| TRANSMETA CORP Item 1A Risk Factors The factors discussed below are cautionary statements that identify important risk factors that could cause actual results to differ materially from those anticipated in the forward-looking statements in this Annual Report on Form 10-K If any of the following risks actually occurs, our business, financial condition and results of operations would suffer |
| In this case, the trading price of our common stock could decline and investors might lose all or part of their investment in our common stock |
| We have a history of losses, and we must successfully execute on our modified business model if we are to sustain our operations |
| Except for the second, third, and fourth quarters of fiscal 2005, we have historically reported negative cash flows from operations, because the gross profit, if any, generated from our product revenue and our licensing and service revenue has not been sufficient to cover our operating cash requirements |
| Beginning during our second quarter of fiscal 2005, our product business contributed positive gross margin to our operating results in part due to end-of-life sales demand and price increases on certain products; however, the sales of those products have declined significantly since the end of the third fiscal quarter of 2005 |
| Further, while we have improved our financial results and financial position beginning during our second quarter of fiscal 2005, we reported net losses during fiscal 2005 and expect to report net losses and negative net cash flows during fiscal 2006 |
| Since our inception, we have incurred a cumulative loss aggregating dlra655dtta5 million, which includes net losses of dlra6dtta2 million during fiscal 2005, dlra106dtta8 million in fiscal 2004, dlra87dtta6 million in fiscal 2003 and dlra110dtta0 million in fiscal 2002, which losses have reduced stockholders’ equity to dlra55dtta0 million at December 31, 2005 |
| At the end of 2004, we determined that there was substantial doubt that our existing cash and cash equivalents and short-term investment balances and cash from operations would be sufficient to fund our operations, planned capital and R&D expenditures for the next twelve months under the business model that we pursued during and through the end of 2004, which business model was primarily focused on designing, developing and selling software-based x86-compatible microprocessor products |
| Accordingly, we undertook a critical evaluation of our customers’ requirements for our products and of the economics and competitive conditions in the market for x86-compatible microprocessors, and we announced a modified business model 7 _________________________________________________________________ [59]Table of Contents and a related restructuring plan based in part on that evaluation in March 2005 |
| We must execute successfully on our modified business model with which we have limited experience |
| We might fail to operate successfully under our modified business model |
| In March 2005, we announced a modified business model and related restructuring plan |
| As part of this modified business model, we have decided to focus our ongoing efforts on licensing our advanced technologies and intellectual property, engaging in synergistic engineering services opportunities and continuing our product business on a modified basis to focus on those customer opportunities and product models that are economically advantageous for the company |
| The modification of our business model entails significant risks and costs, and we might not succeed in operating within this model or under our restructuring plan for many reasons |
| These reasons include the risks that we might not be able to continue developing viable technologies, deliver engineering services in accordance with customer expectations, achieve market acceptance for our products or technologies, earn adequate revenues from the sale of our products or from our licensing and services businesses, or achieve sustained profitability |
| Employee concern about changes in our business model or the effect of such changes on their workloads or continued employment might cause our employees to seek or accept other employment, depriving us of the human and intellectual capital that we need in order to succeed |
| Because we necessarily lack historical operating and financial results for our modified business model, it will be difficult for us, as well as for investors, to predict or evaluate our business prospects and performance |
| Our business prospects would need to be considered in light of the uncertainties and difficulties frequently encountered by companies undergoing a business transition or in the early stages of development |
| The modification of our business model might also create uncertainties and cause our stock price to fall and impair our ability to raise additional capital |
| We might not be able to execute on our modified business model if we lose key management or technical personnel, on whose knowledge, leadership and technical expertise we rely |
| Our success under our modified business model will depend heavily upon the contributions of our key management and technical personnel, whose knowledge, leadership and technical expertise would be difficult to replace |
| Many of these individuals have been with us for several years and have developed specialized knowledge and skills relating to our technology and lines of business |
| We have no individual employment contracts and do not maintain key person insurance on any of our personnel |
| We might not be able to execute on our modified business model if we were to lose the services of any of our key personnel |
| If any of these individuals were to leave our company unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor develops the necessary training and experience |
| We may not be able to raise any more financing, or financing may only be available on terms unfavorable to us or our stockholders |
| Although we believe that our existing cash and cash equivalents and short-term investment balances and cash from operations will be sufficient to fund our operations, planned capital and research and development expenditures for the next twelve months under our modified business model, it is possible that we may need to raise significant additional funds through public or private equity or debt financing in order to continue operations under our modified business model |
| Further, as we continue to develop new technologies or to enhance our products or service competencies in accordance with our modified business model, we might require more cash to fund our operations |
| Although we generated positive cash flows from operations during the second, third and fourth quarters of fiscal 2005, we have had a history of net losses and negative cash flow from operations and we might not sustain positive cash flow or profitability |
| A variety of other business contingencies could contribute to our need for funds in the future, including the need to: • fund expansion; • fund marketing expenditures; • develop or enhance our products or technologies; 8 _________________________________________________________________ [60]Table of Contents • enhance our operating infrastructure; • hire additional personnel; • respond to customer concerns about our viability; • respond to competitive pressures; or • acquire complementary businesses or technologies |
