that the carrying value of our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, and slower growth rates in our industry |
| We may be required to record a significant charge to earnings in our financial statements during the period in which we determine that our goodwill or amortizable intangible assets have been impaired |
| Any such charge would adversely impact our results of operations |
| As of April 30, 2006, our goodwill and amortizable intangible assets totaled approximately dlra31dtta1 million |
| We maintain a backlog of customer orders that is subject to cancellation or delay in delivery schedules, and any cancellation or delay may result in lower than anticipated revenues |
| Our sales are generally made pursuant to standard purchase orders |
| We include in our backlog only those customer orders for which we have accepted purchase orders and assigned shipment dates within the upcoming 12 months |
| Orders constituting our current backlog are subject to cancellation or changes in delivery schedules, and backlog may not necessarily be an indication of future revenue |
| Any cancellation or delay in orders which constitute our current or future backlog may result in lower than expected revenues |
| 21 _________________________________________________________________ [51]Table of Contents If we are unable to maintain processes and procedures to sustain effective internal control over our financial reporting, our ability to provide reliable and timely financial reports could be harmed and this could have a material adverse effect on our stock price |
| We are required to comply with the rules promulgated under Section 404 of the Sarbanes-Oxley Act of 2002 |
| Section 404 requires that we prepare an annual management report assessing the effectiveness of our internal control over financial reporting, and requires a report by our independent registered public accounting firm addressing this assessment, and addressing the effectiveness of our internal control |
| We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement |
| For example, we restated our financial statements for the first, second and third quarters of fiscal 2004 |
| The restatements arose out of an internal review which was initiated in response to issues raised by an employee |
| We notified the Audit Committee of our board of directors of the issues raised, and the Audit Committee, with assistance from special legal counsel, conducted its own independent investigation |
| As a result of the internal review and the independent investigation, management and the Audit Committee determined that certain errors had occurred which principally affected the timing of revenue recognition for certain sales |
| The independent investigation concluded that there was no evidence of wrongdoing in connection with these errors, but, nevertheless, to correct these errors, we did restate our financial results for the first three quarters of fiscal 2004 |
| If these or similar types of issues were to arise with respect to our internal controls in future periods, they could impair our ability to produce accurate and timely financial reports |
| As our business expands, ongoing compliance with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 and maintenance of effective internal controls will require that we hire additional qualified finance and accounting personnel |
| Because other businesses face similar challenges, there is significant competition for such personnel, and there can be no assurance that we will be able to attract and/or retain suitably qualified employees |
| Corporate governance regulations have recently increased our compliance costs and could further increase our expenses if changes occur within our business |
| Changes in laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act, have imposed new requirements on us and on our officers, directors, attorneys and independent registered public accounting firm |
| In order to comply with these new rules, we added internal resources and have utilized additional outside legal, accounting and advisory services, which increased our operating expenses in fiscal 2005 and fiscal 2006 as compared to prior fiscal years |
| We expect to incur ongoing operating expenses as we maintain compliance with Section 404 |
| In addition, if we undergo significant modifications to our structure through personnel or system changes, acquisitions, or otherwise, it may be increasingly difficult to maintain compliance with the existing and evolving corporate governance regulations |
| There are risks associated with our operations in China |
| In December 2000, we established Hua Wei Semiconductor (Shanghai) Co |
| Ltd, or HWSC, as part of our efforts to streamline our manufacturing process and reduce the costs and working capital associated with the testing of our image-sensor products, and relocated our automated image testing equipment from the United States to China |
| However, there are significant administrative, legal and governmental risks to operating in China that could result in increased operating expenses or that could prevent us from achieving our objectives in operations |
| The risks from operating in China that could increase our operating expenses and adversely affect our operating results, financial condition and ability to deliver our products and grow our business include, without limitation: • difficulties in staffing and managing foreign operations, particularly in attracting and retaining personnel qualified to design, sell and support CMOS image sensors; • difficulties in coordinating our operations in China with those in California; • diversion of management attention; • difficulties in maintaining uniform standards, controls, procedures and policies across our global operations, including inventory management and financial consolidation; 22 _________________________________________________________________ [52]Table of Contents • political and economic instability, which could have an adverse impact on foreign exchange rates in Asia and could impair our ability to conduct our business in China; and • inadequacy of the local infrastructure to support our needs |
| We may experience integration or other problems with potential future acquisitions, which could have an adverse effect on our business or results of operations |
| New acquisitions could dilute the interests of existing stockholders, and the announcement of new acquisitions could result in a decline in the price of our common stock |
