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| CTLM > SEC Filings for CTLM > Form 10-K on 5-Mar-2004 | All Recent SEC Filings |
5-Mar-2004
Annual Report
Cautionary Statement
You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this report. The information in this report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC.
The section entitled "Risk Factors" set forth in this report, and similar discussions in our other SEC filings, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to invest in our company or to maintain or increase your investment.
Critical Accounting Policies
General. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities reported in the Consolidated Financial Statements and accompanying notes. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.
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We believe that, of the significant accounting policies used in the preparation of our consolidated financial statements (see Note 1 of Notes to Consolidated Financial Statements), the following are critical accounting policies, which may involve a higher degree of judgment and complexity.
Revenue Recognition. Revenues related to product sales are generally recognized when the products have been shipped and risk of loss has passed to the customer, collection of the resulting receivable is reasonably assured, persuasive evidence of an arrangement exists and the price is fixed or determinable. Sales arrangements may contain customer-specific acceptance requirements for both products and development revenues. In such cases, revenue is deferred at the time of delivery of the product or service and is recognized upon receipt of customer acceptance.
Sales Returns and Allowances. We establish, upon shipment of our products, a provision for estimated returns. Under certain circumstances, we allow our customers to return products and a provision is made for such returns. Our estimate of product returns is based on contractual terms or sales agreements, historical experience and expectation of future conditions. Additional provisions and allowances may be required, resulting in decreased net revenue and gross profit, should we experience increased product returns.
Allowance for Doubtful Accounts. We record allowances for doubtful accounts for estimated losses based upon specifically identified amounts that we believe to be uncollectible. We record additional allowances based on certain percentages of our aged receivables, which are determined based on historical experience and our assessment of the general financial condition of our customer base. If our actual collections experience changes, revisions to our allowances may be required. We have a limited number of customers with individually large amounts due at any given balance sheet date. Any unanticipated change in one of those customers' creditworthiness or other matters affecting the collectibility of amounts due from such customers could have a material effect on our results of operations in the period in which such changes or events occur.
Inventories. Inventories are stated at the lower of standard cost, which approximates cost, or net realizable value. Cost is based on a first-in, first-out basis. We perform detailed reviews of the net realizable value of inventories, both on hand as well as inventories that we are committed to purchase, with consideration given to deterioration, obsolescence and other factors. We may record charges to write down inventories that are excess, obsolete or slow-moving inventory based on an analysis of the impact of changes in technology, the timing of these changes and our estimate of forecasted demand for our products. We typically use a six- or nine-month rolling forecast based on the type of products, anticipated product orders, product order history, forecasts and backlog. We compare our current or committed inventory levels to these forecasts on a regular basis and any adverse changes to our future product demand may result in increased writedowns, resulting in decreased gross profit.
Warranty. A limited warranty is provided on our products for a period of one year and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required.
Litigation and Contingencies. From time to time, we receive various inquiries or claims in connection with patent and other intellectual property rights. In certain cases, we have accrued estimates of the amounts we expect to pay upon resolution of such matters. Should we not be able to secure the terms we expect, these estimates may change and may result in increased accruals, resulting in decreased profit.
Overview
We provide semiconductor products that enable broadband communications, which is the high-speed networking of data, voice and video signals, for consumers and business enterprises. Our product portfolio includes silicon integrated circuits and associated software that are used in communications equipment for
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several broadband markets including digital subscriber line (DSL) and Voice over Packet (VoP) applications. We are also developing a new line of broadband semiconductor products for optical access applications which we plan to introduce in 2004.
To date, our revenues have been derived primarily from the sale of our DSL semiconductor products which include the CopperFlite CO, CopperFlite CPE, Palladia and Maximus families of products and, to a small degree, our Entropia VoP semiconductor products. We have generated a substantial portion of our revenues from sales to a limited number of customers. For the year ended December 31, 2003, NEC and Sumitomo Electric Industries represented 49% and 31% of our revenues, respectively. For the year ended December 31, 2002, NEC and Sumitomo Electric Industries represented 45% and 41% of our revenues, respectively. For the year ended December 31, 2001, Sumitomo Electric Industries and NEC represented 48% and 38% of our revenues, respectively. We expect that our largest customers will continue to account for a substantial portion of our revenues in 2004 and for the foreseeable future.
During the years ended December 31, 2003, 2002, and 2001, 87%, 89% and 89% of our revenues, respectively, were from customers in Asia, primarily Japan. The absolute dollar amount of our revenues from customers in Asia increased in 2003 compared to 2002 primarily due to the increased number of DSL subscriber additions in Japan. Both our revenues and the percentage of revenues from our customers in North America increased in 2003 due to increases in spending in the communications equipment industry. We currently sell through our direct sales force in China, France, Japan, North America, South Korea and Taiwan. We also utilize sales representatives in China, Germany, Hong Kong, Israel, Italy, Japan, North America, South Korea and Taiwan. All of our revenues are denominated solely in U.S. dollars, which reduces our exposure to foreign currency exchange risks.
It often takes more than one year for us to realize volume shipments of our products after we first contact a customer. We first work with customers to achieve a design win, which may take six months or longer. Our customers then complete the design, testing and evaluation of their systems and begin the marketing process, a period which typically lasts an additional three to six months or longer. As a result, a significant period of time may elapse between our sales efforts and our realization of revenues, if any, from volume purchases of our products by our customers. Our customers are not obligated by long-term contracts to purchase our products and can generally cancel or reschedule orders on short notice. Due to this lengthy sales cycle, we may experience significant delays from the time we incur expenses for research and development, selling, general and administrative efforts and investments in inventory, and the generation of corresponding revenue, if any. We anticipate that the rate of new orders may vary significantly from month to month. If anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our results of operations for that quarter, and potentially for future quarters, could be materially and adversely affected.
We outsource the fabrication, assembly and testing of our products. Accordingly, a significant portion of our cost of revenues consists of payments to our manufacturing partners. Costs of revenues also encompass our internal manufacturing and operations functions and a portion of our information systems and facilities costs.
Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers, prototype costs related to the fabrication of our silicon chips, depreciation associated with software development tools and amortization of deferred compensation. We expense our research and development costs as they are incurred. Several components of our research and development effort require significant expenditures, the timing of which can cause significant quarterly variability in our expenses. For example, we require a substantial number of prototypes to build and test our complex products and therefore incur significant prototype costs. Research and development is key to our future success. We anticipate that research and development expense may increase in both the near-term and the long-term as we incur additional costs related to the growth of our Company.
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Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales, customer service and applications engineering support functions, costs associated with promotional and other marketing expenses, as well as amortization of deferred compensation. In addition, the complexity of our products and the applications support necessary for successful interoperability and customer specific applications requires highly trained customer service and support personnel. We anticipate that sales and marketing expense will increase in the near-term and long-term as we add personnel to support our customers and expand our sales force outside of the Japan market.