| If we were to raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced, and these newly issued securities might have rights, preferences or privileges senior to those of our then-existing stockholders |
| For example, in order to raise equity financing, we may decide to sell our stock at a discount to our then current trading price, which may have an adverse effect on our future trading price |
| Our ability to raise additional financing through the issuance of securities may be impaired by our ineligibility until May 25, 2006 to utilize a short-form registration statement on Form S-3 because we were delayed in filing our report on Form 10-Q for the period ended March 31, 2005 until May 25, 2005 |
| Although we can issue unregistered securities, or use other means to register our securities, we might not be able to raise additional financing on terms favorable to us, or at all |
| If we are unable to raise additional funds or to sustain our operations on a modified business model in the future, then substantial doubt may develop as to our ability to continue to operate our business as a going concern, with substantial adverse effects on the value of our common stock and our ability to raise additional capital |
| This uncertainty may also create concerns among our current and future customers, vendors and licensees as to whether we will be able to fulfill our obligations or, in the case of customers, fulfill their future product or service needs |
| As a result, our current and prospective customers, licensees and strategic partners might decide not to do business with us, or only do so on less favorable terms and conditions |
| Employee concern about the future of the business and their continued prospects for employment may cause employees to seek employment elsewhere, depriving us of the human and intellectual capital we need to be successful |
| We may fail to meet the continued listing requirements of the Nasdaq Stock Market, which may cause our stock to be delisted and result in reduced liquidity of our stock, reduce the trading price of our stock, and impair our ability to raise financing |
| During the second quarter of 2005, we received notices of potential delisting of our stock from the Nasdaq National Market based on our failure to satisfy continued listing requirements of the Nasdaq National Market respecting our failure to timely file a periodic report with the SEC and to maintain a minimum bid price per share of at least dlra1dtta00 |
| Since receiving those notices, we filed the periodic report in question and we regained compliance with the minimum bid price rule |
| We received notice from the Nasdaq Listing Qualifications staff indicating that we had cured each of those failures |
| However, it is possible that we might be unable to timely file a periodic report with the SEC in the future or that our stock price may again fall below the minimum bid price in the future |
| If we are unable to maintain compliance with these or other listing requirements, our common stock may be delisted from the Nasdaq National Market |
| Delisting from the Nasdaq National Market would adversely affect the trading price and limit the liquidity of our common stock and therefore cause the value of an investment in our company to substantially decrease |
| If our common stock were to be delisted, holders of our common stock would be less able to purchase or sell shares as quickly and as inexpensively as they have done historically |
| For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities |
| Broker-dealers may be less willing or able to sell or make a market in our common stock |
| The loss or discontinuation of our Nasdaq National Market listing may result in a decrease in the trading price of our common stock due to a decrease in liquidity, reduced analyst coverage and less interest by institutions and individuals in investing in our common stock |
| The success of our licensing business depends on maintaining and increasing our LongRun2 licensing revenue |
| Although we have achieved increased revenue in our licensing business, our licensing business revenue will depend upon executing our obligations under existing licensing agreements and our entering into new 9 _________________________________________________________________ [61]Table of Contents licensing agreements |
| Most of our licensing revenue is currently associated with international customers |
| Our ability to enter into new LongRun2 licensing agreements depends in part upon the adoption of our LongRun2 technology by our licensees and potential licensees and the success of the products incorporating our technology sold by licensees |
| While we anticipate that we will continue our efforts to license our technology to licensees, we cannot predict the timing or the extent of any future licensing revenue, and recent levels of license revenues may not be indicative of future periods |
| We have limited visibility regarding when and to what extent our licensees will use our LongRun2 or other licensed technologies |
| We have not yet earned or received any royalties under any of our LongRun2 licensees |
| Our receipt of royalties from our LongRun2 licenses depends on our licensees incorporating our technology into their manufacturing and products, their bringing their products to market, and the success of their products |
| Our licensees are not contractually obligated to manufacture, distribute or sell products using our licensed technologies |
| Thus, our entry into and our full performance of our obligations under our LongRun2 licensing agreements do not necessarily assure us of any future royalty revenue |
| Any royalties that we are eligible to receive are based upon our licensees’ use of our licensed technologies and, as a result, we do not have direct access to information that would enable us to forecast the timing and amount of any future royalties |
| Factors that negatively affect our licensees and their customers could adversely affect our future royalties |
| The success of our licensees is subject to a number of factors, including: • the competition these companies face and the market acceptance of their products; • the pricing policies of our licensees for their products incorporating our technology and whether those products are competitively priced; • the engineering, marketing and management capabilities of these companies and technical challenges unrelated to our technology that they face in developing their products; and • the financial and other resources of our licensees |
| Because we do not control the business practices of our licensees and their customers, we have little influence on the degree to which our licensees promote our technology |
| Our licensing and services revenue cycle is long and unpredictable, which makes it difficult to predict future revenues, which may cause us to miss analysts’ estimates and may result in unexpected changes in our stock price |
| It is difficult to predict accurately our future revenues from either the granting of new licenses or the generation of royalties by our licensees under our existing licenses |
| In addition, engineering services are dependent upon the varying level of assistance desired by licensees and, therefore, revenue from these services is also difficult to predict |
| Most of our service revenue is currently associated with international customers |