| We may in the future make other acquisitions of, or investments in, businesses that offer products, services and technologies that we believe would complement our products, including CMOS image sensor manufacturers |
| We may also make acquisitions of, or investments in, businesses that we believe could expand our distribution channels |
| Even if we were to announce an acquisition, we may not be able to complete it |
| In addition, any future acquisition or substantial investment could present numerous risks, including: • difficulty in realizing the potential technological benefits of the transaction; • difficulty in integrating the technology, operations or work force of the acquired business with our existing business; • unanticipated expenses related to technology integration; • disruption of our ongoing business; • difficulty in realizing the potential financial or strategic benefits of the transaction; • difficulty in maintaining uniform standards, controls, procedures and policies; • possible impairment of relationships with employees, customers, suppliers and strategic partners as a result of integration of new businesses and management personnel; • reductions in our future operating results from amortization of intangible assets • impairment of resulting goodwill; and • potential unknown or unexpected liabilities associated with acquired businesses |
| We expect that any future acquisitions could include consideration to be paid in cash, shares of our common stock or a combination of cash and our common stock |
| If and when consideration for a transaction is paid in common stock, it will result in dilution to our existing stockholders |
| We may never achieve the anticipated benefits from our joint venture with TSMC In October 2003, we entered into an agreement with TSMC to form VisEra, a joint venture in Taiwan, for the purposes of providing manufacturing services and automated final testing services |
| In August 2005, we amended and restated our agreement with TSMC in part to enable VisEra to acquire approximately 30prca of XinTec, a supplier of chip-scale packaging services in which we originally invested in April 2003 and in which we directly hold an approximate eight percent interest |
| As a result of our step acquisition of VisEra, and in accordance with the provisions of FIN 46, we consolidated the results of VisEra beginning in our fiscal quarter ended October 31, 2005 |
| Any loss that VisEra incurs will negatively impact our reported earnings |
| In January 2006, VisEra acquired certain color filter processing equipment from TSMC and assumed direct responsibility for providing the color filer processing services that had previously been provided by TSMC We expect that VisEra will be able to provide us with a committed supply of high quality manufacturing services at competitive prices and automated final testing services |
| However, there are significant legal, governmental and relationship risks to developing VisEra, and we cannot ensure that we will receive the expected benefits from the joint venture |
| For example, VisEra may not be able to provide manufacturing services or automated testing services that have competitive technology or prices, which could adversely affect our product offerings and our ability to meet customer requirements for our products |
| In addition, the existence of VisEra may also make it more difficult for us to secure dependable services from competing merchant vendors who provide similar manufacturing services |
| We may not achieve the anticipated benefits of our alliances with, and strategic investments in, third parties |
| We expect to develop our business partly through forming alliances or joint ventures with and making strategic investments in other companies, some of which may be companies at a relatively early stage of 23 _________________________________________________________________ [53]Table of Contents development |
| For example, in April 2003, we made an investment in XinTec, a chip scale packaging service company, and in June 2003 we made an investment in ImPac, a plastic packaging service company |
| In October 2005, VisEra, our joint venture with TSMC, completed the acquisition of a further approximately 30prca of the issued and outstanding shares of XinTec |
| In May 2004, we entered into an agreement with PSC under which we established Silicon Optronics, Inc, or SOI, a joint venture as a company incorporated under the laws of Taiwan, and we contributed dlra2dtta1 million in exchange for an ownership percentage of approximately 49prca |
| The purpose of the joint venture is to conduct the business of manufacturing, marketing and selling certain of our legacy products |
| On April 30, 2005, after we appointed a majority of the board of directors, we began to consolidate SOI Our investments in these companies may negatively impact our operating results, because, under certain circumstances, we are required to recognize our portion of any loss recorded by each of these companies or to consolidate them into our operating results |
| We expect to continue to utilize partnerships, strategic alliances and investments, particularly those that enhance our manufacturing capacity and those that provide manufacturing services and testing capability |
| These investments and partnering arrangements are crucial to our ability to grow our business and meet the increasing demands of our customers |
| However, we cannot ensure that we will achieve the benefits expected as a result of these alliances |
| For example, we may not be able to obtain acceptable quality and/or wafer manufacturing yields from these companies, which could result in higher operating costs and could impair our ability to meet customer demand for our products |
| In addition, certain of these investments or partnering relationships may place restrictions on the scope of our business, the geographic areas in which we can sell our products and the types of products that we can manufacture and sell |
| For example, our agreement with TSMC provides that we may not engage in business that will directly compete with the business of VisEra |
| This type of non-competition provision may impact our ability to grow our business and to meet the demands of our customers |
| Several of these companies are at a relatively early stage of development and consequently they may continue to incur losses on a quarterly and annual basis for an extended period |
