| ADAPTEC INC Item 1A Risk Factors 11 Item 1A Risk Factors Our business faces significant risks |
| The risks described below may not be the only risks we face |
| Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations |
| If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could suffer, and the trading price of our common stock could decline |
| The impact of ongoing contract negotiations with our large OEM customers, industry technology transitions and market acceptance of our new products could cause our quarterly revenues to continue to decline |
| Our quarterly revenues have declined in each of the last two quarters and may continue to decline |
| We depend on a small number of large OEM customers for a significant portion of our revenues, and we are engaged in ongoing contract negotiations concerning product specifications and price |
| These negotiations may prove to be unfavorable |
| In addition, we are in the midst of an industry transition from parallel to serial connectivity and the revenue we generate from sales of our serial products may not grow at a fast enough rate to offset of declines in sales of our parallel products |
| Furthermore, although we are developing new products and technologies to replace our legacy products and technologies these new products and technologies may not gain sufficient market acceptance or contribute significantly to revenue |
| These factors, individually or in the aggregate, could cause our quarterly revenues to continue to decline |
| We depend on contract manufacturers and subcontractors, and if they fail to meet our manufacturing needs, it could delay shipments of our products and result in the loss of customers |
| We rely on contract manufacturers for manufacturing of our products and subcontractors for the assembly and packaging of the integrated circuits included in our products |
| On December 23, 2005 we entered into a three-year contract manufacturing agreement with Sanmina-SCI whereby Sanmina-SCI upon the closing of the transaction on January 9, 2006, assumed manufacturing operations of a majority of our products |
| If the transition of the manufacturing facilities does not go as expected it could result in loss of customers or revenue, which would have an adverse effect on our financial results |
| We have no long-term agreements with our assembly and packaging subcontractors |
| We also employ Amkor Technology and Advanced Semiconductor Engineering for our final assembly and test operations related to our ASIC products |
| We cannot assure you 11 _________________________________________________________________ these subcontractors will continue to be able and willing to meet our requirements for these components or services |
| Any significant disruption in supplies from or degradation in the quality of components or services supplied by, these contract manufacturers and subcontractors could delay shipments and result in the loss of customers or revenues, which could have an adverse effect on our financial results |
| Actions that we have taken and the actions that we are considering could adversely affect our business and financial results in the short-term, and may not have the long-term beneficial results that we intend |
| Our new management team is continuing to perform a thorough analysis of our operations, which it initiated in the first quarter of fiscal 2006, and has begun making a detailed plan to support our corporate strategy |
| This analysis of our operations includes a review of all aspects of our business, including our product portfolio, our relationships with strategic partners and our research and development focus |
| To date, we have implemented the steps described in "e Business—Overview, "e set forth above in Part I, Item 1 of this Annual Report on Form 10-K The actions that we have taken and the actions that we are considering could adversely affect our business and financial results in the short-term, may not have the long-term beneficial results that we intend and could result in the following: • loss of customers; • loss of employees; • increased dependency on suppliers; • supply issues; • reduced revenue base; • impairment of our assets; • increased operating costs; and • material restructuring charges |
| If we are unable to successfully complete the divestiture of our systems business it could result in an adverse effect on our business and financial results |
| Completing the divestiture of our systems business (which includes substantially all of the operating assets that were obtained through the Snap Appliance and Eurologic Systems acquisitions) could cause significant diversions of management time and resources |
| In addition, if the net proceeds of any such sale, prove to be less than we anticipate, it could lead to an additional impairment charge against our assets |
| Additionally, customers for our systems products could be reluctant to continue to buy from us due to the uncertainty caused by the planned divestiture |
| We may not be successful in overcoming these risks or any other problems encountered in connection with this divesture which may adversely affect our business, financial position and operating results |
| Our operating results have fluctuated in the past, and are likely to continue to fluctuate, and if our future results are below the expectations of investors or securities analysts, the market price of our common stock would likely decline significantly |
| Our quarterly operating results have fluctuated in the past, and are likely to vary significantly in the future, based on a number of factors related to our industry and the markets for our products |
| Factors that are likely to cause our operating results to fluctuate include those discussed in this Risk Factors section |
| In fiscal 2006, our operating results were materially impacted by unusual charges, such as a goodwill impairment charge of dlra90dtta6 million |
| Our operating expenses are largely based on anticipated revenues, and a large portion of our expenses, including facility costs and salaries, are fixed in the short term |
| As a result, lower than 12 _________________________________________________________________ anticipated revenues for any reason could cause significant variations in our operating results from quarter to quarter |
| Due to the factors summarized above, and the other risks described in this section, we believe that you should not rely on period-to-period comparisons of our financial results as an indication of our future performance |
| In the event that our operating results fall below the expectations of market analysts or investors, the market price of our common stock could decline substantially |
