| DOT HILL SYSTEMS CORP Item 1A Risk Factors Our business, results of operations and financial condition may be materially and adversely affected due to any of the following risks |
| The risks described below are not the only ones we face |
| Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations |
| The trading price of our common stock could decline due to any of these risks |
| In assessing these risks, you should also refer to the other information contained or incorporated by reference in this Annual Report on Form 10-K, including our financial statements and related notes |
| Under our OEM agreements with Sun, NetApp and others, our customers are not required to make minimum purchases or purchase exclusively from us, and we cannot assure you that our relationship with these key customers will not be terminated or will generate significant sales |
| Our business is highly dependent on our relationship with Sun, and we believe will be dependent, in the future, on our relationship with NetApp, once sales to that customer begin to increase |
| Sales to Sun accounted for 86dtta3prca and 86dtta2prca of our net revenue for the years ended December 31, 2004 and 2005 respectively |
| Our OEM agreement with Sun had an initial term of three years and was extended in September 2005 for an additional five years through January 2011 |
| Our OEM agreement with NetApp has a term of three years from the first commercial product shipments by NetApp, which is currently scheduled forth the second half of 2006 |
| There are no minimum purchase requirements or guarantees in our agreement with Sun or NetApp, the agreements do not obligate those customers to purchase storage solutions exclusively from us on a continual basis and either customer may cancel purchase orders submitted under the agreement at any time |
| Further, either customer may terminate the entire contract prior to the contract expiration date upon the occurrence of certain events that are not remedied within a specified cure period |
| The decision by these customers to terminate their respective contracts, to cease making purchases or to cancel purchase orders would cause our revenues to decline substantially |
| We cannot be certain if, when or to what extent any customer might cancel purchase orders, cease making purchases or elect not to renew the applicable contract upon the expiration of the current term |
| We expect to receive a substantial majority of our projected net revenue for the year ended December 31, 2006 from sales of our products to Sun and NetApp |
| We cannot assure you that we will achieve these expected sales levels |
| If we do not achieve the sales levels we expect to receive from these customers, our business and result of operations will be significantly harmed |
| 14 _________________________________________________________________ [65]Table of Contents Any decline in Sun’s or NetApp’s sales could harm our business |
| A substantial majority of our revenues are generated by sales to Sun, and we expect a substantial majority of our future revenues to be generated by a combination of sales to Sun and NetApp |
| If Sun’s or NetApp’s storage-related sales decline, our revenues will also decline and our business could be materially harmed |
| In addition, Sun’s quarterly operating results typically fluctuate downward in the first quarter of their fiscal year when compared with the immediately preceding fourth quarter |
| Further, in June 2005, Sun acquired StorageTek, which is a fellow provider of storage systems |
| Additionally, Sun purchases products from Engenio |
| During October 2004, Engenio announced that it had broadened its OEM agreement with Sun |
| Under terms of the expanded agreement, Engenio will provide Sun with new modular storage technology and will co-develop future Sun storage products |
| While we do not currently believe that Engenio’s relationship with Sun or Sun’s acquisition of StorageTek will impact our sales or our relationship with Sun, we cannot predict with certainty the impact that these circumstances will have, if any, on our future sales to Sun |
| In addition, it is likely that NetApp’s sales of any storage products supplied to it by us will fluctuate on a quarterly or seasonal basis, which fluctuations will affect our financial results |
| Due to the infancy of the relationship, we can not be certain of what affect these fluctuations will have on our quarterly results, if any |
| Lower than anticipated sales to NetApp could harm our business and render our expectations inaccurate, which could lead to a decrease in our stock price |
| During the third quarter of 2005, we entered into a Development and OEM Supply Agreement with NetApp pursuant to which we will design and develop general purpose disk arrays for a variety of products to be developed for sale to NetApp |
| We expect that sales to NetApp will increase, and have predicted that in the future, sales to NetApp will reduce our dependence upon Sun significantly and increase our revenue substantially |
| There are no guarantees that our relationship with NetApp will be successful, or that we will achieve the expected volume of sales to NetApp |