General and administrative expenses consist primarily of salaries and related expenses for executives, finance, accounting, facilities, information services, human resources, recruiting expenses, legal and other professional fees, other corporate expenses, and amortization of deferred compensation. In addition, general and administrative expenses include management's estimate of potential bad debt expense. General and administrative expenses are expected to increase in the near-term and the long-term as we incur additional costs related to the growth of our business and address the requirements of the Sarbanes-Oxley Act.
In connection with the grant of certain stock and other stock-based compensation to our employees, technical advisors and directors, we have recorded stock-based compensation expense of $1.4 million, $3.8 million and $15.3 million for the years ended December 31, 2003, 2002 and 2001, respectively. Deferred compensation is recorded upon grant and represents the difference between the grant price and the fair value of our common stock options granted during these periods. Deferred compensation expense is being amortized using the graded vesting method, in accordance with Statement of Financial Accounting Standards No. 123 (SFAS 123) and FASB Interpretation No. 28, over the vesting period of each respective option, generally four years. Under the graded vesting method, each option grant is separated into portions based on its vesting terms, which results in acceleration of amortization expense for the overall award. The accelerated amortization pattern results in expensing approximately 59% of the total award in year one, 25% in year two, 12% in year three and 4% in year four. Deferred compensation is presented as a reduction of stockholders' equity. As required by APB 25, we record an adjustment to stock-based compensation when employees forfeit options for which compensation expense had been recognized using the graded vesting method, but which were unvested on the date their employment terminated. See Notes 1 and 7 of notes to consolidated financial statements for more information about our equity-based compensation programs.
We have not reported an operating profit for any year since our incorporation and have experienced net losses of approximately $13.4 million, $33.3 million and $19.7 million for the years ended December 31, 2003, 2002 and 2001, respectively.
As we enter fiscal 2004, we continue to face significant challenges with respect to revenue, gross margin, and operating expenses. We are taking a number of steps to address these challenges. To increase revenues, we plan to expand our DSL and VoP product portfolio and introduce products that enable optical access applications. Also, in order to geographically diversify our existing business and drive increased sales from these new products, we are increasing our investment in our sales and marketing resources. To accommodate the difficult pricing environment that we expect to face for the foreseeable future, we are making efforts to reduce the manufacturing costs and expenses of our products.
In the near term, we expect that some of the steps that we are taking will result in continuing downward pressure on income from operations. For example, sales and marketing expenses will increase as a result of increased personnel resources. Also, research and development expenses will increase due to additions to our engineering team and purchasing of additional software development tools. However, we believe that the steps that we are taking are necessary to achieve our goals of diversifying our business, increasing our revenues and eventually reaching sustained profitability.
Our planned actions for fiscal 2004 are based on certain assumptions concerning the adoption of broadband technologies, the rate of DSL subscriber growth and the cost and expense structure of our business. These
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assumptions could prove to be inaccurate. If current economic conditions deteriorate to an unexpected degree, or if our planned actions are not successful in achieving our goals, there could be additional adverse impacts on our financial position, revenues, profitability or cash flows. In that case, we might need to modify our strategic focus and restructure our business to realign our resources and achieve additional cost and expense savings.
Results of Operations
The following table sets forth, for the periods presented, certain data from our consolidated statements of operations expressed as a percentage of total revenues.
Years ended December 31,
-------------------------------------
2003 2002 2001
------ ------ ----
Total net revenues 100 % 100 % 100 %
Cost of revenues 57 57 50
------ --- ------ -- ---- --
Gross profit 43 43 50
------ --- ------ -- ---- --
Operating expenses:
Research and development 37 48 37
Sales and marketing 10 14 11
General and administrative 8 9 9
Amortization of goodwill and other acquisition-related
intangibles 2
Impairment of goodwill 6
In-process research and development 5
------ --- ------ -- ---- --
Total operating expenses 55 77 64
------ --- ------ -- ---- --
Operating loss (12 ) (34 ) (14 )
Interest income, net 1 2 2
Gain (loss) on non-current investment (1 )
Benefit (provision) for income taxes
------ --- ------ -- ---- --
Net loss (11 )% (32 )% (13 )%
------ --- ------ -- ---- --
Years ended December 31, 2003 and 2002
Total Net Revenues: Total net revenues in 2003 were $125.0 million, compared with $105.0 million in 2002, an increase of $20 million or 19%. The growth in revenue was due to a 70% increase in the number of DSL ports shipped, offset by a 29% decrease in the average selling price of our DSL products. Voice over Packet unit sales increased 88%, but were offset by a 56% decrease in the average selling price. Revenue from our DSL products accounted for $122.1 million or 98% of total net revenues in 2003, as compared to $100.9 million or 96% of total net revenues in 2002. Revenues from Voice over Packet products accounted for $2.5 million of revenues in 2003 as compared to $3.0 million in 2002, or 2% and 3% of total net revenues, respectively. We anticipate that revenues from our DSL products will continue to account for greater than 80% of our total net revenues in 2004. We expect our revenues in the first six months of 2004 to be lower than the same period of 2003 as our customers work through their existing inventories and implement transition plans to our next generation of products to be introduced in the second quarter of 2004.
Competition and technological change in the rapidly evolving DSL market has and may continue to influence our quarterly and annual net revenues and results of operations. Average selling prices of our DSL and Voice over Packet products tend to be higher at the time we introduce new products and decline over time due to competitive pressures. We expect this pattern to continue with existing and future products. Our average selling prices are also impacted by our customer concentration and product mix.
Our major customers for the year ended December 31, 2003 were NEC and Sumitomo who represented 49% and 31% of net revenues, respectively. For the year ended December 31, 2002, NEC and Sumitomo represented
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45% and 41% of net revenues, respectively. Revenues from international customers, who were primarily located in Japan, comprised 88% and 89% of our net revenues in each of the years ended December 31, 2003 and 2002.
Cost of Revenues, Gross Profit and Gross Profit Margin: Cost of revenues includes the cost of purchasing the finished silicon wafers manufactured by independent foundries, costs associated with assembly, packaging, test and quality assurance for semiconductor products, royalties related to purchased technology, and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support. Cost of revenues was $71.2 million in 2003 and $59.5 million in 2002 resulting in gross profit of $53.8 million in 2003 and $45.5 in 2002. Gross profit margin was 43% for both 2003 and 2002. The increase in gross profit in absolute dollars was primarily due to increased sales volumes offset by decreased average selling prices. We maintained our gross profit margin from 2002 to 2003 through improved yields, lower subcontractor costs, increased absorption of manufacturing overhead costs as a result of the increased volumes, and lower stock-based compensation expense. Our future gross profit margins may be affected by competitive pricing strategies, fluctuation in the volume of our product sales, fluctuations in silicon wafer costs, possible changes in product mix and the introduction of certain lower margin products, among other factors.
