| Before purchasing our common stock, you should carefully consider the risks described below in addition to the other information in this Report |
| Our business, results of operations and financial condition may be materially and adversely affected due to any of the following risks |
| Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations |
| The trading price of our common stock could decline due to any of these risks, and you could lose all or part of your investment |
| In assessing these risks, you should also refer to the other information contained or incorporated by reference in this Report, including our consolidated financial statements and related notes |
| This Report contains forward-looking statements based on the current expectations, assumptions, estimates and projections about our industry and us |
| These forward-looking statements involve risks and uncertainties |
| Our actual results could differ materially from those discussed in these forward-looking statements as a result of certain factors, as more fully described in this section and elsewhere in this Report |
| We do not undertake to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future |
| We expect our quarterly operating results to fluctuate in future periods, causing our stock price to fluctuate or decline |
| Our quarterly operating results have fluctuated in the past, and we believe they will continue to do so in the future |
| Our future results of operations will depend on many factors including: • Our suppliers’ production levels for the components used in our products; • Our ability to procure required components or fluctuations in the cost of such components; • Fluctuating market demand for, and changes in the average sales prices of our products; • Changes in our customer and product revenue mix; • Our ability to successfully integrate any acquired businesses or assets; • Seasonal purchasing patterns for our Consumer Division products with lower sales generally occurring in the first and second quarters followed by higher sales in the fourth quarter of each year; • Market acceptance of new and enhanced versions of our products; • Expansion of our international business, including the opening of offices and facilities in foreign countries; • The timing of the introduction of new products or components and enhancements to existing products or components by us, our competitors or our suppliers; • Order cancellations, product returns, inventory write-downs, price protections, and rebates; • Manufacturing inefficiencies associated with the start-up of new products and volume production; • Expenses associated with strategic transactions, including acquisitions, joint ventures and capital investments; • Our ability to adequately support future rapid growth; • Our ability to absorb manufacturing overhead; • The effects of litigation; • Increases in our sales and marketing expenses in connection with decisions to pursue new product initiatives; and • Expenses associated with the start up of new operations or divisions |
| Due to the above and other factors, quarterly revenues and results of operations are difficult to forecast, and period-to-period comparisons of our operating results may not be predictive of future performance |
| In one or more future quarters, our results of operations may fall below the expectations of securities analysts and investors |
| In that event, the trading price of our common stock would likely decline |
| In addition, the trading price of our common stock may fluctuate or decline regardless of our operating performance |
| Our dependence on a small number of suppliers for integrated circuit, or IC, devices and inability to obtain a sufficient supply of these components on a timely basis could harm our ability to fulfill orders |
| Typically, IC devices represent more than 90prca of the component costs of our manufactured Flash cards and DRAM modules |
| We are dependent on a small number of suppliers that supply Flash and DRAM components |
| We have no long-term DRAM of Flash IC device supply contracts |
| Some of our competitors have entered into long-term contracts with suppliers that guarantee them a certain allocation of Flash IC devices |
| We have no assurance that our existing suppliers will agree to supply the quantities of Flash IC devices we may need to meet our production goals |
| We periodically review opportunities to develop alternative sources for our Flash and DRAM IC device needs |
| However, our options are very limited because of the small number of memory manufacturers |
| Our dependence on a small number of suppliers and the lack of any guaranteed 15 ______________________________________________________________________ [40]Table of Contents sources of supply expose us to several risks, including the inability to obtain an adequate supply of components, price increases, late deliveries and poor component quality |
| Samsung and ST Microelectonics supply substantially all of the IC devices used in our Flash memory products |
| In addition, Elpida, Infineon Technologies and Samsung currently supply a majority of the DRAM IC devices used in our DRAM and IC Tower stacking DRAM memory products |
| A disruption in or termination of our supply relationship with any of these significant suppliers due to natural disasters or other factors, or our inability to develop relationships with new suppliers, if required, would cause delays, disruptions or reductions in product shipments or require product redesigns which could damage relationships with our customers and negatively affect our revenues and could increase our costs or the prices of our products |
| In particular, if our supply relationships with Elpida, Infineon Technologies, Samsung and ST Microelectonics are disrupted or terminated, our ability to manufacture and sell our DRAM and Flash products would be harmed and our business would be adversely affected |
| Moreover, from time to time, our industry experiences shortages in Flash and DRAM IC devices which have driven up the price of those components and required some vendors to place their customers, ourselves included, on component allocation |
| This means that while we may have customer orders, we may not be able to obtain the materials that we need to fill those orders in a timely manner or at competitive prices |
| If we are unable to obtain Flash and DRAM IC devices at economical prices, our gross margins would decline unless we could raise the prices of our products in a commensurate manner or offset the cost increases elsewhere |
| In addition, if we are unable to obtain sufficient Flash IC devices and other components to meet our customers’ requirements, they may reduce future orders or eliminate us as a supplier and our revenues may decline |
| As a result, our reputation could be harmed, we may not be able to replace any lost business with new customers, and we may lose market share to our competitors |
| Ineffective management of inventory levels or product mix, order cancellations, product returns, inventory write-downs, price protection and rebates could adversely affect our results of operations |