| Our agreement with NetApp does not provide for minimum purchase quantities, and allows for NetApp to terminate the contract or stop purchasing from us upon the occurrence of certain events |
| If our sales to NetApp fall substantially short of our predictions and, to the extent that our current stock price reflects anticipated increases in our revenue or profits based on sales to NetApp, our stock price likely will fall |
| We are dependent on sales to a relatively small number of customers |
| While we intend to expand sales to channel partners, we expect to experience continued concentration in our customer base |
| As a result, if our relationship with any of our customers were disrupted, we would lose a significant portion of our anticipated net revenue |
| We cannot guarantee that our relationship with Sun, NetApp or other channel partners will expand or not otherwise be disrupted |
| Factors that could influence our relationship with significant channel partners, including Sun and NetApp, include: • our ability to maintain our products at prices that are competitive with those of other storage system suppliers; • our ability to maintain quality standards for our products sufficient to meet the expectations of our channel partners; and • our ability to produce, ship and deliver a sufficient quantity of our products in a timely manner to meet the needs of our channel partners |
| None of our contracts with our existing channel partners, including Sun and NetApp, contain any minimum purchasing commitments |
| Further, we do not expect that future contracts with channel partners, if any, will include any minimum purchasing commitments |
| Changes in the timing or volume of purchases by our major customers could result in lower revenue |
| In addition, our existing contracts do not require our channel partners to purchase our products exclusively or on a preferential basis over the products of any of our competitors |
| Consequently, our channel partners may sell the products of our competitors |
| 15 _________________________________________________________________ [66]Table of Contents Our business and operating results may suffer if we encounter significant product defects due to the introduction of our new, integrated systems |
| We completed the integration of RAID controller technology we obtained in our acquisition of Chaparral into certain of our storage systems resulting in the introduction of new, integrated systems |
| Our new, integrated systems, as well as our legacy products, may contain undetected errors or failures, which may be discovered after shipment, resulting in a loss of revenue or a loss or delay in market acceptance, which could harm our business |
| Even if the errors are detected before shipment, such errors could result in the halting of production, the delay of shipments, loss of goodwill, tarnishment of reputation or a substantial decrease in revenue |
| Our standard warranty provides that if our systems do not function to published specifications, we will repair or replace the defective component or system without charge |
| Significant warranty costs, particularly those that exceed reserves, could adversely impact our business |
| In addition, defects in our products could result in our customers claiming property damages, consequential damages, personal injury or even death, which could also result in our loss of customers and goodwill |
| Any such claim could distract management’s attention from operating our business and, if successful, result in damage claims against us that might not be covered by our insurance |
| The loss of one or more suppliers could slow or interrupt the production and sales of our products |
| Solectron, our third party manufacturer, relies on third parties to supply key components of our storage products |
| Many of these components are available only from limited sources in the quantities and quality we require |
| Solectron purchases the majority of our RAID controllers from Infortrend Technology, Inc, or Infortrend |
| Solectron may not be able to purchase the type or quantity of components from third party suppliers as needed in the future |
| From time to time there is significant market demand for disk drives, RAID controllers and other components, and we may experience component shortages, selective supply allocations and increased prices of such components |
| In such event, we may be required to purchase our components from alternative suppliers |
| Even if alternative sources of supply for critical components such as disk drives and controllers become available, incorporating substitute components into our products could delay our ability to deliver our products in a timely manner |
| For example, we estimate that replacing Infortrend’s RAID controllers with those of another supplier would involve several months of hardware and software modification, which could significantly harm our ability to meet our customers’ orders for our products, damage our customer relationships and result in a loss of sales |
| Manufacturing disruptions could harm our business |
| We rely on Solectron to manufacture substantially all of our products |