Research and Development Expenses: Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers, prototype costs related to the fabrication of our silicon chips, depreciation associated with software development tools, and amortization of deferred stock-based compensation. We expense our research and development costs as they are incurred. Several components of our research and development effort require significant expenditures, the timing of which can cause significant quarterly variability in our expenses. Research and development expenses in 2003 were $46.2 million, compared to $50.8 million in 2002, a decrease of 9%. This decrease was primarily due to a $2.0 million decrease in salaries and personnel related expenses, a $2.7 million decrease in software rental expense and amortization of software leases and maintenance contracts, and a $1.6 million decrease in stock based compensation expense, partially offset by a $1.5 million increase in consulting expense. We expect that research and development expenses will increase in fiscal 2004 as a result of the planned headcount increases supporting new development programs, salary and bonus plan increases, prototype costs, and depreciation on purchased software development tools.
Sales and Marketing Expenses: Sales and marketing expenses consist primarily of salaries, commissions, and related expenses for personnel engaged in marketing, sales, customer service and applications engineering support functions, costs associated with promotional and other marketing expenses, as well as amortization of deferred stock-based compensation. Sales and marketing expenses in 2003 were $12.1 million, compared to $14.7 million in 2002, a decrease of 17%. The decrease was due primarily to a $2.2 million decrease in items such as salaries and personnel related expenses, severance pay expense, expatriate allowance and travel expenses, and a decrease of $900,000 in depreciation, partially offset by a $500,000 increase in amortization of deferred compensation. We expect that sales and marketing expenses will increase in fiscal 2004 as we expand our sales force and marketing personnel to support growth of our business outside of Japan as well as our newly developed products.
General and Administrative Expenses: General and administrative expenses consist primarily of salaries and personnel related expenses for executives, finance, accounting, facilities, information services, and human resources; corporate insurance, amortization of deferred stock-based compensation, recruiting expenses, legal, audit and other professional fees, and other corporate expenses. General and administrative expenses were $9.7 million in both 2003 and 2002. While expense levels remained relatively constant year over year there was a decrease in stock based compensation expense of $1.1 million and a $600,000 decrease in legal and professional fees, offset by an increase of $600,000 in bonus expense. In addition, net bad debt expense increased by $700,000 in 2003 compared to 2002 primarily as a result of reducing our bad debt reserve in the prior year. We expect general and administration expenses to increase in 2004 as we incur additional costs related to further investments in our business and as we continue to implement the requirements of the Sarbanes-Oxley Act.
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Amortization of Deferred Compensation and Non-Cash Stock Compensation: Deferred compensation represents the difference between the grant price and the fair value for financial statement reporting purposes of the Company's common stock option grants. Amortization of deferred compensation was $1.4 million in 2003 compared to $3.8 million in 2002, a decrease of $2.4 million. The decrease is primarily related to the use of the graded vesting method, which results in accelerated amortization of deferred compensation expense in the earlier years of the awards' expected life, as well as adjustments in 2002 related to forfeited options. As required by APB 25, we record an adjustment to stock-based compensation expense related to employees who forfeit options for which compensation expense had been recognized using the graded vesting method, but which are unvested on the date their employment terminated. The expense for the amortization of deferred compensation is expected to decrease substantially in 2004 as we enter the last year of the graded vesting method which generally represents only 4% of the total expense to be incurred.
Interest Income, Net: Interest income, net was $1.1 million in 2003, compared to $1.8 million in 2002, a decrease of 40%. This decrease was primarily due to lower interest rates obtained on our cash, cash equivalents and short-term investment portfolio.
Benefit (Provision) for Income Taxes: We recorded a tax provision of $133,000 for the year ended December 31, 2003, which represents state income taxes and foreign income taxes. We recorded a benefit for income taxes of $95,000 for the year ended December 31, 2002, which represents a refund of U.S. Federal Income Taxes, offset by foreign income taxes.
As of December 31, 2003, we have $75 million and $33 million of net operating loss carryforwards for federal and state purposes, respectively. We also have federal and state research and development tax credit carryforwards of approximately $3.8 million and $3.7 million respectively. The federal net operating losses and federal credit carryforwards will expire at various dates beginning in 2018, if not utilized. The California net operating losses are not available to offset income until 2008 due to recent state law changes.
Utilization of net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and tax credit carryforwards before full utilization.
Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes", provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and our reported cumulative net losses to date, we have provided a full valuation allowance against our deferred tax assets.
Net Losses: We incurred net losses of $13.4 million in 2003 compared to $33.3 million in 2002. The decrease in net loss of $19.9 million is primarily the result of higher gross profit of $8.4 million, lower salary and related personnel expenses of $4.4 million, lower amortization of acquisition related intangibles and the absence of a prior year charge for impairment of goodwill of $5.9 million, lower software rental expense and amortization of software leases and maintenance expense of $2.8 million and lower expense for stock-based compensation expense of $2.4 million, partially offset by higher consulting expense of $1.8 million and higher bonus expense of $700,000. Net loss per common share was $0.37 in 2003 and $0.96 in 2002.
Years ended December 31, 2002 and 2001
Total Net Revenues: Total net revenues in 2002 were $105.0 million, compared with $159.5 million in 2001, a decrease of $54.5 million or 34%. The decrease in revenues is primarily due to a 40% decrease in the average selling prices of our DSL products which accounted for approximately $65 million of the decrease. This was partially offset by a 4% increase in unit volume shipments that provided approximately $10 million of revenue in 2002. Revenue from our DSL products accounted for $100.9 million or 96% of total net revenues in
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2002, as compared to $155.7 million or 98% of total net revenues in 2001. Revenues from Voice over Packet products accounted for $3.0 million of revenues in 2002 as compared to $2.5 million in 2001, or 3% and 2% of total net revenues, respectively.
Our major customers for the years ended December 31, 2002 were NEC and Sumitomo who represented 45% and 41% of net revenues, respectively. For the year ended December 31, 2001, Sumitomo and NEC represented 48% and 38% of net revenues, respectively. Revenues from international customers, who were primarily located in Japan, comprised 89% of our net revenues in each of the years ended December 31, 2002 and 2001.
Cost of Revenues: Cost of revenues, which reflects costs of product revenues, was $59.5 million in 2002 and $79.8 million in 2001 resulting in gross profit as a percentage of revenues of 43% and 50%, respectively. The decrease in gross profit and gross profit percentage was primarily due to lower average selling prices per unit, partially offset by lower per unit product costs. Our gross margins in the future may be affected by competitive pricing strategies and the future introduction of certain lower margin items.
Research and Development Expenses: Research and development expenses in 2002 were $50.8 million, compared to $59.0 million in 2001, a decrease of 14%. This decrease was primarily due to a $5.5 million decrease in the amortization of deferred stock-based compensation and a decrease in software expense.