| Our operating results may be adversely affected by unfavorable economic and market conditions and the uncertain geopolitical environment |
| Adverse economic conditions in some markets may impact our business, which could result in: • Reduced demand for our products as a result of a decrease in capital spending by our customers; • Increased price competition for our products; • Increased risk of excess and obsolete inventories; • Excess facilities and manufacturing capacity; and • Higher overhead costs as a percentage of revenues |
| Demand for our products would likely be negatively affected if demand in the server and network storage markets declines |
| For example, demand in the server market declined slightly in fiscal 2002 and fiscal 2003, which contributed to a decline in our net revenues |
| It is difficult to predict future server sales growth, if any |
| In addition, other technologies may replace the technologies used in our existing products and the acceptance of our products using new technologies in the market may not be widespread, which could adversely affect our revenues |
| Because our sales are made by means of standard purchase orders rather than long-term contracts, if demand for our customers &apos products declines or if our customers do not control their inventories effectively, they may cancel or reschedule shipments previously ordered from us or reduce their levels of purchases from us |
| The volume and timing of orders received during a quarter are difficult to forecast |
| Our customers generally order based on their forecasts and they frequently encounter uncertain and changing demand for their products |
| If demand falls below such forecasts or if our customers do not control their inventories effectively, they may cancel or reschedule shipments previously ordered from us |
| Our customers have from time to time in the past canceled or rescheduled shipments previously ordered from us, and we cannot assure you that they will not do so in the future |
| In addition, because our sales are made by means of standard purchase orders rather than long-term contracts, we cannot assure you that these customers will continue to purchase quantities of our products at current levels, or at all |
| Historically, we have set our operating budget based on forecasts of future revenues because we do not have significant backlog |
| Because much of our operating budget is relatively fixed in the short-term, if revenues do not meet our expectations, then our financial results will be adversely affected |
| We depend on a few key customers and the loss of any of them could significantly reduce our revenues |
| Historically, a small number of our customers has accounted for a significant portion of our revenues |
| During fiscal 2006, sales to the ten OEM and distribution customers from which we received the greatest revenues accounted for approximately 92prca of our total revenues |
| In addition, IBM and Dell represented 30prca and 16prca, respectively, of our total revenues in fiscal 2006 |
| We believe that our major customers continually evaluate whether or not to purchase products from alternate or additional sources |
| Additionally, customers &apos economic and market conditions frequently change |
| Accordingly, we cannot assure you that a major customer will not reduce, delay or eliminate its purchases from us, which would likely cause our revenues to decline |
| In addition, we do not carry credit insurance on our accounts receivables and any difficulty in collecting outstanding amounts due from our customers, particularly customers that place larger orders or experience financial difficulties, could adversely affect our revenues 13 _________________________________________________________________ and our net income |
| Because our sales are made by means of standard purchase orders rather than long-term contracts, we cannot assure you that these customers will continue to purchase quantities of our products at current levels, or at all |
| If there is a shortage of components used in our customers &apos products, our sales may decline, which could adversely affect our results of operations and financial position |
| If our customers are unable to purchase certain components which are embedded into their products, their demand for our products may decline |
| In addition, we or our customers may be impacted by component shortages if components that comply with the RoHS Directive are not available |
| Similar shortages of components used in our products or our customers &apos products could adversely affect our net revenues and financial results in future periods |
| We may be subject to a higher effective tax rate that could negatively affect our results of operations and financial position |
| Historically our effective tax rate was benefited by a Singapore tax holiday relating to certain of our products |
| As a result of the contract manufacturing agreement that we entered into with Sanmina-SCI, we will no longer qualify for this holiday |
| If the alternative plans we have developed to reduce our effective tax rate are not successful, our effective tax rate could increase, which would adversely affect our financial results |
| We held approximately dlra88dtta2 million of cash, cash equivalents and marketable securities at our subsidiary in Singapore at March 31, 2006 |
| During the fourth quarter of fiscal 2005, we repatriated dlra360dtta6 million of cash from Singapore to the United States in connection with the American Jobs Creation Act of 2004 which provides a one-time deduction of 85prca for certain dividends from controlled foreign corporations |
| If the amount repatriated does not qualify for the one-time deduction, we could incur additional income taxes at up to the United States Federal statutory rate of 35prca, which would negatively affect our results of operations and financial condition |
| Our dependence on new products may cause our net revenues to fluctuate or decline |
| Our future success significantly depends upon our completing and introducing enhanced and new products at competitive prices and performance levels in a timely manner |
| The success of new product introductions depends on several factors, including the following: • Designing products to meet customer needs; • Product costs; • Timely completion and introduction of new product designs; • Quality of new products; • Differentiation of new products from those of our competitors; and • Market acceptance of our products |
| Our product life cycles in each of our segments may be as brief as 12 months |