| There can be no assurance that we can accurately estimate the amount of resources required to complete projects, or that we will have, or be able to expend, sufficient resources required to complete a project |
| Furthermore, there can be no assurance that the development schedules of our licensees will not be changed or delayed |
| Our licensees are not obligated to continue using our licensed technology or to use future generations of our technologies in future manufacturing processes, and therefore our past contract revenue may not be indicative of the amount of such revenue in any future period |
| All of these factors make it difficult to predict future licensing and service revenue, which may result in us missing analysts’ estimates and may cause unexpected changes in our stock price |
| We have only recently entered the engineering services business, and our ability to succeed in that line of business is uncertain and subject to many risks |
| While we have already generated current and deferred revenue from delivering engineering services to third parties under contract, we entered that line of business only recently and have only limited experience as a provider of contract engineering services |
| Our current engineering services business is substantially limited to 10 _________________________________________________________________ [62]Table of Contents two agreements entered into during fiscal 2005, one entered into with the Sony Group in March 2005, and one entered into with Microsoft in May 2005 |
| The term of the design services agreement with Sony Group extends to March 31, 2007; however, the services we provide are agreed upon pursuant to specific project agreements with terms of one year or less |
| Our current project agreements expire by their terms on March 31, 2006, corresponding to Sony Group’s fiscal year end |
| We expect to continue to provide services to the Sony Group after March 31, 2006, and we are negotiating project agreements with the Sony Group respecting such services |
| However, due to the uncertainty of these negotiations, we cannot assure you that we will extend any of the current project agreements or enter any additional project agreements, or that such agreements, if any, will continue to require engineering services of the same kind or at the same level as we provided in 2005 |
| The Microsoft definitive development services agreements are currently structured so that we provide development services of approximately thirty Transmeta engineers to Microsoft relating to a proprietary Microsoft project |
| We have substantially completed the services to be provided under these development services agreements, and, upon Microsoft’s acceptance thereof, we will recognize the related revenue and direct cost of sale, which we expect will occur in 2006 |
| We currently are in negotiations with Microsoft regarding the provision of additional services, and, although we expect to continue to provide services to Microsoft in 2006, we do not necessarily expect that the scale of those services during 2006 will be at the same level as during 2005 |
| Under both of those agreements, we are obligated to provide certain design or development services to our customers or to achieve certain project milestones |
| While we believe that we can perform our service obligations to the satisfaction of our service customers, there can be no assurance that we can accurately estimate the personnel or other resources required to perform our obligations under those agreements, or that we will have, or be able to devote, the personnel or resources required to complete our project milestones |
| Furthermore, there can be no assurance that the project schedules of our services customers will not be changed, delayed or even canceled |
| We depend upon timely contractual payments from our service customers to cover a substantial portion of our personnel costs, and the cancellation of any project could have a material adverse effect on our operating results in any period |
| Our service customers are not obligated to continue using our engineering services to complete their existing projects, or to engage us to provide engineering services on any future project |
| Our ability to extend or renew our engineering services agreements, or to win other engineering services contracts in the future, will depend in part upon our successful performance of our obligations under our existing engineering services agreements |
| Accordingly, our current engineering services revenue is not necessarily indicative of the engineering services revenue that we can expect in any future period |
| We could encounter a variety of technical and manufacturing problems that could delay or prevent us from satisfying customer demand for Efficeon TM8000 series microprocessors manufactured using a 90 nanometer process |
| We are using Fujitsu Limited to manufacture our 90 nanometer Efficeon TM8000 series microprocessors |
| Manufacturing on an advanced 90 nanometer CMOS process involves a variety of technical and manufacturing challenges |
| Fujitsu Limited has limited experience with the 90 nanometer CMOS process and, although we have achieved production of our Efficeon TM8800 product on the Fujitsu Limited 90 nanometer CMOS process, we cannot be sure that Fujitsu Limited’s 90 nanometer foundry will achieve production shipments on our planned schedule or that other manufacturing challenges might not later arise |
| For example, during 2001 and again in 2004, we experienced yield problems as we migrated our products to smaller geometries, which caused increases in our product costs, delays in product availability and diversion of engineering personnel |
| If we encounter problems with the manufacture of the Efficeon TM8000 series microprocessors using the 90 nanometer process that are more significant or take longer to resolve than we anticipate, our ability to fulfill our customer demand would suffer and we could incur significant expenses |
| Our restructuring plan has reduced our resources and ability to pursue opportunities and support customers in emerging markets for our microprocessor products |
| The modification of our business model has reduced our historical business focus on product sales, and we have reduced operating expenses associated with our product business as part of our restructuring plan, including the reduction of our workforce |
| Our restructuring plan has substantially limited our resources and ability to pursue opportunities in emerging markets for which our products are suited, including new classes of 11 _________________________________________________________________ [63]Table of Contents computing devices such as UPCs and other unique PC form factors, which require newly developed technologies, extensive development time, and marketing support |
| We currently derive a substantial portion of our revenue from a small number of customers and licensees, and our revenue would decline significantly if any major customer were to cancel, reduce or delay a transaction relating to our products, licenses and services |
| Our customer base is highly concentrated |
| For example, revenue from three customers in the aggregate accounted for 83prca of total revenue during fiscal 2005 |
| We expect that a small number of customers will continue to account for a significant portion of our revenue |