Sales and Marketing Expenses: Sales and marketing expenses in 2002 were $14.7 million, compared to $18.0 million in 2001, a decrease of 18%. The decrease was due primarily to a $2.8 million decrease in the amortization of deferred stock-based compensation, a decrease in customer evaluation board costs and a decrease in sales commissions, partially offset by increases in salary and severance costs.
General and Administrative Expenses: General and administrative expenses in 2002 were $9.7 million, compared to $13.9 million in 2001, a decrease of 30%, which was primarily due to a decrease in the amortization of deferred stock-based compensation of $2.7 million, a decrease in bad debt expense of $800,000 and decreases in expensed software and legal and stock administration fees, offset by increases in business insurance costs.
Amortization of Deferred Compensation and Non-Cash Stock Compensation: Amortization of deferred stock-based compensation, which is allocated among the above expense categories, was $3.8 million in 2002 compared to $15.3 million in 2001, a decrease of $11.5 million. The decrease is primarily related to the use of the graded vesting method, which results in accelerated amortization of deferred compensation expense in the earlier years of the awards' expected life, as well as adjustments in 2002 related to forfeited options. As required by APB 25, we record an adjustment to stock-based compensation related to employees who forfeit options for which compensation expense had been recognized using the graded vesting method, but which are unvested on the date their employment terminated.
Amortization of Goodwill and Other Acquisition-Related Intangibles: Amortization of goodwill and other acquisition-related intangibles decreased to $167,000 for the year ended December 31, 2002 from $3.3 million for the year ended December 31, 2001. This was due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), which required us to discontinue the amortization of goodwill effective January 1, 2002. In addition, in accordance with SFAS 142 we reclassified assembled workforce to goodwill, which eliminated the amortization of assembled workforce effective January 1, 2002.
Impairment of Goodwill: During the fourth quarter of 2002, we completed our annual goodwill impairment test. Based upon this test, we recorded a charge of $5.8 million to fully write down the value of goodwill associated with our purchase transactions. No comparable charges were incurred in 2001.
In-Process Research and Development Expense: In 2002, we did not have any acquired in-process research and development. In the first quarter of fiscal 2001, we wrote off $7.4 million of acquired in-process
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research and development (IPR&D) related to our acquisition of vEngines, Inc. The entire IPR&D charge of $7.4 million related to one project. This project related to the development of high-density voice processing semiconductor products, which bridge circuit switched voice and data networks. The write off was necessary because the acquired technology had not yet reached technological feasibility and there were no alternative future uses for the technology.
Gain (Loss) on Long-Term Investment: We monitor and evaluate the realizable value of our long-term equity investment and if events and circumstances indicate that a decline in value of this asset is other than temporary, we write down the carrying value to its estimated fair value. In June 2001, in connection with the ongoing evaluation and review of our only long-term equity investment, we recorded a non-cash charge of $990,000 to write down the basis of this investment to zero as a result of this impairment. In January 2002, we sold this equity investment for $440,000 and reported this as a gain in the first quarter of 2002.
Interest Income, net: Interest income, net was $1.8 million in 2002, compared to $3.5 million in 2001, a decrease of 49%. This decrease was primarily due to lower interest rates obtained on our cash, cash equivalents and short-term investment portfolio, and slightly lower average invested balances.
Benefit (Provision) for Income Taxes: We recorded a tax benefit of $95,000 for the year ended December 31, 2002, which represents a refund of U.S. Federal Income Taxes, offset by foreign income taxes. We recorded a provision for income taxes of $400,000 for the year ended December 31, 2001, which represents federal and state minimum taxes as well as foreign income taxes.
Net Losses: We incurred net losses of $33.3 million in 2002 compared to $19.7 million in 2001. The increase in net loss of $13.6 million or 69% is primarily the result of lower gross profit of $34.3 million, the write off of goodwill of $5.8 million, and higher depreciation and amortization expense of $3.0 million partially offset by lower expenses for deferred stock-based compensation of $11.5 million, in-process research and development of $7.4 million, goodwill amortization of $3.1 million, bad debt expense of $800,000 and lower interest income of $1.7 million. Net loss per common share was $0.96 in 2002 and $0.59 in 2001.
Liquidity and Capital Resources
At December 31, 2003, we had $89.6 million in cash, cash equivalents and short-term investments as compared to $102.0 million at December 31, 2002. Short term investments are defined as income yielding securities with no maturity dates or maturity dates greater than 90 days when purchased that can be readily converted into cash.
Cash and cash equivalents decreased to $24.7 million at December 31, 2003 from $93.5 million at December 31, 2002. The decrease was primarily due to our investing $56.4 million of our cash in short term investments and the use of $21.6 million in operations, offset by proceeds of $13.3 million from employee stock plans.
Operating activities during 2003 used $21.6 million in cash. This was primarily the result of the net loss of $13.4 million, an increase in our accounts receivable of $9.6 million, an increase in our inventories of $7.8 million, an increase of $1.1 million in other prepaids and current assets, and a decrease in accounts payable of $1.1 million, offset by the non-cash impact of a $6.4 million of depreciation and amortization and $1.4 million in amortization of deferred stock-based compensation and an increase in accrued liabilities and accrued payroll and related expenses of $3.8 million. Net cash used by operating activities increased significantly in the fourth quarter of 2003 compared to the third quarter of 2003. This was due largely to the decline in revenues and gross margins without a commensurate decrease in operating expenses for the quarter. We expect to increase operating expenses and use additional cash in 2004 as we add planned headcount and incur additional expenses to support new PON and VoP product lines.
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Accounts receivable increased from $2.9 million at December 31, 2002 to $12.5 million at December 31, 2003. The increase in accounts receivable resulted primarily from the timing of shipments, as a significant portion of the 2003 fourth quarter's shipments were made in the last month of the quarter. In addition, accounts receivable in 2002 were lower due to an early payment from a significant customer at the end of the year.
Inventories increased $7.8 million to $11.9 million at December 31, 2003. In 2003, lead times at our major foundry subcontractor increased to between 16 and 18 weeks for several of our key products compared to 12 and 14 weeks in 2002. The extended lead time required us to place orders with the foundry based on sales forecast well ahead of firm purchase commitments. As our sales fell below sales forecast in the fourth quarter, we ended the quarter with higher inventories.
Net cash used by investing activities was $59.7 million for the year ended December 31, 2003, and was primarily related to net purchases of short-term investments of $56.4 million and purchases of fixed assets of $3.4 million. As of December 31, 2003, our short term securities were invested primarily in government agency instruments totaling $30.8 million, auction rate securities totaling $32.6 million, and municipal and corporate bonds totaling $1.0 million.
Cash provided by financing activities was $12.6 million for the year ended December 31, 2003, and was related to the net proceeds from issuance of common stock under employee stock plans of $13.3 million and $900,000 from proceeds required to be disgorged by a shareholder, offset by $1.5 million of capital lease payments.
Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. We consider our option program critical to our operations and productivity. All of our full-time employees participate in this program. The program consists of two plans; one under which officers, directors and employees may be granted options to purchase shares of our stock and a broad-based plan under which options may be granted to all employees other than directors.
Our principal source of liquidity as of December 31, 2003 consisted of $89.6 million of cash and cash equivalents, and short-term investments. There are no assurances that we can reduce losses from operations and avoid negative cash flow or raise capital as needed to fund the operations. However, based on current plans and business conditions, but subject to the discussion in the "Business" section and "Risk Factors" section, we believe our current cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least 12 months. The rate at which we will consume cash will be dependent on the cash needs of future operations, which will, in turn, be directly affected by the levels of demand for our products.
Significant cash-based operating commitments in future periods include lease payments and inventory purchase commitments. As of December 31, 2003, future obligations totaled $15.1 million, $7.2 million of which will be paid in fiscal 2004. Inventory purchase commitments of approximately $3.1 million as of December 31, 2003 will be paid in the first six months of fiscal 2004.
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Significant contractual obligations and commercial commitments are shown in the table below (in thousands):
Total Less than 1 Year 1-3 Years After 3 Years
-------- ------------------ ----------- ---------------
Operating leasesfacilities $ 7,720 $ 1,439 $ 3,083 $ 3,198
Capital leasessoftware 527 527
Operating leasessoftware 3,780 2,184 1,596
Inventory purchases 3,077 3,077
- ------ --- -------------- -- -------- --- -----------
Total cash obligations $ 15,104 $ 7,227 $ 4,679 $ 3,198
- ------ --- -------------- -- -------- --- -----------
If we are able to sustain our current business plan and general economic conditions stabilize, we hope to achieve profitability in 2005. We believe our revenue forecast and the steps we have taken to increase revenue while controlling spending will allow us to achieve that objective. Our future capital requirements depend on many factors that affect our research, development, collaboration and sales and marketing activities. We believe that existing cash and investment securities and anticipated cash flow from operations will be sufficient to support our current operating plan for 2004. These cash flow and profitability expectations are subject to numerous assumptions, many of which may not actually occur. If some or all of such assumptions do not occur, our results may be substantially lower or different than expected. Such assumptions include, without limitation, assumptions that new product introductions will occur on a timely basis and achieve market acceptance, that our existing and potential customer base will continue to grow and that our industry's competitive landscape will not change adversely. For more information about the risks relating to our business, please read carefully the Risk Factors set forth below.
We expect to devote capital resources to continue our research and development efforts, to support our sales, marketing, and product development programs, to establish additional facilities worldwide and to fund other general corporate activities. From time to time, we receive various inquiries or claims in connection with intellectual property and other rights and may become party to associated claims. In certain cases, management has accrued estimates of the amounts it expects to pay upon resolution of such matters. Depending on the amount and timing of the resolutions of these claims, our future cash flows could be materially adversely affected in a particular period.
If our existing resources and cash generated from operations are insufficient to satisfy our liquidity requirements, we may seek to raise additional funds through public or private debt or equity financings. The sale of equity or debt securities could result in additional dilution to our stockholders, and we cannot be certain that additional financing will be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial condition and operating results.
Recent Accounting Pronouncements
In January 2003, the FASB issued EITF No. 00-21, "Revenue Arrangements with Multiple Deliverables" (EITF 00-21). EITF 00-21 provides guidance on how to determine whether an arrangement involves multiple deliverables and contains more than one unit of accounting. EITF 00-21 was effective for arrangements entered into after June 15, 2003. The adoption of EITF 00-21 did not have a material effect on the Company's consolidated results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements" (FIN 46). FIN 46 establishes accounting guidance for consolidation of variable interest entities (VIE's) that function to support the activities of the primary beneficiary. FIN 46 applies to any business enterprise, both public and private, that has a variable interest in a VIE. The Company does not have any variable interests in VIE's and therefore the adoption did not have any impact on the Company's consolidated financial position or results of operations.
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Risk Factors
You should carefully consider the risks described below and all of the information contained in this Form 10-K. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed, the trading price of our common stock could decline, and you may lose all or part of your investment in our common stock.
WE HAVE A HISTORY OF LOSSES AND WE MAY NOT ACHIEVE PROFITABILITY.
We have not reported an operating profit for any year since our incorporation and have experienced net losses of approximately $13.4 million, $33.3 million and $19.7 million for the years ended December 31, 2003, 2002 and 2001, respectively.
WE ANTICIPATE LOWER MARGINS, WHICH COULD ADVERSELY AFFECT OUR PROFITABILITY.
We expect the average selling prices of our products to decline as they mature. Historically, competition in the semiconductor industry has driven down the average selling prices of products. If we price our products too high, our customers may use a competitor's product or an in-house solution. To maintain profit margins, we must reduce our costs sufficiently to offset declines in average selling prices or successfully sell proportionately more new products with higher average selling prices. Yield or other production problems or shortages of supply may preclude us from lowering or maintaining current product costs.
We have also experienced more aggressive price competition from competitors in market segments in which we are attempting to expand our business. These circumstances may make some of our products less competitive, and we may be forced to decrease our prices significantly to win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE.
The market price of our common stock has been volatile and will likely continue to fluctuate significantly in response to the following factors, some of which are beyond our control:
variations in our quarterly operating results;
changes in financial estimates of our revenues and operating
results by securities analysts;
changes in market valuations of integrated circuit companies;
announcements by us, our competitors or others in related market
segments of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
loss or decrease in sales to a major customer or failure to
complete significant transactions;
loss or reduction in manufacturing capacity from one or more of
our key suppliers;
additions or departures of key personnel;
future sales of our common stock;
inconsistent or low levels of trading volume of our common stock;
commencement of or involvement in litigation;
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announcements by us or our competitors of key design wins and
product introductions;
a decrease in the average selling price of our products;
ability to achieve cost reductions; and
fluctuations in the timing and amount of customer requests for
product shipments.
A GENERAL ECONOMIC SLOWDOWN, AND A SLOWDOWN IN SPENDING IN THE
TELECOMMUNICATIONS INDUSTRY, HAS AFFECTED AND MAY CONTINUE TO NEGATIVELY AFFECT
OUR BUSINESS AND OPERATING RESULTS.
There have been announcements throughout the worldwide telecommunications industry of current and planned reductions in component inventory levels and equipment production volumes, and of delays in the build-out of new infrastructure. Any of these trends, if continued, could result in lower than expected demand for our products, which could have a material adverse effect on our revenues and results of operations generally, and could cause the market price of our common stock to decline. Specifically, we have experienced:
reduced demand for our products;
increased price competition for our products;
increased risk of excess and obsolete inventories;
excess facilities and manufacturing capacity; and
higher general and administrative costs, as a percentage of revenue.