| If we are unable to properly monitor, control and manage our inventory and maintain an appropriate level and mix of products with our customers, we may incur increased and unexpected costs associated with this inventory |
| For example, if our Consumer Division customers are unable to sell their inventory in a timely manner, we may choose or be required to lower the price of our products or allow our customers to exchange the slow-moving products for newer products |
| Similarly, if we manufacture products in anticipation of future demand that does not materialize, or if a customer cancels outstanding orders, we could experience an unanticipated increase in our inventory that we may be unable to sell in a timely manner, if at all |
| A majority of our sales through commercial channels include limited rights to return unsold inventory |
| In addition, while we may not be contractually obligated to accept returned products, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers |
| Product returns would increase our inventory and reduce our revenues |
| In addition, some of our inventory is shipped on a consignment basis, and we have very little ability to control or manage that inventory |
| Alternatively, we could end up with too little inventory and we may not be able to satisfy demand, which could have a material adverse effect on our customer relationships |
| Our risks related to inventory management are exacerbated by our strategy of closely matching inventory levels with product demand, leaving limited margin for error |
| We have had to write-down inventory in the past for reasons such as obsolescence, excess quantities and declines in market value below our costs |
| These inventory write-downs were dlra1dtta4 million in 2005, dlra1dtta1 million in 2004 and dlra367cmam000 in 2003 |
| In addition, we offer some of our Consumer Division customers limited price protection rights for inventories of our products held by them |
| If we reduce the list price of our products, these customers may receive credits from us |
| We also offer rebate programs through some of our Consumer Division customers to end-users |
| Rebate charges increased significantly in 2005 compared to 2004 due primarily to the expansion of our revenues from the retail channel, which typically involves the frequent use of rebate programs |
| Price protection and rebate charges declined in 2004 compared to 2003 due primarily to a reduction of the number of customers that we offer price protection and rebate programs to as a result of our decision to reduce the sales of our Flash products into certain unprofitable sales channels |
| We are also subject to repurchase agreements with various financial institutions in connection with wholesale inventory financing |
| Under these agreements, we may be required to repurchase inventory upon customer default with a financing institution and then resell the inventory through normal distribution channels |
| As of December 31, 2005, we have never been required to repurchase inventory in connection with the customer default agreements noted above |
| However, it may be possible that we will be required to repurchase inventory, upon customer default, in the future |
| Sales under such agreements were dlra1dtta3 million in 2005, dlra1dtta1 million in 2004 and dlra1dtta2 million in 2003 |
| We have no long-term volume commitments from our customers |
| Sales of our products are made through individual purchase orders and, in certain cases, are made under master agreements governing the terms and conditions of the relationships |
| 16 ______________________________________________________________________ [41]Table of Contents Customers may change, cancel or delay orders with limited or no penalties |
| We have experienced cancellations of orders and fluctuations in order levels from period-to-period and we expect to continue to experience similar cancellations and fluctuations in the future, which could result in fluctuations in our revenues |
| Declines in our average sales prices may result in declines in our revenues and gross profit |
| Our industry is competitive and characterized by historical declines in average sales prices |
| From time to time, overcapacity in the DRAM memory component market has resulted in significant declines in component prices, which has negatively impacted our average sales prices, revenues and gross profit |
| During periods of overcapacity, our revenues and gross profit will decline if we do not increase unit sales of existing products or fail to introduce and sell new products in quantities sufficient to offset declines in sales prices |
| Any efforts to reduce costs and develop new products to offset the impact of further declines in average sales prices may not be successful |
| Declines in average sales prices would also enable OEMs to pre-install higher capacity base memory into new systems at existing price points, and thereby reduce the demand for our aftermarket memory products |
| Our competitors and customers also impose significant pricing pressures on us |
| Since a large percentage of our sales are to a small number of customers that are primarily retail consumer chains, distributors and large OEMs, these customers have exerted, and we expect they will continue to exert, pressure on us to make price concessions |
| In addition, the continued transition to smaller design geometries and the use of 300 millimeter wafers by existing memory manufacturers could lead to a significant increase in the worldwide supply of DRAM and Flash components |
| Increases in the worldwide supply of DRAM and Flash components could also result from manufacturing capacity expansions |
| If not offset by increases in demand, these increases would likely lead to further declines in the average sales prices of our products and have a material adverse effect on our business and operating results |
| Furthermore, even if supply remains constant, if demand were to decrease, it would harm our average sales prices |
| We are subject to the cyclical nature of the semiconductor industry and any future downturn could continue to adversely affect our business |
| The semiconductor industry, including the memory markets in which we compete, is highly cyclical and characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand |
| The industry has experienced significant downturns often connected with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions |
| These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average sales prices |
| Prior downturns in the semiconductor industry negatively impacted our average sales prices, revenues and earnings |
| Any future downturns could have a material adverse effect on our business and results of operations |
| Sales to a limited number of customers represent a significant portion of our revenues, and the loss of any key customer would materially reduce our revenues |
| Our dependence on a limited number of customers means that the loss of a major customer or any reduction in orders by a major customer would materially reduce our revenues |