| Our future revenue will depend upon our ability to meet contractual obligations under our customer agreements and on our ability to fulfill product orders, if any, from these customers |
| Our customers and licensees are significantly larger than we are and have bargaining power to demand changes in terms and conditions of our agreements |
| The loss of any major customer or licensee, or delays in delivery or performance under our customer agreements, and could significantly reduce or delay our recognition of revenue |
| We face intense competition in the power management, engineering services and x86-compatible microprocessor markets |
| Many of our competitors are much larger than we are and have significantly greater resources |
| We may not be able to compete effectively |
| The development of power management and transistor leakage control technologies is an emerging field subject to rapid technological change, and our competition for licensing such technologies, and providing related services, is unknown and could increase |
| Our LongRun2 technologies are highly proprietary and, though the subject of patents and patents pending, are marketed primarily as trade secrets subject to strict confidentiality protocols |
| Although we are not aware of any other company offering any comparable power management or leakage control technologies, we note that most semiconductor companies have internal efforts to reduce transistor leakage and power consumption in current and future semiconductor products |
| Indeed, all of our current and prospective licensees are larger, technologically sophisticated companies, which generally have significant resources and internal efforts to develop their own technological solutions |
| Our microprocessor design and development engineering services are highly specialized and customized, and the related technical know how is subject to rapid technological change |
| We experience competition to provide these services primarily from our customers, which are larger, technologically sophisticated companies, and have their own internal engineering resources |
| Further, our existing and potential customers typically have existing relationships with other third parties that provide competitive engineering services |
| The market for microprocessor products is intensely competitive, is subject to rapid technological changes and has been for many years dominated by Intel Corporation |
| In our legacy product business, we faced competition from Intel, Advanced Micro Devices and VIA Technologies |
| Under our modified business model, we expect to continue to face competition from these and other companies in the markets that we currently target or may target in the future |
| We are dependent on third-party companies for the design and manufacture of core-logic chipsets, graphics chips, motherboards, BIOS software and other components |
| Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition, significantly greater influence and leverage in the industry and much larger customer bases than we do |
| We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage |
| We may experience manufacturing difficulties that could increase the cost and reduce the supply of our products |
| The fabrication of wafers for our microprocessors is a highly complex and precise process that requires production in a tightly controlled, clean room environment |
| Minute impurities, difficulties in the fabrication 12 _________________________________________________________________ [64]Table of Contents process, defects in the masks used to print circuits on a wafer or other factors can cause numerous die on each wafer to be nonfunctional |
| The proportion of functional die expressed as a percentage of total die on a wafer is referred to as product “yield |
| ” Semiconductor companies frequently encounter difficulties in achieving expected product yields, particularly when introducing new products |
| Yield problems may not be identified and resolved until a product has been manufactured and can be analyzed and tested, if ever |
| As a result, yield problems are often difficult, time-consuming and expensive to correct |
| We have experienced yield problems in the past, and we may experience yield problems in the future that impair our ability to deliver our products to our customers, increase our costs, adversely affect our margins and divert the efforts of our engineering personnel |
| Difficulties in achieving the desired yields often occur in the early stages of production of a new product or in the migration of manufacturing processes to smaller geometries |
| We could experience difficulties in achieving desired yields or other manufacturing problems in the production of our Efficeon TM8000 series products that could delay our ability to deliver Efficeon TM8000 series products, adversely affect our costs and gross margins and harm our reputation |
| Even with functional die, normal variations in wafer fabrication can cause some die to run faster than others |
| Variations in speed yield could lead to excess inventory of the slower, less valuable die, a resulting unfavorable impact on gross margins and an insufficient inventory of faster products, depending upon customer demand |
| Our lengthy and variable product sales cycles make it difficult for us to predict when and if a design win will result in volume shipments |
| We depend upon other companies designing our microprocessors into their products, which we refer to as design wins |
| Many of our targeted customers consider the choice of a microprocessor to be a strategic decision |
| Thus our targeted customers may take a long time to evaluate our products, and many individuals may be involved in the evaluation process |
| We anticipate that the length of time between our initial contact with a customer and the time when we recognize revenue from that customer will vary |
| We expect our sales cycles to range typically from six to 12 months, or more, from the time we achieve a design win to the time the customer begins volume production of products that incorporate our microprocessors |
| We do not have historical experience selling our products that is sufficient for us to determine accurately how our sales cycles will affect the timing of our revenue |
| Variations in the length of our sales cycles could cause our revenue to fluctuate widely from period to period |
| While potential customers are evaluating our products and before they place an order with us, we may incur sales and marketing expenses and expend significant management and engineering resources without any assurance of success |
| The value of any design win depends upon the commercial success of our customers’ products |
| If our customers cancel projects or change product plans, we could lose anticipated sales |
| We can offer no assurance that we will achieve further design wins or that the products for which we achieve design wins will ultimately be introduced or will, if introduced, be commercially successful |
| If we fail to forecast demand for our products accurately, we could lose sales and incur inventory losses |
| The demand for our products depends upon many factors and is difficult to forecast |
| Many shipments of our products may be made near the end of each fiscal quarter, which makes it difficult to estimate demand for our products |
| Significant unanticipated fluctuations in demand have caused, and in the future could cause, problems in our operations |