Recent geopolitical and social turmoil in many parts of the world, including actual incidents and potential future acts of terrorism and war, may continue to put pressure on global economic conditions. These geopolitical and social conditions, together with the resulting economic uncertainties, make it extremely difficult for our company, our customers and our vendors to accurately forecast and plan future business activities. This reduced predictability challenges our ability to operate profitably or to increase revenues. In particular, it is difficult to develop and implement strategies to create sustainable business models and efficient operations, and to effectively manage outsourced relationships for services such as contract manufacturing and information technology. If the current uncertain economic conditions continue or deteriorate, there could be additional material adverse impact on our financial position, revenues, results of operations, or cash flow.
A SLOWDOWN IN DEPLOYMENT OF DSL IN JAPAN WOULD ADVERSELY AFFECT OUR BUSINESS AND
OPERATING RESULTS.
Sales to customers located in Japan accounted for 79% of net revenues for the year ended December 31, 2003, compared to 86% of net revenues for year ended December 31, 2002. Our sales are dependent on the continuous additions to DSL subscribers in Japan and a slow down in new DSL subscribers may cause our revenue to decline. Our sales have been historically denominated in U.S. dollars and major fluctuations in currency exchange rates could materially affect our Japanese customers' demand, thereby forcing them to reduce their orders, which could adversely affect our operating results.
WE DERIVE A SUBSTANTIAL AMOUNT OF OUR REVENUES FROM JAPAN, AND OUR FAILURE TO
DIVERSIFY THE GEOGRAPHIC SOURCES OF OUR REVENUE COULD HARM OUR BUSINESS AND
OPERATING RESULTS.
Because a substantial portion of our revenues have been derived from sales into Japan, our revenues have been heavily dependent on developments in the Japan market. While part of our strategy is to diversify the geographic sources of our revenues, failure to further penetrate markets outside of Japan could harm our business and results of operations.
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COMPETING DSL TECHNOLOGIES WHICH HAVE BEEN DEPLOYED IN JAPAN MAY ADVERSELY
IMPACT THE DEMAND FOR OUR DSL PRODUCTS, MARKET SHARE AND OPERATING RESULTS.
We have worked in partnership with local telecommunications companies to develop the Annex C standard for the DSL market in Japan and have been able to achieve the majority market share of DSL equipment purchases, based on our products, in Japan. In July 2001, a certain service provider announced plans to deploy lower priced competing DSL technologies in Japan and has subsequently deployed these competing technologies. If these competing technologies continue to be successful, our market share in the DSL market in Japan may decline, and our business and operating results may be adversely affected.
WE DERIVE A SUBSTANTIAL AMOUNT OF OUR REVENUES FROM INTERNATIONAL SOURCES, AND
DIFFICULTIES ASSOCIATED WITH INTERNATIONAL OPERATIONS COULD HARM OUR BUSINESS.
A substantial portion of our revenues has been derived from customers located outside of the United States. For 2003 and 2002, 87% and 89%, respectively, of our net revenues were to customers located in Asia. We may be unable to successfully overcome the difficulties associated with international operations. These difficulties include:
staffing and managing foreign operations;
changes in regulatory requirements;
licenses, tariffs and other trade barriers;
political and economic instability;
difficulties in protecting intellectual property rights in some
foreign countries;
a limited ability to enforce agreements and other rights in
some foreign countries;
obtaining governmental approvals for products; and
complying with a wide variety of complex foreign laws and treaties.
Because sales of our products are denominated exclusively in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country.
WE DEPEND ON A FEW CUSTOMERS, AND IF WE LOSE ANY OF THEM OUR SALES AND
OPERATIONS WILL SUFFER.
We sell DSL products primarily to network equipment manufacturers. Our top two customers for the year ended December 31, 2003 were NEC and Sumitomo, accounting for 49% and 31% of our net revenues, respectively. For the year ended December 31, 2002, NEC and Sumitomo accounted for 45% and 41% of our net revenues, respectively. We do not have contractual volume commitments with these customers but rather sell our products to them on an order-by-order basis. We expect to be dependent upon a relatively small number of large customers in future periods, although the specific customers may vary from period to period. If we are not successful in maintaining relationships with key customers and winning new customers, our business and results of operations will suffer.
WE ARE SUBJECT TO ORDER AND SHIPMENT UNCERTAINTIES, AND ANY SIGNIFICANT ORDER
CANCELLATIONS OR DEFERRALS COULD ADVERSELY AFFECT OUR BUSINESS.
We typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty. Any significant cancellations or deferrals in the future could
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materially and adversely affect our business, financial condition and results of operations. In addition, cancellations or deferrals of product orders, the return of previously sold products or the overproduction of products due to the failure of anticipated orders to materialize could cause us to hold excess or obsolete inventory, which could reduce our profit margins, increase product obsolescence and restrict our ability to fund our operations. Furthermore, we generally recognize revenue upon shipment of products to a customer. If a customer refuses to accept shipped products,we could incur significant charges against our revenue.
OUR CUSTOMERS MAY DEMAND PREFERENTIAL TERMS OR DELAY OUR SALES CYCLE, WHICH
WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our customers are in most cases larger than us and are able to exert a high degree of influence over us. These customers may have sufficient bargaining power to demand low prices and other terms and conditions that may materially adversely affect our business, financial condition and results of operations. In addition, prior to selling our products to such customers, we must typically undergo lengthy product approval processes, often taking up to one year. Accordingly, we are continually submitting successive versions of our products, as well as new products, to our customers for approval. The length of the approval process can vary and is affected by a number of factors, including customer priorities, customer budgets and regulatory issues affecting telecommunications service providers. Delays in the product approval process could materially adversely affect our business, financial condition and results of operations. While we have been successful in the past in obtaining product approvals from our customers, such approvals and the ensuing sales of such products may not continue to occur. Delays can also be caused by late deliveries by other vendors, changes in implementation priorities and slower-than-anticipated growth in demand for the services that our products support. A delay in, or cancellation of, the sale of our products could adversely affect our results from operations or cause them to significantly vary from quarter to quarter.
SALES OF OUR PRODUCTS DEPEND ON THE WIDESPREAD ADOPTION OF BROADBAND ACCESS
SERVICES, ESPECIALLY DSL. IF THE DEMAND FOR BROADBAND ACCESS SERVICES DOES NOT
INCREASE, WE MAY NOT BE ABLE TO GENERATE SUBSTANTIAL SALES.
Sales of our products depend on the increased use and widespread adoption of broadband access services, and DSL services in particular, and the ability of telecommunications service providers to market and sell broadband access services. Our business would be harmed, and our results of operations and financial condition would be adversely affected, if the use of broadband access services does not increase as anticipated. Certain critical factors will likely continue to affect the development of the broadband access service market. These factors include:
inconsistent quality and reliability of service;
lack of availability of cost-effective, high-speed service;
lack of interoperability among multiple vendors' network equipment;
congestion in service providers' networks;
inadequate security; and
slow deployment of new broadband services over DSL lines.