| Historically, a relatively limited number of customers have accounted for a significant percentage of our revenues |
| Our ten largest customers accounted for an aggregate of 65dtta9prca of our total revenues in 2005, 68dtta4prca of our total revenues in 2004 and 51dtta9prca of our total revenues in 2003 |
| Our ten largest Consumer Division customers accounted for an aggregate of 61dtta8prca of our Consumer Division revenues, or 31dtta6prca of our total revenues, in 2005, 66dtta1prca of our Consumer Division revenues, or 34dtta5prca of our total revenues, in 2004 and 58dtta4prca of our Consumer Division revenues, or 42dtta3prca of our total revenues, in 2003 |
| The following table sets forth certain information about each of our Consumer Division customers that accounted for more than 10dtta0prca of our total revenues in 2005, 2004 and 2003 |
| (formerly CDW Computer Centers) 15dtta0 % 29dtta4 % 17dtta9 % 34dtta2 % 19dtta2 % 26dtta6 % Our ten largest OEM Division customers accounted for an aggregate of 85dtta1prca of our OEM Division revenues, or 41dtta6prca of our total revenues, in 2005, 85dtta9prca of our OEM Division revenues, or 41dtta1prca of our total revenues, in 2004 and 72dtta2prca of our OEM Division revenues, or 19dtta9prca of our total revenues, in 2003 |
| The following table sets forth certain information about each of our OEM Division customers that accounted for more than 10dtta0prca of our total revenues in 2005, 2004 and 2003 |
| 17 ______________________________________________________________________ [42]Table of Contents Year Ended December 31, 2005 Year Ended December 31, 2004 Year Ended December 31, 2003 OEM Division Customers % of Total Revenues % of OEM Division Revenues % of Total Revenues % of OEM Division Revenues % of Total Revenues % of OEM Division Revenues Micron Semiconductor 14dtta2 % 28dtta9 % 21dtta3 % 44dtta6 % * * Smart Modular 18dtta4 % 37dtta6 % 13dtta7 % 29dtta8 % * * _____ * Data not provided since customer represented less than 10prca of total revenues |
| Consolidation in some of our customers’ industries may result in increased customer concentration and the potential loss of customers as a result of acquisitions |
| In addition, the composition of our major customer base changes from quarter to quarter as the market demand for our customers’ products changes, and we expect this variability to continue in the future |
| We expect that sales of our products to a limited number of customers will continue to contribute materially to our revenues in the foreseeable future |
| The loss of, or a significant reduction in purchases by, any of our major customers could harm our business, financial condition and results of operations |
| We may be less competitive if we fail to develop new and enhanced products and introduce them in a timely manner |
| The memory, high-performance computing, networking and communications, consumer electronics and OEM markets are subject to rapid technological change, product obsolescence, frequent new product introductions and enhancements, changes in end-user requirements and evolving industry standards |
| Our ability to compete in these markets will depend in significant part upon our ability to successfully develop, introduce and sell new and enhanced products on a timely and cost-effective basis, and to respond to changing customer requirements |
| We have experienced, and may in the future experience, delays in the development and introduction of new products |
| These delays would provide a competitor a first-to-market opportunity and allow a competitor to achieve greater market share |
| Our product development is inherently risky because it is difficult to foresee developments in technology, anticipate the adoption of new standards, coordinate our technical personnel, and identify and eliminate design flaws |
| Defects or errors found in our products after commencement of commercial shipments could result in delays in market acceptance of these products |
| New products, even if first introduced by us, may not gain market acceptance |
| Accordingly, there can be no assurance that our future product development efforts will result in future profitability or market acceptance |
| Lack of market acceptance for our new products will jeopardize our ability to recoup research and development expenditures, hurt our reputation and harm our business, financial condition and results of operations |
| We may also seek to develop products with new standards for our industry |
| It will take time for these new standards and products to be adopted, for consumers to accept and transition to these new products and for significant sales to be generated from them, if this happens at all |
| Moreover, broad acceptance of new standards or products by consumers may reduce demand for our older products |
| If this decreased demand is not offset by increased demand for our new products, our results of operations could be harmed |
| We cannot assure you that any new products or standards we develop will be commercially successful |
| Our efforts to expand our business internationally may not be successful and may expose us to additional risks that may not exist in the United States, which in turn could cause our business and operating results to suffer |
| We sell our products to customers in foreign countries and seek to increase our level of international business activity through the expansion of our operations into select international markets, including Asia and Europe |
| Such strategy may include opening sales offices in foreign countries, the outsourcing of manufacturing operations to third party contract manufacturers, establishing joint ventures with foreign partners, and the establishment of manufacturing operations in foreign countries |
| Since the beginning of 2004, we have opened sales, marketing and engineering offices in the Netherlands, France, Hong Kong and Taiwan |
| Establishing operations in any other foreign country or region presents numerous risks, including: • foreign laws and regulations, which may vary country by country, may impact how we conduct our business; • higher costs of doing business in certain foreign countries, including different employment laws; • difficulty protecting our intellectual property rights from misappropriation or infringement; • difficulties and costs of staffing and managing operations in certain foreign countries; • political or economic instability; • changes in import/export duties; • necessity of obtaining government approvals; • trade restrictions; • work stoppages or other changes in labor conditions; 18 ______________________________________________________________________ [43]Table of Contents • difficulties in collecting of accounts receivables on a timely basis or at all; • taxes; • longer payment cycles and foreign currency fluctuations; and • seasonal reductions in business activity in some parts of the world, such as Europe |