| As a result, we believe that we will continue to incur significant expenditures for research and development in the future |
| We may fail to identify new product opportunities and may not develop and bring new products to market in a timely manner |
| In addition, products or technologies developed by others may render our products or technologies obsolete or noncompetitive, or our targeted customers may not select our products for design or integration into their products |
| The failure of any of our new product development efforts could have an adverse effect on our business and financial results |
| We have introduced RAID-enabled products based on the next generation SATA technology and delivered our products based on Serial Attached SCSI technology to certain major OEMs for testing and integration |
| We will not succeed in generating significant revenues from our new SATA and Serial Attached SCSI technology products if the market does not adapt to these new technologies, which would, over time, adversely affect our net revenues and operating results |
| 14 _________________________________________________________________ Our reliance on industry standards and technological changes in the marketplace may cause our net revenues to fluctuate or decline |
| The computer industry is characterized by various, evolving standards and protocols |
| We design our products to conform to certain industry standards and protocols such as the following: Technologies: • ATA • Fibre channel • FireWire/1394 • IPsec • iSCSI • PCI • PCI-Express • PCI-X • RAID • Serial Attached SCSI • SATA • SCSI • SMI-S • Ultra DMA • USB Operating Systems: • Linux • Macintosh • Netware • OS/2 • UNIX • Windows If user acceptance of these standards declines, or if new standards emerge, and if we do not anticipate these changes and develop new products, these changes could adversely affect our business and financial results |
| If we lose the cooperation of other hardware and software producers whose products are integral to ours, our ability to sustain or grow our revenues could be adversely affected |
| We must design our products to operate effectively with a variety of hardware and software products supplied by other manufacturers, including the following: • Microprocessors; • Peripherals; and • Operating system software |
| We depend on significant cooperation from these manufacturers to achieve our design objectives and develop products that operate successfully with their products |
| These companies could, from time to time, elect to make it more difficult for us to design our products for successful operability with their products |
| For example, if one or more of these companies were to determine that as a result of competition or other factors our technology or products would not be broadly accepted by the markets we target, these companies may no longer work with us to plan for new products and new generations of our products, which would make it more difficult to introduce products on a timely basis or at all |
| Further, some of these companies might decide not to continue to offer products that are compatible with our technology and our 15 _________________________________________________________________ markets could contract |
| If any of these events were to occur, our revenue and financial results could be adversely affected |
| We are subject to various environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business |
| The European Parliament has enacted the RoHS Directive, which restricts the sale of new electrical and electronic equipment containing certain hazardous substances, including lead that is currently used in some of our products |
| We are working to eliminate lead from our products in accordance with the timelines established in the RoHS Directive |
| The costs associated with compliance may negatively impact our operating results and competitive position |
| For example, in fiscal 2006, we had an excess inventory expense of dlra1dtta9 million related to the transition of our products to comply with the RoHS Directive |
| We are also working with our suppliers to redesign or reformulate their components containing lead to reduce or eliminate lead in our products |
| If we are unable to comply with the RoHS Directive, we may suffer a loss of revenue, be unable to sell affected products in certain markets or countries and be at a competitive disadvantage |
| The European Parliament has also finalized the Waste Electrical and Electronic Equipment Directive, or WEEE Directive, which makes producers of electrical and electronic equipment financially responsible for specified collection, recycling, treatment and disposal of past and future covered products |
| We may incur financial responsibility for the collection, recycling, treatment or disposal of products covered under the WEEE Directive |
| Because the EU member states have not fully implemented the WEEE Directive, the nature and extent of the costs to comply and fees or penalties associated with non-compliance are unknown at this time |
| Costs to comply with the WEEE Directive and similar future legislation, if applicable, may also include legal and regulatory costs and insurance costs |
| We may also be required to take reserves for costs associated with compliance with these regulations |
| We entered into strategic alliances with Vitesse for the development of our Serial Attached SCSI ROC product and with ServerEngines to advance our development of iSCSI products, and if these companies fail to develop and bring new products to market in a timely manner, it could result in an adverse effect on our business and financial results |
| In January 2005, we entered into a strategic alliance with Vitesse for it to develop and market the next generation of our Serial Attached SCSI products |
| In March 2005, we entered into a strategic alliance with ServerEngines to develop and market the next generation of our IP storage products, such as 10Gb iSCSI Accordingly, we are at risk that Vitesse and ServerEngines may encounter challenges in fulfilling their responsibilities under these alliances, such as timely completing and introducing new product designs, maintaining the quality of new products, minimizing product costs, differentiating new products from those of our competitors and achieving market acceptance of our products |
| Vitesse has recently become subject to investigation by the SEC and the US Attorneyapstas office in New York regarding its historical practices with respect to the granting of stock options, which has resulted in Vitesse terminating certain of their executives |