BECAUSE OTHER BROADBAND TECHNOLOGIES MAY COMPETE EFFECTIVELY WITH DSL SERVICES
OR OTHER SERVICES ADDRESSED BY OUR PRODUCTS, A SLOWDOWN IN DEPLOYMENT OF DSL
SERVICES, THE LACK OF SIGNIFICANT GROWTH IN NON-DSL MARKETS THAT WE ARE
TARGETING AND OUR LACK OF SUCCESS IN PENETRATING SUCH MARKETS WOULD ADVERSELY
AFFECT OUR BUSINESS AND OPERATING RESULTS.
Our revenues are heavily dependent on the increase in demand for DSL services. DSL services are competing with a variety of different broadband data transmission technologies, including cable modems,
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satellite and other wireless technologies. While part of our strategy is to diversify our product markets beyond DSL into such areas as optical access and VoP, if any technology that is competing with the technologies that we offer is more reliable, faster and/or less expensive or has any other advantages over the technologies for which we have products, then the demand for our products may decrease. The lack of significant growth in those markets we are targeting in general and the lack of success of our products in particular would also adversely affect our business and results of operations.
BECAUSE THE SALES CYCLE FOR OUR PRODUCTS TYPICALLY LASTS UP TO ONE YEAR AND MAY
BE SUBJECT TO DELAYS, IT IS DIFFICULT TO FORECAST SALES FOR ANY GIVEN PERIOD.
If we fail to realize forecasted sales for a particular period, our stock price could decline significantly. The sales cycle of our products is lengthy and typically involves a detailed initial technical evaluation of our products by our prospective customers, followed by the design, construction and testing of prototypes incorporating our products. Only after these steps are complete will we receive a purchase order from a customer for volume shipments. This process generally takes from 9 to 12 months and may last longer. Given this lengthy sales cycle, it is difficult to accurately predict when sales to a particular customer will occur. In addition, we may experience unexpected delays in orders from customers, which may prevent us from realizing forecasted sales for a particular period. Our products are typically sold to equipment manufacturers, who incorporate our products in the products that they in turn sell to consumers or to network service providers. As a result, any delay by our customers, or by our customers' customers, in the manufacture or distribution of their products will result in a delay in obtaining orders for our products, which could cause our business and results to suffer.
RAPID CHANGES IN THE MARKET FOR DSL CHIPSETS MAY RENDER OUR CHIPSETS OBSOLETE OR
UNMARKETABLE.
The market for chipsets for DSL products is characterized by:
intense competition;
rapid technological change;
frequent new product introductions by our competitors;
changes in customer demands; and
evolving industry standards.
Any of these factors could make our products obsolete or unmarketable. In addition, the life cycles of some of our products may depend upon the life cycles of the end products into which our products will be designed. Products with short life cycles require us to closely manage production and inventory levels. Unanticipated changes in the estimated total demand for our products and/or the estimated life cycles of the end products into which our products are designed may result in obsolete or excess inventories, which in turn may adversely affect our operating results. To compete, we must innovate and introduce new products. If we fail to successfully introduce new products on a timely and cost-effective basis that meet customer requirements and are compatible with evolving industry standards, then our business, financial condition and results of operations will be seriously harmed.
OUR MARKETS ARE HIGHLY COMPETITIVE, AND MANY OF OUR COMPETITORS ARE ESTABLISHED
AND HAVE GREATER RESOURCES THAN WE HAVE.
The market for communications semiconductor and software products is intensely competitive. Given our stage of development, there is a substantial risk that we will not have the financial resources, technical expertise or marketing and support capabilities to compete successfully. In addition, a number of other semiconductor companies have announced their intent to enter the market segments adjacent to or addressed by our products.
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These competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical and marketing resources than we have. We may also face competition from customers' or prospective customers' own internal development efforts. Any of these competitors may be able to introduce new technologies, respond more quickly to changing customer requirements or devote greater resources to the development, promotion and sale of their products than we can.
BECAUSE OUR PRODUCTS ARE COMPONENTS OF OTHER EQUIPMENT, IF BROADBAND EQUIPMENT
MANUFACTURERS DO NOT INCORPORATE OUR PRODUCTS IN THEIR EQUIPMENT, WE MAY NOT BE
ABLE TO GENERATE SALES OF OUR PRODUCTS IN VOLUME QUANTITIES.
Our products are not sold directly to the end-user; they are components of other products. As a result, we rely upon equipment manufacturers to design our products into their equipment. We further rely on the manufacturing and deployment of the equipment to be successful. If equipment that incorporates our products is not accepted in the marketplace, we may not achieve sales of our products in volume quantities, which would have a negative impact on our results of operations.
BECAUSE MANUFACTURERS OF COMMUNICATIONS EQUIPMENT MAY BE RELUCTANT TO CHANGE
THEIR SOURCES OF COMPONENTS, IF WE DO NOT ACHIEVE DESIGN WINS WITH SUCH
MANUFACTURERS, WE MAY BE UNABLE TO SECURE SALES FROM THESE CUSTOMERS IN THE
FUTURE.
Once a manufacturer of communications equipment has designed a supplier's semiconductor into its products, the manufacturer may be reluctant to change its source of semiconductors due to the significant costs associated with qualifying a new supplier. Accordingly, our failure to achieve design wins with equipment manufacturers, who have chosen a competitor's semiconductor could create barriers to future sales opportunities with these manufacturers.
THIRD-PARTY CLAIMS REGARDING INTELLECTUAL PROPERTY MATTERS COULD CAUSE US TO
STOP SELLING OUR PRODUCTS, PAY MONETARY DAMAGES OR OBTAIN LICENSES ON ADVERSE
TERMS.
There is a significant risk that third parties, including current and potential competitors, will claim that our products, or our customers' products, infringe on their intellectual property rights. The owners of these intellectual property rights may bring infringement claims against us or our customers. Any such litigation, whether or not determined in our favor or settled by us, would be costly and divert the attention of our management and technical personnel. Inquiries with respect to the coverage of our intellectual property could develop into litigation. In the event of an adverse ruling for an intellectual property infringement claim, we could be required to obtain a license or pay substantial damages or have the sale of our products stopped by an injunction. Such a license may not be available on reasonable terms, or at all. In addition, if a customer of our products cannot acquire a required license on commercially reasonable terms, that customer may choose not to use our products. We have obligations to indemnify our customers under some circumstances for infringement of third-party intellectual property rights. If any intellectual property claims from third parties against one of our customers whom we have indemnified is held to be valid, the costs to us could be substantial and our business could be harmed.