| In addition, changes in policies and/or laws of the United States or foreign governments resulting in, among other things, higher taxation, currency conversion limitations, restrictions on fund transfers or the expropriation of private enterprises, could reduce the anticipated benefits of our international expansion |
| We may also encounter potential adverse tax consequences if taxing authorities in different jurisdictions worldwide disagree with our interpretation of various tax laws or our determinations as to the income and expenses attributable to specific jurisdictions, which could result in our paying additional taxes, interest and penalties |
| Furthermore, any actions by countries in which we conduct business to reverse policies that encourage foreign trade or investment could adversely affect our business |
| If we fail to realize the anticipated revenue growth of our future international operations, our business and operating results could suffer |
| We expect that our strategy to expand our international operations will require the expenditure of significant resources and involve the efforts and attention of our management |
| Unlike some of our competitors, we have limited experience operating our business in foreign countries |
| Some of our competitors may have substantial advantage over us in attracting customers in certain foreign countries due to earlier established operations in that country, greater knowledge with respect to cultural differences of customers residing in that country and greater brand recognition and longer-standing relationships with customers in that country |
| If our international expansion efforts in any foreign country are unsuccessful, we may decide to cease these foreign operations, which would likely harm our reputation and cause us to incur expenses and losses |
| New accounting and financial reporting requirements, including new standards that affect how we account for equity compensation, may impact our financial results |
| We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America |
| These principles are subject to interpretation by the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies |
| A change in these policies could significantly impact our reported results and could retroactively affect previously reported transactions |
| Historically, we have accounted for employee stock options and employee stock purchase plan shares for financial and accounting purposes under Accounting Principles Board Opinion Nodtta 25, “Accounting for Stock Issued to Employees”, which does not require the expensing of stock options until they are exercised |
| In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Nodtta 123(R), which amended financial accounting standards and require that awards under such plans be treated as compensation expense using the fair value method |
| On April 14, 2005, the US Securities and Exchange Commission adopted a new rule amending the compliance dates for SFAS 123(R) |
| In accordance with the new rule, the accounting provisions of SFAS 123(R) will be effective in fiscal 2006 |
| We believe this revised standard will increase our compensation expense, could make our operating results less predictable and affect the way we compensate our employees or cause other changes in the way we conduct our business |
| For discussion of our employee stock option plan, see Note 11 to our consolidated financial statements —”Stock Option Plan” |
| Failure to maintain effective internal control over financial reporting could result in a negative market reaction |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires that we undertake a thorough examination of our internal control systems and procedures for financial reporting |
| We also are required to completely document and test those systems |
| Ultimately, our management will be responsible for assessing the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm will be requested to attest to that report |
| We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations since there is no precedent available by which to measure compliance adequacy |
| Our filing of our annual report on a timely basis will depend upon our timely completion of these tasks |
| A late annual report could have material adverse effects on us, both legally and with respect to the opinions of the participants in the securities market |
| If we identify one or more material weaknesses in our internal control over financial reporting, our management will be unable to assert such internal controls are effective |
| If we are unable to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to attest that our management’s report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls, it could result in a negative market reaction |
| 19 ______________________________________________________________________ [44]Table of Contents Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses |
| Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules, have required most public companies, including us, to devote additional internal and external resources to various governance and compliance matters |
| Because we have a relatively small corporate staff, we rely heavily on outside professional advisers to assist us with these efforts |
| As of December 31, 2005, we had incurred approximately dlra659cmam000 in connection with these efforts |
| Although we are uncertain about the total costs we will ultimately incur, we know they will at least be substantial |
| These costs will include increased accounting related fees associated with preparing the attestation report on our internal controls over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002 |
| These new or changed laws, regulations and standards are subject to varying interpretations, as well as modifications by the government and Nasdaq |
| The way in which they are applied and implemented may change over time, which could result in even higher costs to address and implement revisions to compliance (including disclosure) and governance practices |
| We intend to invest the necessary resources to comply with evolving laws, regulations and standards |
| If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed and we will be required to incur additional expenses |
| We may make acquisitions that are dilutive to existing shareholders, result in unanticipated accounting charges or otherwise adversely affect our results of operations |
| We intend to grow our business through business combinations or other acquisitions of businesses, products or technologies that allow us to complement our existing product offerings, expand our market coverage, increase our engineering workforce or enhance our technological capabilities |
| If we make any future acquisitions, we could issue stock that would dilute our shareholders’ percentage ownership, incur substantial debt, reduce our cash reserves or assume contingent liabilities |
| Furthermore, acquisitions may require material infrequent charges and could result in adverse tax consequences, substantial depreciation, deferred compensation charges, in-process research and development charges, the amortization of amounts related to deferred compensation and identifiable purchased intangible assets or impairment of goodwill, any of which could negatively impact our results of operations |