| To the extent that these investigations cause disruptions in Vitesseapstas operations, or if we otherwise encounter issues with respect to our strategic alliances, it could have an adverse effect on our business and financial results |
| If we do not provide adequate support during our customers &apos design and development stage, or if we are unable to provide such support in a timely manner, we may lose revenues to our competitors |
| Certain of our products are designed to meet our customers &apos specifications and, to the extent we are not able to meet these expectations in a timely manner or provide adequate support during our customers &apos design and development stage, our customers may choose to buy similar products from another company |
| If this were to occur we may lose revenues and market share to our competitors |
| If we are unable to compete effectively, our net revenues could be adversely affected |
| The markets for all of our products are intensely competitive and are characterized by the following: • Rapid technological advances; • Frequent new product introductions; 16 _________________________________________________________________ • Evolving industry standards; and • Price erosion |
| Consequently, we must continue to enhance our products on a timely basis to keep pace with market demands |
| If we do not do so, or if our competition is more effective in developing products that meet the needs of our existing and potential customers, we may lose market share and not participate in the future growth of our target markets |
| For example, intense competition in the transition from products employing Ultra 160 technology to products employing Ultra 320 technology has adversely affected revenues from our SCSI products |
| Our future success will depend on the level of acceptance of our RAID products and products based on the next generation SATA and Serial Attached SCSI technologies by new and existing customers |
| In addition, we expect that our future success will depend significantly on our ability to participate in the ongoing development of the network storage market in which we face intense competition from other companies that are also focusing on networked storage products |
| We cannot assure you that we will have sufficient resources to accomplish all of the following: • Satisfy any growth in demand for our products; • Make timely introductions of new products; • Compete successfully in the future against existing or potential competitors; • Provide OEMs with design specifications in a timely manner; and • Prevent price competition from eroding margins |
| As part of our overall strategy we may make acquisitions and enter into strategic alliances |
| Costs associated with these acquisitions or strategic alliances may adversely affect our results of operations, which could be exacerbated if we are unable to integrate the acquired companies, products or technologies |
| As part of our overall strategy we may acquire or invest in complementary companies, products or technologies and enter into strategic alliances with other companies |
| In order to be successful in these activities, we must: • Conduct acquisitions that enhance our time to market with new products; • Successfully prevail over competing bidders for target acquisitions at an acceptable price; • Invest in companies and technologies that contribute to the growth of our business; • Integrate acquired operations into our business and maintain uniform standards, controls and procedures; • Retain the key employees of the acquired operations; and • Develop the capabilities necessary to exploit newly acquired technologies |
| The benefits of acquisitions or strategic alliances may prove to be less than anticipated and may not outweigh the costs reported in our financial statements |
| For example, during fiscal 2006, we sold the IBM i/p Series RAID business for a loss of dlra2dtta3 million |
| Further, we plan to divest the remainder of our systems business, which includes certain assets obtained through the Snap Appliance acquisition |
| During the fourth quarter of fiscal 2006, we recorded an impairment charge of dlra10dtta0 million to reduce these long-lived assets to fair value, less cost to sell |
| Completing any potential future acquisitions or strategic alliances could cause significant diversions of management time and resources |
| If we acquire new businesses, products or technologies in the future, we may be required to assume warranty claims or other contingent liabilities, including liabilities unknown at the time of acquisition, and amortize significant amounts of other intangible assets and, over time, recognize significant charges for impairment of goodwill, other intangible assets or other losses |
| If we consummate any potential future acquisitions in which the consideration consists of stock or other 17 _________________________________________________________________ securities, our existing stockholders &apos ownership may be significantly diluted |
| If we proceed with any potential future acquisitions in which the consideration is cash, we may be required to use a substantial portion of our available cash |
| In addition, we may be required to invest significant resources in order to perform under a strategic alliance or to complete an acquisition, which could adversely affect our results of operations, at least in the short-term, even if we believe the strategic alliance or acquisition will benefit us in the long-term |
| We may not be successful in overcoming these risks or any other problems encountered in connection with these or other business combinations, investments or strategic alliances |
| These transactions may adversely affect our business, financial position and operating results |
| Product quality problems could lead to reduced revenues and gross margins |
| We produce highly complex products that incorporate leading-edge technologies, including both hardware and software |
| Software often contains "e bugs "e which can interfere with expected operations |
| We cannot assure you that our pre-shipment testing programs will be adequate to detect all defects which might interfere with customer satisfaction, reduce sales opportunities, or affect our gross margins if the costs of remedying the problems exceed reserves established for that purpose |
| An inability to cure a product defect could result in the failure of a product line, and withdrawal, at least temporarily, from a product or market segment, damage to our reputation, inventory costs, product reengineering expenses, and a material impact on revenues and gross margins |