| If our agreement with Solectron is terminated or if Solectron does not perform its obligations under our agreement, it could take several months to establish alternative manufacturing for our products and we may not be able to fulfill our customers’ orders in a timely manner |
| Under our OEM agreement with Sun, Sun has the right to require that we use a third party to manufacture our products |
| Such an external manufacturer must meet Sun’s engineering, qualification and logistics requirements |
| If our agreement with Solectron terminates, we may be unable to find another external manufacturer that meets Sun’s requirements |
| With our increased use of third-party manufacturers, our ability to control the timing of shipments has continued and will continue to decrease |
| Delayed shipment could result in the deferral or cancellation of purchases of our products |
| Any significant deferral or cancellation of these sales would harm our results of operations in any particular quarter |
| Net revenue for a period may be lower than predicted if large orders forecasted for that period are delayed or are not realized, which could result in cash flow problems or a decline in our stock price |
| Any shortage of disk drives or other components could increase our costs or harm our ability to manufacture and deliver our storage products to our customers in a timely manner |
| Demand for disk drives recently surpassed supply, forcing drive manufacturers, including those who supply the disk drives integrated into many of our storage products, to manage allocation of their inventory |
| If 16 _________________________________________________________________ [67]Table of Contents this shortage is prolonged, we may be forced to pay higher prices for disk drives or may be unable to purchase sufficient quantities of disk drives to meet our customers’ demand for our storage products in a timely manner or at all |
| Similar circumstances could occur with respect to other necessary components |
| For the years ended December 31, 2005, 2004 and 2003 we recorded net income of dlra26dtta6 million, dlra11dtta6 million and dlra12dtta1 million, respectively; however, for the years ended December 31, 2002 and 2001, we incurred net losses of dlra34dtta3 million and dlra43dtta4 million, respectively |
| Further, our latest forecast predicts that we will incur a loss during our first quarter of 2006, fueled, in part, by an increased investment in research and development and the implementation of a new enterprise resource planning, or ERP, software package |
| We cannot assure you that we will be profitable in any future period |
| Our future capital requirements will depend on, and could increase substantially as a result of, many factors, including: • our plans to maintain and enhance our engineering, research, development and product testing programs; • the success of our manufacturing strategy; • the success of our sales and marketing efforts; • the extent and terms of any development, marketing or other arrangements; • changes in economic, regulatory or competitive conditions; and • costs of filing, prosecuting, defending and enforcing intellectual property rights |
| Our available cash, cash equivalents and short-term investments as of December 31, 2005 totaled dlra122dtta2 million |
| We presently expect cash, cash equivalents, short-term investments and cash generated from operations to be sufficient to meet our operating and capital requirements through at least the next twelve months |
| However, unanticipated events, such as Sun’s or NetApp’s failure to meet its product purchase forecast or extraordinary expenses or operating expenses in excess of our projections, may require us to raise additional funds |
| We may not be able to raise additional funds on commercially reasonable terms or at all |
| Any sales of our debt or equity securities in the future may have a substantial dilutive effect on our existing stockholders |
| If we are able to borrow funds, we may be required to grant liens on our assets to the provider of any source of financing or enter into operating, debt service or working capital covenants with any provider of financing that could hinder our ability to operate our business in accordance with our plans |
| As a result, our ability to borrow money on a secured basis may be impaired, and we may not be able to issue secured debt on commercially reasonable terms or at all |
| 17 _________________________________________________________________ [68]Table of Contents Our quarterly operating results have fluctuated significantly in the past and are not a good indicator of future performance |
| Our quarterly operating results have fluctuated significantly in the past as shown in the following table and are not a good indicator of future performance (in millions) |
| Quarter Net Revenue Net Income (Loss) First Quarter 2002 $ 10dtta9 $ (6dtta2 ) Second Quarter 2002 11dtta2 (8dtta9 ) Third Quarter 2002 8dtta6 (7dtta3 ) Fourth Quarter 2002 16dtta3 (11dtta9 ) First Quarter 2003 30dtta5 (1dtta5 ) Second Quarter 2003 48dtta4 2dtta6 Third Quarter 2003 51dtta0 4dtta3 Fourth Quarter 2003 57dtta5 6dtta6 First Quarter 2004 47dtta9 (2dtta6 ) Second Quarter 2004 69dtta0 6dtta7 Third Quarter 2004 57dtta0 3dtta5 Fourth Quarter 2004 65dtta5 4dtta0 First Quarter 2005 58dtta0 2dtta1 Second Quarter 2005 65dtta9 3dtta3 Third Quarter 2005 53dtta6 (1dtta3 ) Fourth Quarter 2005* 56dtta3 22dtta5 * Includes deferred tax benefit from reversal of valuation allowance of dlra25dtta3 million |