| Our limited experience in acquiring other businesses, product lines and technologies may make it difficult for us to overcome problems encountered in connection with any acquisitions we may undertake |
| We continually evaluate and explore strategic opportunities as they arise, including business combinations, strategic partnerships, capital investments and the purchase, licensing or sale of assets |
| Our experience in acquiring other businesses, product lines and technologies is limited |
| The attention of our small management team may be diverted from our core business if we undertake any future acquisitions |
| Our recent acquisition of Memtech SSD, Corporation and any potential future acquisitions also involve numerous risks, including, among others: • Problems and delays in successfully assimilating and integrating the purchased operations, personnel, technologies, products and information systems; • Unanticipated costs and expenditures associated with the acquisition, including any need to infuse significant capital into the acquired operations; • Adverse effects on existing business relationships with suppliers, customers and strategic partners; • Risks associated with entering markets and foreign countries in which we have no or limited prior experience; • Contractual, intellectual property or employment issues; • Potential loss of key employees of purchased organizations; and • Potential litigation arising from the acquired company’s operations before the acquisition |
| These risks could disrupt our ongoing business, distract our management and employees, harm our reputation and increase our expenses |
| Our inability to overcome problems encountered in connection with any acquisitions could divert the attention of management, utilize scarce corporate resources and otherwise harm our business |
| These challenges are magnified as the size of an acquisition increases, and we cannot assure you that we will realize the intended benefits of any acquisition |
| For example, in June 2004 we discontinued the operation of our Xiran Division, which was formed in 2002 as a result of our acquisition of the assets of Irvine Networks, LLC The Xiran Division developed advanced board-level solutions that optimize server performance for networked storage applications, including IP storage |
| We were unable to successfully bring the Xiran Division products to market after funding its operations for over two years |
| In connection with the discontinued operation, we recorded a non-cash charge of approximately dlra3dtta0 million in the second quarter of 2004 |
| 20 ______________________________________________________________________ [45]Table of Contents We are unable to predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed |
| Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions on commercially acceptable terms or realize the anticipated benefits of any acquisitions we do undertake |
| Three of our beneficial shareholders have substantial influence over our operations and could control all matters requiring shareholder approval |
| Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi, each of whom is an executive officer and director of SimpleTech, are brothers and beneficially own approximately 63dtta4prca of our outstanding common stock at December 31, 2005 (assuming the inclusion of shares of common stock subject to options that are presently exercisable or will become exercisable within 60 days of such date) |
| In addition, they have a non-binding understanding that at any shareholders’ meeting of SimpleTech where action is to be taken with respect to the election of directors, they each would cause the shares of SimpleTech common stock beneficially owned by them to be voted in favor of their election as directors |
| As a result, they have the ability to control all matters requiring approval by our shareholders, including the election and removal of directors, approval of significant corporate transactions and the decision of whether a change in control will occur |
| This control could affect the price that certain investors may be willing to pay in the future for shares of our common stock |
| We are involved from time to time in claims and litigation over intellectual property rights, which may adversely affect our ability to manufacture and sell our products |
| The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights |
| We believe that it may be necessary, from time to time, to initiate litigation against one or more third parties to preserve our intellectual property rights |
| Some of our suppliers and licensors have generally agreed to provide us with various levels of intellectual property indemnification for products and technology we purchase or license from them |
| A third-party could claim that our products, which incorporate the products purchased or technology licensed from our suppliers and licensors, infringes a patent or other proprietary right |
| In addition, from time to time, we have received, and may continue to receive in the future, notices that claim we have infringed upon, misappropriated or misused other parties’ proprietary rights |
| Any of the foregoing events or claims could result in litigation |
| Such litigation, whether as plaintiff or defendant, would likely result in significant expense to us and divert the efforts of our technical and management personnel, whether or not such litigation is ultimately determined in our favor |
| In the event of an adverse result in such litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of certain products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses to use the infringed technology |
| In addition, our suppliers’ and licensors’ obligation to indemnify us for intellectual property infringement may be insufficient or inapplicable to any such litigation |
| A license may not be available on commercially reasonable terms, if at all |
| Our failure to obtain a license on commercially reasonable terms, or at all, could cause us to incur substantial costs and suspend manufacturing products using the infringed technology |
| If we obtain a license, we would likely be required to pay license fees or make royalty payments for sales under the license |
| Such payments would increase our costs of revenues and reduce our gross margins and gross profit |
| If we are unable to obtain a license from a third party for technology, we could incur substantial liabilities or be required to expend substantial resources redesigning our products to eliminate the infringement |
| There can be no assurance that we would be successful in redesigning our products or that we could obtain licenses on commercially reasonable terms, if at all |
| Product development or license negotiating would likely result in significant expense to us and divert the efforts of our technical and management personnel |
| We are currently a party to one lawsuit regarding intellectual property as further described under “Legal Proceedings |