| We currently purchase all of the finished production silicon wafers used in our products from wafer suppliers, and if they fail to meet our manufacturing needs, it would delay our production and our product shipments to customers and negatively affect our operations |
| Independent foundries manufacture to our specifications all of the finished silicon wafers used for our products |
| We currently purchase finished production silicon wafers used in our products from Taiwan Semiconductor Manufacturing Company, or TSMC, and IBM The manufacture of semiconductor devices is sensitive to a wide variety of factors, including the following: • The availability of raw materials; • The availability of manufacturing capacity; • Transition to smaller geometries of semiconductor devices; • The level of contaminants in the manufacturing environment; • Impurities in the materials used; and • The performance of personnel and equipment |
| We cannot assure you that manufacturing problems may not occur in the future |
| A shortage of raw materials or production capacity could lead our wafer suppliers to allocate available capacity to other customers |
| Any prolonged inability to obtain wafers with competitive performance and cost attributes, adequate yields or timely deliveries would delay our production and our product shipments, and could have an adverse effect on our business and financial results |
| We expect that our wafer suppliers will continually seek to convert their processes for manufacturing wafers to more advanced process technologies |
| Such conversions entail inherent technological risks that can affect yields and delivery times |
| If for any reason the wafer suppliers we use are unable or unwilling to satisfy our wafer needs, we will be required to identify and qualify additional suppliers |
| Additional wafer suppliers may be unavailable, may take significant amounts of time to qualify or may be unable to satisfy our requirements on a timely basis |
| We depend on the efforts of our distributors, which if reduced, could result in a loss of sales of our products in favor of competitive offerings |
| We derived approximately 38prca of our revenues for fiscal 2006 from independent distributor and reseller channels |
| Our financial results could be adversely affected if our relationships with these distributors or resellers were to deteriorate or if the financial condition of these distributors or resellers were to decline |
| 18 _________________________________________________________________ Our distributors generally offer a diverse array of products from several different manufacturers |
| Accordingly, we are at risk that these distributors may give higher priority to selling products from other suppliers |
| A reduction in sales efforts by our current distributors could adversely affect our business and financial results |
| For example, some of our distributors have threatened to stop selling our products or make pricing of our products non-competitive if we do not agree to absorb their costs to comply with the RoHS and WEEE Directives with respect to our products |
| Our distributors build inventories in anticipation of future sales, and if such sales do not occur as rapidly as they anticipate, our distributors will decrease the size of their product orders |
| If we decrease our price protection or distributor-incentive programs, our distributors may also decrease their orders from us |
| In addition, we have from time to time taken actions to reduce levels of products at distributors and may do so in the future |
| These actions may affect our net revenues and negatively affect our financial results |
| If we do not meet our restructuring objectives, we may have to implement additional plans in order to reduce our operating costs and may, as a result, incur additional material restructuring charges |
| We have implemented several restructuring plans to reduce our operating costs in fiscal 2006, fiscal 2005 and fiscal 2004, and recorded related restructuring charges of dlra10dtta4 million, dlra5dtta9 million and dlra4dtta3 million, respectively |
| The plans included primarily the reduction of our workforce and the consolidation of our manufacturing operations in Singapore |
| The goals of these plans were to support future growth opportunities, focus on investments that grow revenues and increase operating margins |
| If we do not meet our restructuring objectives, we may have to implement additional restructuring plans to reduce our operating costs, which could cause us to incur material restructuring charges |
| Further, these restructuring plans may not achieve the original goals we had in implementing them due to such factors as significant costs or restrictions on workforce reductions that may be imposed in some international locales and a potential adverse effect on employee capabilities that could harm our efficiency and our ability to act quickly and effectively in the rapidly changing technology markets in which we sell our products |
| Some of our products contain "e open source "e software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business |
| Some of our products are distributed with software licensed by its authors or other third parties under so-called "e open source "e licenses, including, for example, the GNU General Public License, or GPL, GNU Lesser General Public License, or LGPL, the Mozilla Public License, the BSD License, and the Apache License |
| Some of those licenses may require as a condition of the license that we make available source code for modifications or derivative works we create based upon, incorporating, or using the open source software, that we provide notices with our products, and/or that we license such modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use |
| If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of those open source licenses, we could be required to incur legal expenses in defending against such allegations, and if our defenses were not successful we could be enjoined from distribution of the products that contained the open source software and required to either make the source code for the open source software available, to grant third parties certain rights of further use of our software, or to remove the open source software from our products, which could disrupt our distribution and sale of some of our products |
| In addition, if we combine our proprietary software with open source software in a certain manner, we could under some of the open source licenses, be required to release the source code of our proprietary software |