| Changes in our relationships with our joint ventures and/or companies in which we hold less than a majority interest could change the way we account for such interests in the future |
| As part of our strategy, we have formed joint ventures with two of our foundry partners, and we hold a minority interest in two companies from which we purchase certain manufacturing services |
| Under the applicable provisions of generally accepted accounting principles in the United States of America, including FIN 46, we currently consolidate the financial statements and results of operations of both joint ventures into our consolidated financial statements and results of operations, and record the equity interests that we do not own as minority interests |
| For certain of our other investments, accounted for under the equity method, we record as part of other income or expense our share of the increase or decrease in the equity of the companies in which we have invested |
| It is possible that, in the future, our relationships and/or our interests in or with these joint ventures or equity method investees could change |
| Such potential future changes could result in deconsolidation or consolidation of such entities, as the case may be, which could result in changes in our reported results |
| We may be unable to adequately protect our intellectual property, and therefore we may lose some of our competitive advantage |
| We rely on a combination of patent, copyright, trademark and trade secret laws as well as nondisclosure agreements and other methods to protect our proprietary technologies |
| We have been issued patents and have a number of pending United States and foreign patent applications |
| However, we cannot provide assurance that any patent will be issued as a result of any applications or, if issued, that any claims allowed will be sufficiently broad to protect our technology |
| It is possible that existing or future patents may be challenged, invalidated or circumvented |
| For example, in August 2002 we initiated a patent infringement action in Taiwan, Republic of China against IC Media Corporation of San Jose, California for infringement of a Taiwanese patent that had been issued to us |
| In response to our patent infringement action, in October 2002, IC Media Corporation initiated a cancellation proceeding in the Taiwan Intellectual Property Office with respect to our patent |
| In July 2003, the Taiwan Intellectual Property Office made an initial determination to grant the cancellation of the subject patent, which decision was upheld by the Taiwan Ministry of Economic Affairs and the High Administrative Court |
| We decided not to appeal such decision by the May 31, 2005 deadline |
| Although we do not believe the cancellation of the Taiwanese patent at issue in the dispute described above will have a material adverse effect on our business or prospects, there may be other situations where our inability to adequately protect our intellectual property rights 24 _________________________________________________________________ [54]Table of Contents could materially and adversely affect our competitive position and operating results |
| If a third party can copy or otherwise obtain and use our products or technology without authorization, develop corresponding technology independently or design around our patents, this could materially adversely affect our business and prospects |
| Effective patent, copyright, trademark and trade secret protection may be unavailable or limited in foreign countries |
| Any disputes over our intellectual property rights, whatever the ultimate resolution of such disputes, may result in costly and time-consuming litigation or require the license of additional elements of intellectual property for a fee |
| Litigation regarding intellectual property could divert management attention, be costly to defend and prevent us from using or selling the challenged technology |
| In recent years, there has been significant litigation in the United States involving intellectual property rights, including in the semiconductor industry |
| We have in the past been, and may in the future be, subject to legal proceedings and claims with respect to our intellectual property, including such matters as trade secrets, patents, product liabilities and other actions arising out of the normal course of business |
| These claims may increase as our intellectual property portfolio becomes larger or more valuable |
| Intellectual property claims against us, and any resulting lawsuit, may cause us to incur significant expenses, subject us to liability for damages and invalidate our proprietary rights |
| In fiscal 2002 we paid dlra3dtta5 million to settle an intellectual property litigation matter |
| Any potential intellectual property litigation against us would likely be time-consuming and expensive to resolve and would divert management’s time and attention and could also force us to take actions such as: • ceasing the sale or use of products or services that incorporate the infringed intellectual property; • obtaining from the holder of the infringed intellectual property a license to sell or use the relevant technology, which license may not be available on acceptable terms, if at all; or • redesigning those products or services that incorporate the disputed intellectual property, which could result in substantial unanticipated development expenses and delay and prevent us from selling the products until the redesign is completed, if at all |
| If we are subject to a successful claim of infringement and we fail to develop non-infringing intellectual property or license the infringed intellectual property on acceptable terms and on a timely basis, we may be unable to sell some or all of our products, and our operating results could be adversely affected |
| We may in the future initiate claims or litigation against third parties for infringement of our intellectual property rights or to determine the scope and validity of our proprietary rights or the proprietary rights of competitors |
| These claims could also result in significant expense and the diversion of technical and management attention |
| We have been named as a defendant in certain litigation that could have a material adverse impact on our operating results and financial condition |
| We are currently a defendant in ongoing litigation matters as |