We have received correspondence from certain parties, including Texas Instruments, Alcatel and Ricoh, requesting us to discuss the potential need for non-exclusive licenses permitting us to utilize technology covered by various patents held by these parties. We could be subject to claims similar to the Texas Instruments, Alcatel and Ricoh claims in the future. Depending on the amount and timing of any unfavorable resolutions of these claims, our future results of operations or cash flows could be materially adversely affected.
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IF WE DELIVER PRODUCTS WITH DEFECTS, OUR CREDIBILITY WILL BE HARMED, AND THE
SALES AND MARKET ACCEPTANCE OF OUR PRODUCTS WILL DECREASE.
Our products are complex and have contained errors, defects and bugs when introduced and revised. If we deliver products with errors, defects or bugs or products that have reliability, quality or compatibility problems, our credibility and the market acceptance and sales of our products could be harmed, which could adversely affect our ability to retain existing customers or attract new customers. Further, if our products contain errors, defects and bugs, then we may be required to expend significant capital and resources to alleviate such problems and may have our sales to customers interrupted or delayed. If any of these problems are not found until we have commenced commercial production, we may be required to incur additional development costs and product repair or replacement costs. Defects could also lead to potential liability as a result of product liability lawsuits against us or against our customers. We have agreed to indemnify our customers in some circumstances against liability from defects in our products. A successful product liability claim could seriously harm our business, financial condition and results of operations, and may divert our technical and other resources from other development efforts.
WE DEPEND ON SOLE SOURCE SUPPLIERS FOR SEVERAL KEY COMPONENTS OF OUR PRODUCTS.
We obtain certain parts, components and packaging used in the delivery of our products from sole sources of supply. For example, we obtain semiconductor wafers from Taiwan Semiconductor Manufacturing Co., Ltd, Semiconductor Manufacturing International Corporation and United Microelectronics Corporation. If we fail to obtain components in sufficient quantities when required or if we cannot adequately control manufacturing process quality, product yields or production costs, our business could be harmed. Developing and maintaining these strategic relationships with our vendors is critical for us to be successful.
Any of our sole source suppliers may:
enter into exclusive arrangements with our competitors;
stop selling their products or components to us at commercially
reasonable prices;
refuse to sell their products or components to us at any price; or
be subject to production disruptions such as earthquakes.
WE MAY EXPERIENCE DIFFICULTIES IN TRANSITIONING TO SMALLER GEOMETRY PROCESS
TECHNOLOGIES OR IN ACHIEVING HIGHER LEVELS OF DESIGN INTEGRATION AND THAT MAY
RESULT IN REDUCED MANUFACTURING YIELDS, DELAYS IN PRODUCT DELIVERIES AND
INCREASED EXPENSES.
In order to remain competitive, we expect to continue to transition our products to increasingly smaller line width geometries. This transition will require us to modify the manufacturing processes for our products and redesign some products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs, and we have designed some of our products to be manufactured in .35 micron, .25 micron, .18 micron and .13 micron geometry processes. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes. We are dependent on our relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our foundry relationships. If our foundries or we experience significant delays in this transition or fail to efficiently implement this transition, our business, financial condition and results of operations could be materially and adversely affected. As smaller geometry processes become more prevalent, we expect to continue to integrate greater levels of functionality, as well as customer and third party intellectual property, into our products. However, we may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis, or at all.
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FUTURE CONSOLIDATION IN THE TELECOMMUNICATIONS EQUIPMENT INDUSTRY MAY INCREASE
COMPETITION THAT COULD HARM OUR BUSINESS.
The markets in which we compete are characterized by increasing consolidation both within the telecommunications equipment sector and by companies combining or acquiring data communications assets and assets for delivering voice-related services. We cannot predict with certainty how industry consolidation will affect our competitors. We may not be able to compete successfully in an increasingly consolidated industry. Increased competition and consolidation in our industry may require that we reduce the prices of our products or result in a loss of market share, which could materially adversely affect our business, financial condition and results of operations. Additionally, because we are now, and may in the future be, dependent on certain strategic relationships with third parties in our industry, any additional consolidation involving these parties could reduce the demand for our products and otherwise harm our business prospects.
WE MAY MAKE FUTURE ACQUISITIONS AND ACQUISITIONS INVOLVE NUMEROUS RISKS.
Our business is highly competitive and, as such, our growth is dependent upon market growth, our ability to enhance our existing products and our ability to introduce new products on a timely basis. One of the ways we have addressed and may continue to address the need to develop new products is through acquisitions of other companies. Acquisitions involve numerous risks, including the following:
difficulties in integration of the operations, technologies and
products of the acquired companies;
the risk of diverting management's attention from normal daily
operations of the business;
potential difficulties in completing projects associated with
purchased in-process research and development;
risks of entering markets in which we have no or limited
direct prior experience and where competitors in such markets
have stronger market positions; and
the potential loss of key employees of the acquired company.
Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results or financial condition.
We must also maintain our ability to manage such growth effectively. Failure to manage growth effectively and successfully integrate acquisitions could harm our business and operating results.
OUR EXECUTIVE OFFICERS AND KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND THESE
OFFICERS AND PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE.
We depend upon the continuing contributions of our key management, sales, customer support and product development personnel. The loss of such personnel could seriously harm us. In addition, we have not obtained key-man life insurance on any of our executive officers or key employees.
OUR FUTURE SUCCESS WILL DEPEND IN PART ON OUR ABILITY TO PROTECT OUR PROPRIETARY
RIGHTS AND THE TECHNOLOGIES USED IN OUR PRINCIPAL PRODUCTS, AND IF WE DO NOT
ENFORCE AND PROTECT OUR INTELLECTUAL PROPERTY, OUR BUSINESS WILL BE HARMED.
We rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and other contractual provisions to protect our proprietary rights. However, these measures afford only limited protection. Our failure to adequately protect our proprietary rights may adversely affect us. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary.
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The laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and many U.S. companies have encountered substantial infringement problems in these countries. There is a risk that our efforts to protect proprietary rights may not be adequate. For example, our competitors may independently develop similar technology, duplicate our products or design around our patents or our other intellectual property rights. If we fail to adequately protect our intellectual property or if the laws of a foreign jurisdiction do not effectively permit such protection, it would be easier for our competitors to sell competing products.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL WHICH MIGHT NOT BE AVAILABLE OR WHICH,
IF AVAILABLE, COULD BE ON TERMS ADVERSE TO OUR COMMON STOCKHOLDERS.
We expect that our current cash and cash equivalents and short-term investment balances will be adequate to meet our working capital and capital expenditure needs for at least twelve months. After that, we may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. We may also require additional capital for the acquisition of businesses, products and technologies that are complementary to ours. Further, if we issue equity securities, the ownership percentage of our stockholders would be reduced, and the new equity securities may have rights, preferences or privileges senior to those existing holders of our common stock. If we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results and financial condition.
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