| If an author or other third party that distributes open source software were to obtain a judgment against us based on allegations that we had not complied with the terms of any such open source licenses, we could also be subject to liability for copyright infringement damages and breach of contract for our past distribution of such open source software |
| Our operations depend on key personnel, the loss of whom could affect the growth and success of our business |
| In order to be successful, we must retain and motivate our executives, our principal engineers and other key employees, including those in managerial, technical, marketing and information technology support positions |
| In particular, our product generation efforts depend on hiring and retaining qualified engineers |
| 19 _________________________________________________________________ Competition for experienced management, technical, marketing and support personnel remains intense |
| For example, we transitioned certain research and development efforts to North Carolina, where we have experienced significant competition in our efforts to attract and retain qualified software engineers |
| The loss of any of these key employees could have a significant impact on our operations |
| We also must continue to motivate employees and keep them focused on our strategies and goals, which may be particularly difficult due to morale challenges posed by workforce reductions, the announcement of the divestiture of the systems business and general uncertainty |
| Our international operations involve risks, and may be subject to political or other non-economic barriers to our being able to sell our products in certain countries, local economic conditions that reduce demand for our products among our target markets and potential disruption in the supply of necessary components |
| Many of our subcontractors are primarily located in Asia and we have sales offices and customers located throughout Europe, Japan and other countries |
| Our international operations and sales are subject to political and economic risks, including political instability, currency controls, changes in import/export regulations, tariffs and freight rates |
| In addition, because our primary wafer supplier, TSMC, is located in Taiwan, we may be subject to certain risks resulting from political instability in Taiwan, including conflicts between Taiwan and the Peopleapstas Republic of China |
| These and other international risks could result in the creation of political or other non-economic barriers to our being able to sell our products in certain countries, create local economic conditions that reduce demand for our products among our target market or expose us to potential disruption in the supply of necessary components or otherwise adversely affect our ability to generate revenue and operate effectively |
| We depend on third parties to transport our products |
| We rely on independent freight forwarders to move our products between manufacturing plants and our customers |
| Any transport or delivery problems because of their errors, or because of unforeseen interruptions in their activities due to factors such as strikes, political instability, terrorism, natural disasters and accidents, could adversely affect our business, financial condition and results of operations and ultimately impact our relationship with our customers |
| If the carrying value of our long-lived assets is not recoverable, an impairment loss must be recognized which would adversely affect our financial results |
| Certain events or changes in circumstances would require us to assess the recoverability of the carrying amount of our long-lived assets |
| For example, in fiscal 2006, we recorded a goodwill impairment charge of dlra90dtta6 million related to our DPS segment |
| In fiscal 2005, we recorded a goodwill impairment charge of dlra52dtta3 million related to our former Channel segment |
| In fiscal 2004, we recorded an impairment charge of dlra5dtta0 million related to certain properties classified as held-for sale and a charge of dlra1dtta0 million relating to the decline in value of a minority investment |
| We will continue to evaluate the recoverability of the carrying amount of our long-lived assets, and we may incur substantial impairment charges which could adversely affect our financial results |
| If actual results or events differ materially from those contemplated by us in making estimates and assumptions, our reported financial condition and results of operations for future periods could be materially affected |
| The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes |
| For example, we have identified key accounting estimates in our Critical Accounting Policies in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006, which includes revenue recognition, inventory, goodwill and income taxes |
| In addition, Note 1 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006 describes the significant accounting policies essential to preparing our consolidated financial statements |
| The preparation of these financial statements requires estimates and assumptions that affect the reported amounts and disclosures |
| Although we believe that our judgments and estimates are appropriate and correct, actual future results may differ materially from our estimates |
| 20 _________________________________________________________________ If we are unable to protect and enforce our intellectual property rights, we may be unable to compete effectively |
| Although we actively maintain and defend our intellectual property rights, we may be unable to adequately protect our proprietary rights |
| In addition, the laws of certain territories in which our products are or may be developed, manufactured or sold, including Asia and Europe, may not protect our products and intellectual property rights to the same extent as the laws of the United States |
| Because we conduct a substantial portion of our operations outside of the United States and sell to a worldwide customer base, we are more dependent on our ability to protect our intellectual property in international environments than would be the case if a larger portion of our operations were domestic |
| Despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, which could harm our business and ability to compete effectively |
| We have from time to time discovered counterfeit copies of our products being manufactured or sold by others |
| Although we have programs to detect and deter the counterfeiting of our products, significant availability of counterfeit products could reduce our revenues and damage our reputation and goodwill with customers |