| The lead-time required to fabricate large volumes of wafers is often longer than the lead-time our customers provide to us for delivery of their product requirements |
| As a result, we have only a limited ability to react to fluctuations in demand for our products, which could cause us to have either too much or too little inventory of a particular product |
| If demand does not develop as we expect, we could have excess production |
| Excess production would result in excess inventories of product, which would use cash and could result in inventory write-downs and write-offs |
| We have limited capability to reduce ongoing production once wafer fabrication has commenced |
| Conversely, if demand exceeds our expectations, Fujitsu Limited might not be able to fabricate wafers as quickly as we need them |
| Also, Advanced Semiconductor Engineering, or ASE, might not be able to increase assembly functions in a timely manner |
| In that event, we would need to increase production and assembly rapidly or find, qualify and begin production and assembly at additional manufacturers or providers of assembly and test services, which may not be possible within a time frame acceptable to our customers |
| The inability of our product manufacturer or ASE to increase production 13 _________________________________________________________________ [65]Table of Contents rapidly enough could cause us to fail to meet customer demand |
| In addition, rapid increases in production levels to meet unanticipated demand could result in higher costs for manufacturing and other expenses |
| These higher costs could lower our gross margins |
| If our customers are not able to obtain the other components necessary to build their systems, sales of our products could be delayed or cancelled |
| Suppliers of other components incorporated into our customers’ systems may experience shortages, which could reduce the demand for our products |
| For example, from time to time, the computer and semiconductor industries have experienced shortages of some materials and devices, such as memory components, displays, and storage devices |
| Our customers could defer or cancel purchases of our products if they are not able to obtain the other components necessary to build their systems |
| We rely on an independent foundry that has no obligation to provide us with fixed pricing or production capacity for the fabrication of our wafers, and our business will suffer if we are unable to obtain sufficient production capacity on favorable terms |
| We do not have our own manufacturing facilities and, therefore, must rely on third parties to manufacture our products |
| We currently rely on Fujitsu Limited in Japan to manufacture our 90 nanometer Efficeon TM8000 series products |
| We do not have manufacturing contracts with Fujitsu Limited, and therefore we cannot be assured that we will have any guaranteed production capacity |
| These foundries may allocate capacity to other companies’ products while reducing the capacity available to us on short notice |
| Foundry customers that are larger than we and have greater economic resources, that have long-term agreements with these foundries or that purchase in significantly larger volumes than we may cause these foundries to reallocate capacity to them, decreasing the capacity available to us |
| In addition, these foundries could, with little or no notice, refuse to continue to fabricate all or some of the wafers that we require |
| If these foundries were to stop manufacturing for us, we would likely be unable to replace the lost capacity in a timely manner |
| Transferring to another manufacturer would require a significant amount of time and money |
| As a result, we could lose potential sales and fail to meet existing obligations to our customers |
| These foundries could also, with little or no notice, change the terms under which they manufacture for us, which could cause our manufacturing costs to increase substantially |
| Our reliance on Fujitsu to fabricate our wafers limits our ability to control the production, supply and delivery of our products |
| Our reliance on third-party manufacturers exposes us to a number of risks outside our control, including the following: • unpredictability of manufacturing yields and production costs; • interruptions in shipments; • Inability to control quality of finished products; • Inability to control product delivery schedules; • potential lack of access to key fabrication process technologies; and • potentially greater exposure to misappropriation of our intellectual property |
| We depend on ASE to provide assembly and test services |
| If ASE were to cease providing services to us in a timely manner and on acceptable terms, our business would suffer |
| We rely on ASE, which is located in Taiwan, for the majority of our assembly and test services |
| We do not have a contract with ASE for test and assembly services, and we typically procure these services from ASE on a per order basis |
| ASE could cease to perform all of the services that we require, or could change the terms upon which it performs services for us |
| If we were required to find and qualify alternative assembly or testing services, we could experience delays in product shipments, increased product costs or a decline in 14 _________________________________________________________________ [66]Table of Contents product quality |
| In addition, as a result of our reliance on ASE, we do not directly control our product delivery schedules |
| If ASE were not to provide high quality services in a timely manner, our costs could increase, we could experience delays in the delivery of our products and our product quality could suffer |
| If our products are not compatible with industry standards, hardware that our customers design into their systems or that is used by end-users or software applications or operating systems for x86-compatible microprocessors, market acceptance of our products and our ability to maintain or increase our revenues would suffer |
| Our products are designed to function as components of a system |
| If our customers experience system-level incompatibilities between our products and the other components in their systems, we could be required to modify our products to overcome the incompatibilities or delay shipment of our products until the manufacturers of other components modify their products or until our customers select other components |
| These events would delay purchases of our products, cause orders for our products to be cancelled or result in product returns |
| In addition, to gain and maintain market acceptance, our microprocessors must not have significant incompatibilities with software for x86-compatible microprocessors, and in particular, the Windows operating systems, or hardware used by end-users |
| Software applications, games or operating systems with machine-specific routines programmed into them can result in specific incompatibilities |
| If a particular software application, game or operating system is programmed in a manner that makes it unable to respond correctly to our microprocessor, it will appear to users of that software that our microprocessor is not compatible with that software |
| Software or hardware incompatibilities that are significant or are perceived to be significant could hinder our products from achieving or maintaining market acceptance and impair our ability to increase our revenues |