| ” Because litigation is inherently uncertain, we cannot predict the outcome of this lawsuit |
| Although this lawsuit has been stayed pending the outcome of related lawsuits against other parties, we expect that if this lawsuit resumes, it is likely to divert the efforts and attention of our key management and technical personnel |
| In addition, we expect to incur substantial legal fees and expenses in connection with this lawsuit if it resumes |
| As a result, our defense of this lawsuit, regardless of its eventual outcome, is expected to be costly and time consuming |
| Our indemnification obligations for the infringement by our products of the intellectual property rights of others could require us to pay substantial damages |
| As is common in the industry, we currently have in effect a number of agreements in which we have agreed to defend, indemnify and hold harmless our customers and suppliers from damages and costs which may arise from the infringement by our products of third-party patents, trademarks or other proprietary rights |
| The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorneys’ fees |
| Our insurance does not cover intellectual property infringement |
| The term of these indemnification agreements is generally perpetual any time after execution of the agreement |
| The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited |
| We may periodically have to respond to claims and litigate these types of indemnification obligations |
| Any such indemnification claims could require us to pay substantial damages |
| 21 ______________________________________________________________________ [46]Table of Contents Our indemnification obligations to our customers and suppliers for product defects could require us to pay substantial damages |
| A number of our product sales and product purchase agreements provide that we will defend, indemnify and hold harmless our customers and suppliers from damages and costs which may arise from product warranty claims or claims for injury or damage resulting from defects in our products |
| We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not be adequate to cover all or any part of the claims asserted against us |
| A successful claim brought against us that is in excess of, or excluded from, our insurance coverage could substantially harm our business, financial condition and results of operations |
| Our intellectual property may not be adequately protected, which could harm our competitive position |
| Our intellectual property is critical to our success |
| We protect our intellectual property rights through patents, trademarks, copyrights and trade secret laws, confidentiality procedures and employee disclosure and invention assignment agreements |
| It is possible that our efforts to protect our intellectual property rights may not: • Prevent the challenge, invalidation or circumvention of our existing patents; • Result in patents that lead to commercially viable products or provide competitive advantages for our products; • Prevent our competitors from independently developing similar products, duplicating our products or designing around the patents owned by us; • Prevent third-party patents from having an adverse effect on our ability to do business; • Provide adequate protection for our intellectual property rights; • Prevent disputes with third parties regarding ownership of our intellectual property rights; • Prevent disclosure of our trade secrets and know-how to third parties or into the public domain; and • Result in patents from any of our pending applications |
| As part of our confidentiality procedures, we enter into non-disclosure and invention assignment agreements with all of our employees and attempt to control access to and distribution of our technology, documentation and other proprietary information |
| However, if such agreements are found to be unenforceable, we may be unable to adequately protect our intellectual property rights |
| In addition, despite these procedures, third parties could copy or otherwise obtain and make unauthorized use of our technologies or independently develop similar technologies |
| In addition, if our IC Tower stacking patent is found to be invalid, our ability to exclude competitors from making, using or selling the same or similar products to our IC Tower stacking products would cease |
| We have on at least one occasion applied for and may in the future apply for patent protection in foreign countries |
| The laws of foreign countries, however, may not adequately protect our intellectual property rights |
| Many US companies have encountered substantial infringement problems in foreign countries |
| Because we sell some of our products overseas, we have exposure to foreign intellectual property risks |
| We may not be able to maintain or improve our competitive position because of the intense competition in the memory industry |
| We conduct business in an industry characterized by intense competition, rapid technological change, evolving industry standards, declining average sales prices and rapid product obsolescence |
| Our primary competitors in the third-party memory module industry include: Crucial Memory, a division of Micron Technology, Kingston Technology, Lexar Media, M-Systems, PNY Technologies, SanDisk, and SMART Modular |
| Our competitors include many large domestic and international companies that have substantially greater financial, technical, marketing, distribution and other resources, broader product lines, lower cost structures, greater brand recognition and longer-standing relationships with customers and suppliers |
| As a result, our competitors may be able to respond better to new or emerging technologies or standards and to changes in customer requirements |
| Further, some of our competitors are in a better financial and marketing position from which to influence industry acceptance of a particular industry standard or competing technology than we are |
| Our competitors may also be able to devote greater resources to the development, promotion and sale of products, and may be able to deliver competitive products at a lower price |
| We expect to face competition from existing competitors and new and emerging companies that may enter our existing or future markets with similar or alternative products, which may be less costly or provide additional features |
| In addition, some of our significant suppliers, including Infineon Technology and Samsung Semiconductor, are also our competitors, many of whom have the ability to manufacture competitive products at lower costs as a result of their higher levels of integration |
| We also face competition from current and prospective customers that evaluate our capabilities against the merits of manufacturing products internally |
| Competition may arise due to the development of cooperative relationships among our current and potential competitors or third parties to increase the ability of their products to address the needs of our prospective customers |
| Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share |