| Third parties may assert infringement claims against us, which may be expensive to defend and could divert our resources |
| From time to time, third parties assert exclusive patent, copyright and other intellectual property rights to our key technologies, and we expect to continue to receive such claims in the future |
| and Thomas A Gafford (jointly, "e NSE "e ) entered into a license and release agreement, pursuant to which we paid NSE dlra1dtta7 million as a one-time, fully paid-up license fee to settle NSEapstas claims that some of our products infringed certain patents |
| In addition, we entered into a patent cross-license agreement with IBM in May 2000 |
| Under this agreement, which was amended in March 2002, we received a release from infringement claims prior to January 1, 2000 and received the right to use certain of IBMapstas patents through June 30, 2007 |
| In consideration, we paid, in annual installments, an aggregate patent fee of dlra13dtta3 million through June 30, 2004 |
| The risks of our receiving additional claims from third parties may be increased in periods such as the one that we are currently entering where we are beginning to offer product lines employing new technologies relative to our existing products |
| We cannot assure you that third parties will not assert other infringement claims against us, directly or indirectly, in the future, that assertions by third parties will not result in costly litigation or that we would prevail in such litigation or be able to license any valid and infringed intellectual property from third parties on commercially reasonable terms |
| These claims may be asserted in respect of intellectual property that we own or that we license from others |
| In addition to claims brought against us by third parties, we may also bring litigation against others to protect our rights |
| Intellectual property litigation, regardless of the outcome, could result in substantial costs to us and diversion of our resources, and could adversely affect our business and financial results |
| We may be required to pay additional federal income taxes which could negatively affect our results of operations and financial position |
| On December 15, 2000, we received a statutory notice of deficiency from the IRS with respect to our Federal income tax return for fiscal 1997 |
| We filed a Petition with the United States Tax Court on March 14, 2001, contesting the asserted deficiencies and settlement agreements have been filed with the United States Tax Court on all but one issue |
| In addition, the IRS is currently auditing our Federal income tax returns for fiscal 1998 through fiscal 2003 |
| We have resolved all issues for fiscal 1998 through fiscal 2001 other than the rollover impact of any potential resolution on the remaining fiscal 1997 issue and tax credits that were generated but not used in subsequent years that may be carried back |
| While we believe we have meritorious defenses against the asserted deficiencies and any proposed adjustments, and that sufficient taxes have been provided, we cannot predict the final outcome of these matters, and the final resolution could adversely affect our results of operations and financial position |
| We may be engaged in legal proceedings that could cause us to incur unforeseen expenses and could occupy a significant amount of our managementapstas time and attention |
| From time to time we are subject to litigation or 21 _________________________________________________________________ claims that could negatively affect our business operations and financial position |
| Such disputes could cause us to incur unforeseen expenses, could occupy a significant amount of our managementapstas time and attention, and could negatively affect our business operations and financial position |
| We have in the past financed a portion of our capital expenditure needs from capital market financing, and if we need to seek additional financing, it may not be available on favorable terms |
| Historically, we have been able to access capital markets, but this does not necessarily guarantee that we will be able to access these markets in the future or at terms that are acceptable to us |
| The availability of capital in these markets is affected by several factors, including geopolitical risk, the interest rate environment and the condition of the economy as a whole |
| In addition, our own operating performance, capital structure and expected future performance impacts our ability to raise capital |
| For example, in the third quarter of fiscal 2006, Standard and Poorapstas Ratings Services downgraded our subordinated debt rating from B- to CCC+ |
| We believe that our current cash, cash equivalents, short-term investments and future cash provided by operations will be sufficient to fund our needs for at least the next twelve months |
| However, if our operating performance falls below expectations, we may need additional funds, which may not be available on favorable terms, if at all |
| We are exposed to fluctuations in foreign currency exchange rates |
| Because a significant portion of our business is conducted outside the United States, we face exposure to adverse movements in non-United States currency exchange rates |
| These exposures may change over time as business practices evolve and could have an adverse impact on our financial results and cash flows |
| Historically, our exposures have related to non-dollar-denominated operating expenses in Europe and Asia |
| We began Euro-denominated sales to our distribution customers in the European Union in the fourth quarter of fiscal 2003 |
| An increase in the value of the dollar could increase the real cost to our customers of our products in markets outside the United States where we sell in dollars, and a weakened dollar could increase the cost of local operating expenses and procurement |
| We hold minority interests in privately held venture funds, and if these venture funds face financial difficulties in their operations, our investments could be impaired |
| We continue to hold minority interests in privately held venture funds |
| We have also committed to provide additional funding of up to dlra0dtta2 million |
| These investments are inherently risky because these venture funds invest in companies that may still be in the development stage or depend on third parties for financing to support their ongoing operations |
| In addition, the markets for the technologies or products of these companies are typically in the early stages and may never develop |