| In addition, the announcement of financial results that fall short of the results anticipated by the public markets could have an immediate and significant negative effect on the trading price of our common stock in any given period |
| We may have difficulty predicting future operating results due to both internal and external factors affecting our business and operations, which could cause our stock price to decline |
| Our operating results may vary significantly in the future depending on a number of factors, many of which are out of our control, including: • the size, timing, cancellation or rescheduling of significant orders; • the cost of litigation and settlements involving intellectual property and other issues; • product configuration, mix and quality issues; • market acceptance of our new products and product enhancements and new product announcements or introductions by our competitors; • manufacturing costs; • deferrals of customer orders in anticipation of new products or product enhancements; • changes in pricing by us or our competitors; • our ability to develop, introduce and market new products and product enhancements on a timely basis; • hardware component costs and availability, particularly with respect to hardware components obtained from Infortrend, a sole-source provider; • our success in creating brand awareness and in expanding our sales and marketing programs; 18 _________________________________________________________________ [69]Table of Contents • the level of competition; • potential reductions in inventories held by channel partners; • slowing sales of the products of our channel partners; • technological changes in the open systems storage market; • levels of expenditures on research, engineering and product development; • changes in our business strategies; • personnel changes; and • general economic trends and other factors |
| If our customers delay or cancel orders or return products, our results of operations could be harmed |
| We generally do not enter into long-term purchase contracts with customers, and customers usually have the right to extend or delay shipment of their orders, return products and cancel orders |
| As a result, sales in any period are generally dependent on orders booked and shipped in that period |
| Delays in shipment orders, product returns and order cancellations in excess of the levels we expect would harm our results of operations |
| Our sales cycle varies substantially and future net revenue in any period may be lower than our historical revenues or forecasts |
| Our sales are difficult to forecast because the open systems storage market is rapidly evolving and our sales cycle varies substantially from customer to customer |
| Customer orders for our products can range in value from a few thousand dollars to over a million dollars |
| The length of time between initial contact with a potential customer and the sale of our product may last from six to 24 months |
| This is particularly true during times of economic slowdown, for sales to channel partners and for the sale and installation of complex solutions |
| We have shifted our business strategy to focus primarily on channel partners, with whom sales cycles are generally lengthier, more costly and less certain than direct sales to end-users |
| Additional factors that may extend our sales cycle, particularly orders for new products, include: • the amount of time needed for technical evaluations by customers; • customers’ budget constraints and changes to customers’ budgets during the course of the sales cycle; • customers’ internal review and testing procedures; and • our engineering work necessary to integrate a storage solution with a customer’s system |
| Our net revenue is difficult for us to predict since it is directly affected by the timing of large orders |
| Due to the unpredictable timing of customer orders, we may ship products representing a significant portion of our net sales for a quarter during the last month of that quarter |
| In addition, our expense levels are based, in part, on our expectations as to future sales |
| As a result, if sales levels are below expectations, our operating results may be disproportionately affected |
| We cannot assure you that we will experience sales growth in future periods |
| The market for our products is subject to substantial pricing pressure that may decrease our margins |
| Pricing pressures exist in the data storage market and have harmed and may, in the future, continue to harm our net revenue and earnings |
| These pricing pressures are due, in part, to continuing decreases in component prices, such as those of disks and RAID controllers |
| Decreases in component prices are customarily passed on to customers by storage companies through a continuing decrease in price of storage hardware systems |
| In addition, because we expect to continue to make most of our sales to a small number of customers, we are subject to continued pricing pressures from our customers, particularly our OEM customers |