| In an effort to test and ensure the compatibility of our products with hardware and software for x86-compatible microprocessors, we rely on the cooperation of third-party hardware and software companies, including manufacturers of graphics chips, motherboards, BIOS software and other components |
| All of these third-party designers and manufacturers produce chipsets, motherboards, BIOS software and other components to support each new generation of Intel’s microprocessors, and Intel has significant leverage over their business opportunities |
| If these third parties were to cease supporting our microprocessor products, our business would suffer |
| Our products may have defects that could damage our reputation, decrease market acceptance of our products, cause us to lose customers and revenue and result in liability to us |
| Highly complex products such as our microprocessors may contain hardware or software defects or bugs for many reasons, including design issues or defective materials or manufacturing processes |
| If any of our products contains defects, or has reliability, quality or compatibility problems, our reputation might be damaged significantly and customers might be reluctant to buy our products, which could result in the loss of or failure to attract customers |
| In addition, these defects could interrupt or delay sales |
| We may have to invest significant capital and other resources to correct these problems |
| If any of these problems is not found until after we have commenced commercial production of a new product, we might incur substantial additional development costs |
| If we fail to provide solutions to the problems, such as software patches, we could also incur product recall, repair or replacement costs |
| These problems might also result in claims against us by our customers or others |
| In addition, these problems might divert our technical and other resources from other development efforts |
| Moreover, we would likely lose, or experience a delay in, market acceptance of the affected product or products, and we could lose credibility with our current and prospective customers |
| This is particularly significant as we are a new entrant to a market dominated by large well-established companies |
| 15 _________________________________________________________________ [67]Table of Contents We are subject to general economic and market conditions |
| Our business is subject to the effects of general economic conditions in the United States and worldwide and, in particular, market conditions in the semiconductor and computer industries |
| In 2001, 2002 and through parts of 2003, our operating results were adversely affected by unfavorable global economic conditions and reduced information technology spending, particularly in Japan, where we currently generate a substantial portion of our revenue |
| These adverse conditions resulted in decreased demand for notebook computers and, as a result, our products, which are components of notebook computers |
| Further, demand for our products decreases as computer manufacturers seek to manage their component and finished product inventory levels |
| If we do not keep pace with technological change, our products may not be competitive and our revenue and operating results may suffer |
| The semiconductor industry is characterized by rapid technological change, frequent new product introductions and enhancements, and ongoing customer demands for greater performance |
| In addition, the average selling price of any particular microprocessor product has historically decreased substantially over its life, and we expect that trend to continue |
| As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands |
| It may be difficult or costly for us, or we may not be able, to enhance existing products to fully meet customer demands, particularly in view of our restructuring plan |
| Advances in battery design, cooling systems and power management systems could adversely affect our ability to achieve widespread market acceptance for our products and technologies |
| We believe that our ability to achieve widespread market acceptance for our products and technologies will depend in large part on whether potential purchasers of our products believe that the low power usage of our products is a substantial benefit |
| Advances in battery technology, or energy technologies such as fuel cell technologies, that offer increased battery life and enhanced power capacity, as well as the development and introduction of more advanced cooling systems, may make microprocessor power consumption a less important factor to our customers and potential customers |
| These developments, or developments in power management systems by third parties, may adversely affect our ability to market and sell our products |
| Our products and technologies may infringe the intellectual property rights of others, which may cause us to become subject to expensive litigation, cause us to incur substantial damages, require us to pay significant license fees or prevent us from selling our products |
| Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights |
| We cannot be certain that our products and technologies do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others |
| In addition, leading companies in the semiconductor industry have extensive intellectual property portfolios with respect to semiconductor technology |
| From time to time, third parties, including these leading companies, may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies and related methods that are important to us |
| We expect that we may become subject to infringement claims as the number of products and competitors in our target markets grows and the functionality of products overlaps |
| We have received, and may in the future receive, communications from third parties asserting patent or other intellectual property rights covering our products |
| Litigation may be necessary in the future to defend against claims of infringement or invalidity, to determine the validity and scope of the proprietary rights of others, to enforce our intellectual property rights, or to protect our trade secrets |
| We may also be subject to claims from customers for indemnification |
| Any resulting litigation, regardless of its resolution, could result in substantial costs and diversion of resources |
| If it were determined that our products infringe the intellectual property rights of others, we would need to obtain licenses from these parties or substantially reengineer our products and technologies in order to avoid 16 _________________________________________________________________ [68]Table of Contents infringement |
| We might not be able to obtain the necessary licenses on acceptable terms, or at all, or to reengineer our products and technologies successfully |
| Moreover, if we are sued for infringement and lose the suit, we could be required to pay substantial damages or be enjoined from licensing or using the infringing products or technology |
| Any of the foregoing could cause us to incur significant costs and prevent us from selling our products |
| Any dispute regarding our intellectual property may require us to indemnify certain licensees or third parties, the cost of which could severely hamper our business operations and financial condition |