| If these companies do not have adequate cash funding to support their operations, or if they encounter difficulties developing their technologies or products, the venture funds &apos investments in these companies may be impaired, which in turn, could result in impairment of our investment in these venture funds |
| Our spin-off of Roxio Inc, which is now known as Napster Inc, may have potential subsequent tax liabilities that could negatively affect our results of operations |
| Pursuant to our distribution of the Roxio, Inc |
| common stock, we received an opinion from PricewaterhouseCoopers LLP, or PwC, regarding the tax-free nature of the transaction to us and to our stockholders under Section 355 of the Internal Revenue Code |
| The validity of the PwC opinion relating to the qualification of the distribution as a tax-free transaction is subject to factual representations and assumptions |
| We are not aware of any facts or circumstances that would cause such representations and assumptions to be untrue |
| In addition, the opinion of PwC is not binding on the IRS If Napster or we fail to conform to the requirements set forth in the IRS regulations, it could cause the distribution to be taxable to us and to our stockholders, and our financial results could be adversely affected |
| Changes in securities laws and regulations have increased and may continue to increase our costs |
| Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules promulgated by the Securities and Exchange Commission, have increased and may 22 _________________________________________________________________ continue to increase our expenses as we evaluate the implications of these rules and devote resources to respond to their requirements |
| In particular, we incurred additional administrative expense to implement Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting |
| In addition, the Nasdaq National Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance |
| These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices |
| We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage |
| Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties |
| As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would adversely affect our business |
| Internal control deficiencies or weaknesses that are not yet identified could emerge |
| Over time we may identify and correct deficiencies or weaknesses in our internal control over financial reporting and, where and when appropriate, report on the identification and correction of these deficiencies or weaknesses |
| However, the internal control procedures can provide only reasonable, and not absolute, assurance that deficiencies or weaknesses are identified |
| Deficiencies or weaknesses that are not yet identified could emerge, and the identification and corrections of these deficiencies or weaknesses could have a material impact on our results of operations |
| Internal control issues that appear minor now may later become material weaknesses |
| We are required to publicly report on deficiencies or weaknesses in our internal control over financial reporting that meet a materiality standard as required by law and related regulations and interpretations |
| Management may, at a point in time, accurately categorize a deficiency or weakness as immaterial or minor and therefore not be required to publicly report such deficiency or weakness |
| Such determination, however, does not preclude a change in circumstances such that the deficiency or weakness could, at a later time, become a material weakness that could have a material impact on our results of operations |
| We may encounter natural disasters, which could cause disruption to our employees or interrupt the manufacturing process for our products |
| Our operations could be subject to natural disasters and other business disruptions, which could seriously harm our revenues and financial condition and increase our costs and expenses |
| Our corporate headquarters are located in California, near major earthquake faults |
| Additionally, our primary wafer supplier, TSMC, is located in Taiwan, which has experienced significant earthquakes in the past |
| A severe earthquake could cause disruption to our employees or interrupt the manufacturing process, which could affect TSMCapstas ability to supply wafers to us, which would negatively affect our business and financial results |
| The ultimate impact on us and our general infrastructure of being located near major earthquake faults is unknown, but our net revenues and financial condition and our costs and expenses could be significantly impacted in the event of a major earthquake |
| Manmade problems such as computer viruses or terrorism may disrupt our operations and harm our operating results |
| Despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems |
| Any such event could have an adverse effect on our business, operating results, and financial condition |
| In addition, the effects of war or acts of terrorism could have an adverse effect on our business, operating results, and financial condition |
| In addition, as a company with headquarters and significant operations located in the United States, we may be impacted by actions against the United States |
| We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war |
| We may experience significant fluctuations in our stock price, which may, in turn, significantly affect the trading price of our convertible notes |
| Our stock has experienced substantial price volatility, particularly as a 23 _________________________________________________________________ result of quarterly variations in our operating results, the published expectations of analysts and as a result of announcements by our competitors and us |
| In addition, the stock market has experienced price and volume fluctuations that have affected the market price of many technology companies, in particular, and that have often been unrelated to the operating performance of such companies |
| In addition, the price of our securities may also be affected by general global, economic and market conditions and the cost of operations in one or more of our product markets |
| While we cannot predict the individual effect that these factors may have on the price or our securities, these factors, either individually or in the aggregate, could result in significant variations in the price of our common stock during any given period of time |
| These fluctuations in our stock price also impact the price of our outstanding convertible securities and the likelihood of the convertible securities being converted into our common stock |