| 22 ______________________________________________________________________ [47]Table of Contents We expect our competitors will continue to improve the performance of their current products, reduce their prices and introduce new products that may offer greater performance and improved pricing, any of which could cause a decline in sales or loss of market acceptance of our products |
| In addition, our competitors may develop enhancements to, or future generations of, competitive products that may render our technology or products obsolete or uncompetitive |
| The Flash-based storage market is constantly evolving, and we may not have rights to manufacture and sell certain types of products utilizing emerging new Flash formats, or we may be required to pay a royalty to sell products utilizing these formats |
| The Flash-based storage market is constantly undergoing rapid technological change and evolving industry standards |
| Many consumer devices, such as digital cameras, PDAs and smartphones, may transition to emerging Flash memory formats, such as the xD Picture Card format, which we do not currently manufacture and do not have rights to manufacture |
| This will likely result in a decline in demand, on a relative basis, for other products that we manufacture such as CompactFlash, Secure Digital, Mini-SD and MultiMedia cards |
| If we decide to manufacture Flash products utilizing emerging formats, we will be required to secure licensing arrangements to give us the right to manufacture such products which may not be available at reasonable rates or at all |
| If we are not able to supply all Flash card formats at competitive prices or if we were to have product shortages, our revenues could be adversely impacted and our customers would likely cancel orders or seek other suppliers to replace us |
| The execution of our growth strategy depends on our ability to retain key personnel, including our executive officers, and to attract qualified personnel |
| Competition for employees in our industry is intense |
| We have had and may continue to have difficulty hiring the necessary engineering, sales and marketing and management personnel to support our growth |
| The successful implementation of our business model and growth strategy depends on the continued contributions of our senior management and other key research and development, sales and marketing and operations personnel, including Manouch Moshayedi, our Chief Executive Officer, Mike Moshayedi, our President, and Mark Moshayedi, our Chief Operating Officer, Chief Technical Officer and Secretary |
| In addition, as a result of our adoption of SFAS 123(R), we have begun to significantly reduce the use and quantity of stock options compared to the quantity of stock options we granted in recent years |
| We may be at a disadvantage in our ability to maintain and recruit qualified employees since many of the companies that compete with us for the same pool of qualified employees continue to offer stock options as part of their compensation package |
| We have experienced difficulties maintaining and attracting qualified employees as a result of our reduction in the use of stock options and we expect this difficulty to continue in the future unless we are able to develop other forms of incentive compensation to replace stock options |
| The loss of any key employee, the failure of any key employee to perform in his or her current position, or the inability of our officers and key employees to expand, train and manage our employee base would prevent us from executing our growth strategy |
| We face risks associated with doing business in foreign countries, including foreign currency fluctuations and trade barriers, that could lead to a decrease in demand for our products or an increase in the cost of the components used in our products |
| The volatility of general economic conditions and fluctuations in currency exchange rates affect the prices of our products and the prices of the components used in our products |
| International sales of our products accounted for 12dtta9prca, 18dtta2prca and 18dtta8prca of our revenues in 2005, 2004 and 2003, respectively |
| Except for Europe, which accounted for 10dtta3prca of our revenues in 2003, no other foreign geographic area or single foreign country accounted for more than 10dtta0prca of our revenues in 2005, 2004 or 2003 |
| For 2005, 2004 and 2003, more than 95dtta0prca of our international sales were denominated in US dollars |
| However, if there is a significant devaluation of the currency in a specific country, the prices of our products will increase relative to that country’s currency and our products may be less competitive in that country |
| In addition, we cannot be sure that our international customers will continue to be willing to place orders denominated in US dollars |
| If they do not, our revenues and results of operations will be subject to foreign exchange fluctuations, which could harm our business |
| We do not hedge against foreign currency exchange rate risks |
| We purchase a majority of the DRAM and Flash components used in our products from local distributors of foreign suppliers |
| Although our purchases of DRAM and Flash components are currently denominated in US dollars, devaluation of the US dollar relative to the currency of a foreign supplier would likely result in an increase in our cost of DRAM and Flash components |
| 23 ______________________________________________________________________ [48]Table of Contents Our international sales are subject to other risks, including regulatory risks, tariffs and other trade barriers, timing and availability of export licenses, political and economic instability, difficulties in accounts receivable collections, difficulties in managing distributors, lack of a significant local sales presence, difficulties in obtaining governmental approvals, compliance with a wide variety of complex foreign laws and treaties and potentially adverse tax consequences |
| In addition, the United States or foreign countries may implement quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products, leading to a reduction in sales and profitability in that country |
| We have experienced quarterly and annual losses in the past and may continue to experience losses in the future |
| Although we have been profitable for most of our history, we have experienced losses on a quarterly and annual basis in the past |
| In 2003 and in the second quarter of 2004, we incurred net losses of dlra1dtta6 million and dlra1dtta9 million, respectively |
| We have expended, and will continue to expend, substantial funds to pursue engineering, research and development projects, enhance sales and marketing efforts and otherwise operate our business |
| There can be no assurance that we will be profitable on a quarterly or annual basis in the future |
| Disruption of our operations in our Santa Ana, California, manufacturing facilities would substantially harm our business |
| Substantially all of our manufacturing operations is located in our facilities in Santa Ana, California |