| In any potential dispute involving our patents or other intellectual property, our licensees could also become the target of litigation |
| Our LongRun2 license agreements and certain of our development services agreements provide limited indemnities |
| In addition to the time and expense required for us to supply such indemnification to our licensees, a licensee’s development, marketing and sales of licensed products incorporating our LongRun2 technology could be severely disrupted or shut down as a result of litigation, which in turn could severely hamper our business operations and financial condition |
| If we are unable to protect our proprietary rights adequately, our competitors might gain access to our technology and we might not compete successfully in our markets |
| We believe that our success will depend in part upon our proprietary technology |
| We rely on a combination of patents, copyrights, trademarks, trade secret laws and contractual obligations with employees and third parties to protect our proprietary rights |
| These legal protections provide only limited protection and may be time consuming and expensive to obtain and enforce |
| If we fail to protect our proprietary rights adequately, our competitors might gain access to our technology |
| As a result, our competitors might offer similar products and we might not be able to compete successfully in our market |
| Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary |
| Also, our competitors may independently develop similar, but not infringing, technology, duplicate our products, or design around our patents or our other intellectual property |
| In addition, other parties may breach confidentiality agreements or other protective contracts with us, and we may not be able to enforce our rights in the event of these breaches |
| Furthermore, the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States |
| We may be required to spend significant resources to monitor and protect our intellectual property rights |
| Our pending patent and trademark applications may not be approved |
| Our patents, including any patents that may result from our patent applications, may not provide us with any competitive advantage or may be challenged by third parties |
| If challenged, our patents might not be upheld or their claims could be narrowed |
| We may initiate claims or litigation against third parties based on our proprietary rights |
| Any litigation surrounding our rights could force us to divert important financial and other resources from our business operations |
| The evolution of our business could place significant strain on our management systems, infrastructure and other resources, and our business may not succeed if we fail to manage it effectively |
| Our ability to implement our business plan in a rapidly evolving market requires effective planning and management process |
| Changes in our business plans could place significant strain on our management systems, infrastructure and other resources |
| In addition, we expect that we will continue to improve our financial and managerial controls and procedures |
| We will also need to expand, train and manage our workforce worldwide |
| Furthermore, we expect that we will be required to manage an increasing number of relationships with suppliers, manufacturers, customers and other third parties |
| If we fail to manage change effectively, our employee-related costs and employee turnover could increase and our business may not succeed |
| 17 _________________________________________________________________ [69]Table of Contents We have significant international operations, which exposes us to risk and uncertainties |
| In addition, ASE is located in Taiwan, and the Fujitsu Limited foundry we use for our 90 nanometer product is located in Japan |
| In addition, we generally ship our products from a third-party warehouse facility located in Hong Kong |
| In attempting to conduct and expand business internationally, we are exposed to various risks that could adversely affect our international operations and, consequently, our operating results, including: • difficulties and costs of staffing and managing international operations; • fluctuations in currency exchange rates; • unexpected changes in regulatory requirements, including imposition of currency exchange controls; • longer accounts receivable collection cycles; • import or export licensing requirements; • problems in the timeliness or quality of product deliveries; • potentially adverse tax consequences; • major health concerns, such as SARS; • political and economic instability, for example as a result of tensions between Taiwan and the People’s Republic of China; and • potentially reduced protection for intellectual property rights |
| Our operating results are difficult to predict and fluctuate significantly |
| A failure to meet the expectations of securities analysts or investors could result in a substantial decline in our stock price |
| Our operating results fluctuate significantly from quarter to quarter, and we expect that our operating results will fluctuate significantly in the future as a result of one or more of the risks described in this section or as a result of numerous other factors |
| You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance |
| Our stock price has declined substantially since our stock began trading publicly |
| If our future operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price would likely decline from current levels |
| A large portion of our expenses, including rent and salaries, is fixed or difficult to reduce |
| Our expenses are based in part on expectations for our revenue |
| If our revenue does not meet our expectations, the adverse effect of the revenue shortfall upon our operating results may be acute in light of the fixed nature of our expenses |
| We often make many shipments of our products at or near the end of each fiscal quarter, which makes it difficult to estimate or adjust our operating activities quickly in response to a shortfall in expected revenue |
| Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States |
| Generally accepted accounting principles in the United States are subject to issuance and interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles |
| A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change |
| For example, in December 2004, FASB issued SFAS 123(R), “Share-Based Payment,” which replaces SFAS 123 and supersedes APB 25 |
| We are required to adopt SFAS 123(R) in our first quarter of fiscal year 2006 |
| SFAS 123(R) requires that compensation costs relating to share-based payment transactions be recognized in the financial statements |
| The pro forma disclosure previously permitted under SFAS 123 will no longer be an acceptable alternative to recognition of expense in the financial statements |
| We currently measure compensation costs related to share-based payments under APB 25, as allowed by SFAS 123, and 18 _________________________________________________________________ [70]Table of Contents provide disclosure in notes to our financial statements as required by SFAS 123 |
| We might experience payment disputes for amounts owed to us under our LongRun2 licensing agreements, and this may harm our results of operations |
| The standard terms of our LongRun2 license agreements require our licensees to document the royalties owed to us from the sale of products that incorporate our technology and report this data to us on a quarterly basis |