| Pricing pressures are also due, in part, to the current difficult economic conditions, which have led many companies in our industry to pursue a strategy of decreasing prices in order to win sales, the narrowing of 19 _________________________________________________________________ [70]Table of Contents functional differences among competitors, which forces companies to compete on price as opposed to features of products, and the introduction of new technologies, which leaves older technology more vulnerable to pricing pressures |
| To the extent we are unable to offset those pressures with commensurate cost reductions from our suppliers or by providing new products and features, our margins will be harmed |
| Our success depends significantly upon our ability to protect our intellectual property and to avoid infringing the intellectual property of third parties, which has already resulted in costly, time-consuming litigation and could result in the inability to offer certain products |
| We rely primarily on patents, copyrights, trademarks, trade secrets, nondisclosure agreements and common law to protect our intellectual property |
| For example, we have registered trademarks for SANnet, SANpath, SANscape, Stratis, Dot Hill, Dot Hill Systems and the Dot Hill logo |
| Despite our efforts to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary |
| In addition, the laws of foreign countries may not adequately protect our intellectual property rights |
| Our efforts to protect our intellectual property from third party discovery and infringement may be insufficient and third parties may independently develop technologies similar to ours, duplicate our products or design around our patents |
| On October 17, 2003, Crossroads Systems, or Crossroads, filed a lawsuit against us in the United States District Court in Austin, Texas alleging that our products infringe two United States patents assigned to Crossroads, Patent Numbers 5cmam941cmam972 and 6cmam425cmam035 |
| We were served with the lawsuit on October 27, 2003 |
| In March 2004, Chaparral was added as a party to the lawsuit |
| The patents involve storage routers and methods for providing virtual local storage |
| Patent Number 5cmam941cmam972 involves the interface of SCSI storage devices and the Fibre Channel protocol and Patent Number 6cmam425cmam035 involves the interface of any one-transport medium and a second transport medium |
| We believe that we have meritorious defenses to Crossroads’ claims and intend to vigorously defend against them |
| We have already incurred, and expect to continue to incur, significant legal expenses in connection with this litigation |
| These defense costs, and other expenses related to this litigation, will be expensed as incurred and will negatively affect our future operating results |
| If we are not successful in our defense of Crossroads’ claims, we may be required to pay significant amounts in the form of damages for past infringement |
| We also could be required to pay significant amounts in the form of licensing fees to allow us to continue to market certain products in the future, or Crossroads may deny us a license, which could lead to our inability to market certain products at all |
| Further, other third parties may assert additional infringement claims against us in the future, which would similarly require us to incur substantial license fees, legal fees and other expenses, and distract management from the operations of our business |
| We expect that providers of storage products will increasingly be subject to infringement claims as the number of products and competitors increases |
| In addition to the formal claims brought against us by Crossroads, we receive, from time to time, letters from third parties suggesting that we may require a license from such third parties to manufacture or sell our products |
| We evaluate all such communications to assess whether to seek a license from the patent owner |
| We may be required to purchase licenses that could have a material impact on our business, or, we may not be able to obtain the necessary license from a third party on commercially reasonable terms, or at all |
| Consequently, we could be prohibited from marketing products that incorporate the protected technology or incur substantial costs to redesign our products in a manner to avoid infringement of third party intellectual property rights |
| The market for storage systems is intensely competitive and our results of operations, pricing and business could be harmed if we fail to maintain or expand our market position |
| The storage market is intensely competitive and is characterized by rapidly changing technology |
| We compete primarily against independent storage system suppliers, including EMC, Hitachi, Engenio, and Xyratex |
| 20 _________________________________________________________________ [71]Table of Contents Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources than us |
| As a result, they may have more advanced technology, larger distribution channels, stronger brand names, better customer service and access to more customers than we do |
| Other large companies with significant resources could become direct competitors, either through acquiring a competitor or through internal efforts |