| Due to this geographic concentration, a disruption of our manufacturing operations, resulting from sustained process abnormalities, human error, government intervention or natural disasters, including earthquakes, power failures, fires or floods, could cause us to cease or limit our manufacturing operations and consequently harm our business, financial condition and results of operations |
| Our ability to use our tax credit carryforwards may be substantially limited, which could harm our financial condition |
| In recent years, we have generated state tax credits, which we are not fully able to utilize at this time |
| The availability of some of these state tax credit carryforwards is subject to certain limitations |
| We had the following state credits as of December 31, 2005: research and development credit carryforwards of approximately dlra2dtta4 million, which carryforward indefinitely and enterprise zone credit carryforwards of approximately dlra1dtta9 million, which carryforward indefinitely |
| We periodically review our ability to use our tax credit carryforwards |
| Based on this periodic review, we may determine that the amount of tax credit carryforwards that can be utilized to offset future tax liabilities should be limited |
| Since a potential limitation is based on a number of factors, we cannot determine the impact of such a limitation at this time, but if our ability to use tax credit carryforwards were substantially limited, it could harm our financial condition |
| Compliance with environmental laws and regulations could harm our operating results |
| We are subject to a variety of environmental laws and regulations governing, among other things, air emissions, waste water discharge, waste storage, treatment and disposal, and remediation of releases of hazardous materials |
| Our failure to comply with present and future requirements could harm our ability to continue manufacturing our products |
| Such requirements could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations |
| The imposition of additional or more stringent environmental requirements, the results of future testing at our facilities, or a determination that we are potentially responsible for remediation at other sites where problems are not presently known to us, could result in expenses in excess of amounts currently estimated to be required for such matters |
| Failure to comply with governmental laws and regulations could harm our business |
| Our business is subject to regulation by various federal and state governmental agencies |
| Such regulation includes the radio frequency emission regulatory activities of the Federal Communications Commission, the anti-trust regulatory activities of the Federal Trade Commission and Department of Justice, the consumer protection laws of the Federal Trade Commission, the import/export regulatory activities of the Department of Commerce, the product safety regulatory activities of the Consumer Products Safety Commission, the regulatory activities of the Occupational Safety and Health Administration, the environmental regulatory activities of the Environmental Protection Agency, the labor regulatory activities of the Equal Employment Opportunity Commission and tax and other regulations by a variety of regulatory authorities in each of the areas in which we conduct business |
| In certain jurisdictions, such regulatory requirements may be more stringent than in the United States |
| We are also subject to a variety of federal and state employment and labors laws and regulations, including the Americans with Disabilities Act, the Federal Fair Labor Standards Act, the WARN Act and other regulations related to working conditions, wage-hour pay, over-time pay, employee benefits, anti-discrimination, and termination of employment |
| 24 ______________________________________________________________________ [49]Table of Contents Noncompliance with applicable regulations or requirements could subject us to investigations, sanctions, mandatory product recalls, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties, or injunctions |
| In addition from time to time we have received, and expect to continue to receive, correspondence from former employees terminated by us who threaten to bring claims against us alleging that we have violated one or more labor and employment regulations |
| In certain of these instances the former employee has brought claims against us and we expect that we will encounter similar actions against us in the future |
| An adverse outcome in any such litigation could require us to pay contractual damages, compensatory damages, punitive damages, attorneys’ fees and costs |
| These enforcement actions could harm our business, financial condition, results of operations and cash flows |
| If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, financial condition, results of operations and cash flows could be materially adversely affected |
| In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees |
| Our stock price is likely to be volatile and could drop unexpectedly |
| Our common stock has been publicly traded since September 2000 |
| The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering |
| The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices of securities, particularly securities of technology companies |
| As a result, the market price of our common stock may materially decline, regardless of our operating performance |
| In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company |
| We may become involved in this type of litigation in the future |
| Litigation of this type is often expensive and diverts management’s attention and resources |
| Anti-takeover provisions in our charter documents and stock option plan could prevent or delay a change in control and, as a result, negatively impact our shareholders |
| We have taken a number of actions that could have the effect of discouraging a takeover attempt |
| For example, provisions of our amended and restated articles of incorporation and amended and restated bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders |
| These provisions also could limit the price that certain investors might be willing to pay in the future for shares of our common stock |
| These provisions include: • limitations on who may call special meetings of shareholders; • advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon by shareholders at shareholder meetings; • elimination of cumulative voting in the election of directors; • the right of a majority of directors in office to fill vacancies on the board of directors; • the ability of our board of directors to issue, without shareholder approval, “blank check” preferred stock to increase the number of outstanding shares and thwart a takeover attempt |
| Provisions of our 2000 Stock Incentive Plan allow for the automatic vesting of all outstanding options granted under the 2000 Stock Incentive Plan upon a change in control under certain circumstances |
| Such provisions may have the effect of discouraging a third party from acquiring us, even if doing so would be beneficial to our shareholders |