| While standard license terms give us the right to audit books and records of our licensees to verify this information, audits can be expensive, time consuming, and potentially detrimental to our ongoing business relationship with our licensees |
| Our failure to audit our licensees’ books and records may result in us receiving more or less royalty revenues than we are entitled to under the terms of our license agreements |
| The result of such royalty audits could result in an increase, as a result of a licensee’s underpayment, or decrease, as a result of a licensee’s overpayment, to previously reported royalty revenues |
| Such adjustments would be recorded in the period they are determined |
| Any adverse material adjustments resulting from royalty audits or dispute resolutions may result in us missing analyst estimates and causing our stock price to decline |
| Royalty audits may also trigger disagreements over contract terms with our licensees and such disagreements could hamper customer relations, divert the efforts and attention of our management from normal operations and impact our business operations and financial condition |
| The price of our common stock has been volatile and is subject to wide fluctuations |
| The market price of our common stock has been volatile and is likely to remain subject to wide fluctuations in the future |
| Many factors could cause the market price of our common stock to fluctuate, including: • variations in our quarterly results; • market conditions in our industry, the industries of our customers and the economy as a whole; • announcements of technological innovations by us or by our competitors; • introductions of new products or new pricing policies by us or by our competitors; • acquisitions or strategic alliances by us or by our competitors; • recruitment or departure of key personnel; • the gain or loss of significant orders; • the gain or loss of significant customers; and • changes in the estimates of our operating performance or changes in recommendations by securities analysts |
| In addition, the stock market generally and the market for semiconductor and other technology-related stocks in particular experienced a decline during 2000, 2001 and through 2002, and could decline from current levels, which could cause the market price of our common stock to fall for reasons not necessarily related to our business, results of operations or financial condition |
| The market price of our stock also might decline in reaction to events that affect other companies in our industry even if these events do not directly affect us |
| Accordingly, you may not be able to resell your shares of common stock at or above the price you paid |
| Securities litigation is often brought against a company following a period of volatility in the market price of its securities, and we have been subject to such litigation in the past |
| Any such lawsuits in the future will divert management’s attention and resources from other matters, which could also adversely affect our business and the price of our stock |
| 19 _________________________________________________________________ [71]Table of Contents Our California facilities and the facilities of third parties upon which we rely to provide us critical services are located in regions that are subject to earthquakes and other natural disasters |
| Our California facilities, including our principal executive offices, are located near major earthquake fault lines |
| If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, our business could be materially and adversely affected |
| In addition, ASE, upon which we currently rely for the majority of our assembly and test services, is located in Taiwan, and |
| Fujitsu Limited, which fabricates a significant amount of our wafers, is located in Japan |
| Taiwan and Japan have experienced significant earthquakes and could be subject to additional earthquakes in the future |
| Any earthquake or other natural disaster in these areas could materially disrupt our manufacturer’s production capabilities and ASE’s assembly and test capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of wafers and possibly in higher wafer prices |
| Our certificate of incorporation and bylaws, stockholder rights plan and Delaware law contain provisions that could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders |
| Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders |
| These provisions include: • establishing a classified board of directors so that not all members of our board may be elected at one time; • providing that directors may be removed only “for cause” and only with the vote of 66^2/3prca of our outstanding shares; • requiring super-majority voting to amend some provisions in our certificate of incorporation and bylaws; • authorizing the issuance of “blank check” preferred stock that our board could issue to increase the number of shares and to outstanding discourage a takeover attempt; • limiting the ability of our stockholders to call special meetings of stockholders; • prohibiting stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; and • establishing advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings |
| In addition, the stockholder rights plan, which we implemented in 2002, and Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control |
| We may identify material weaknesses in our internal control over financial reporting |
| In compliance with the Sarbanes-Oxley Act of 2002, we test our system of internal control over financial reporting as of December 31 of the applicable fiscal year |
| In our evaluation as of December 31, 2004, we identified six material weaknesses |
| A material weakness is a control deficiency, or a combination of control deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| The material weaknesses that we had identified affected all of our significant accounts |
| During 2005, we undertook actions in order to remediate each of the material weaknesses, and as a consequence of these actions, we have remediated all of those material weaknesses in our system of internal control over financial reporting |
| However, we cannot assure you that we will not in the future identify further material weaknesses or significant deficiencies in our internal control over financial reporting |
| 20 _________________________________________________________________ [72]Table of Contents Changes in securities laws and regulations have increased our costs |
| The Sarbanes-Oxley Act of 2002 has required and will require changes in some of our corporate governance, public disclosure and compliance practices |
| The Act has also required the SEC to promulgate new rules on a variety of subjects and the National Association of Securities Dealers to adopt revisions to its requirements for companies, such as us, that are listed on the NASDAQ National Market |
| These developments have increased our legal and financial compliance costs and have made some activities, such as SEC reporting requirements, more difficult |
| Additionally, we expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage |
| These developments could make it more difficult for us to attract qualified executive officers and attract and retain qualified members of our board of directors, particularly to serve on our audit committee |
| We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result |