| Additionally, a number of new, privately held companies are currently attempting to enter the storage market, some of which may become significant competitors in the future |
| Any of these existing or potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion and sale of products or deliver competitive products at lower prices than us |
| We could also lose current or future business to any of our suppliers or manufacturers, some of which directly and indirectly compete with us |
| Currently, we leverage our supply and manufacturing relationships to provide a significant share of our products |
| Our suppliers and manufacturers are very familiar with the specific attributes of our products and may be able to provide our customers with similar products |
| We also expect that competition will increase as a result of industry consolidation and the creation of companies with new, innovative product offerings |
| Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers |
| Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share |
| Increased competition is likely to result in price reductions, reduced operating margins and potential loss of market share, any of which could harm our business |
| We believe that the principal competitive factors affecting the storage systems market include: • product performance, features, scalability and reliability; • price; • product breadth; • timeliness of new product introductions; and • interoperability and ease of management |
| We cannot assure you that we will be able to successfully incorporate these factors into our products and compete against current or future competitors or that competitive pressures we face will not harm our business |
| If we are unable to develop and market products to compete with the products of competitors, our business will be materially and adversely affected |
| In addition, if major channel partners who are also competitors cease purchasing our products in order to concentrate on sales of their own products, our business will be harmed |
| The open systems storage market is rapidly changing and we may be unable to keep pace with or properly prepare for the effects of those changes |
| The open systems data storage market in which we operate is characterized by rapid technological change, frequent new product introductions, evolving industry standards and consolidation among our competitors, suppliers and customers |
| Customer preferences in this market are difficult to predict and changes in those preferences and the introduction of new products by our competitors or us could render our existing products obsolete |
| Our success will depend upon our ability to address the increasingly sophisticated needs of customers, to enhance existing products, and to develop and introduce on a timely basis, new competitive products, including new software and hardware, and enhancements to existing software and hardware that keep pace with technological developments and emerging industry standards |
| If we cannot successfully identify, manage, develop, manufacture or market product enhancements or new products, our business will be harmed |
| In addition, consolidation among our competitors, suppliers and customers may harm our business by increasing the resources of our competitors, reducing the number of suppliers available to us for our product components and increasing competition for customers by reducing customer-purchasing decisions |
| 21 _________________________________________________________________ [72]Table of Contents A significant percentage of our expenses are fixed, and if we fail to generate revenues in associated periods, our operating results will be harmed |
| Although we have taken a number of steps to reduce operating costs, we may have to take further measures to reduce expenses if we experience operating losses or do not achieve a stable net income |
| A number of factors could preclude us from successfully bringing costs and expenses in line with our net revenue, such as the fact that our expense levels are based in part on our expectations as to future sales, and that a significant percentage of our expenses are fixed, which limits our ability to reduce expenses quickly in response to any shortfalls in net revenue |
| As a result, if net revenue does not meet our projections, operating results may be negatively affected |
| We may experience shortfalls in net revenue for various reasons, including: • significant pricing pressures that occur because of declines in selling prices over the life of a product or because of increased competition; • sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers and manufacturers to allocate available supplies or capacity to other customers, which, in turn, may harm our ability to meet our sales obligations; and • the reduction, rescheduling or cancellation of customer orders |
| In addition, we typically plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially |
| From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers, we may order materials in advance of anticipated customer demand |
| This advance ordering has continued and may result in excess inventory levels or unanticipated inventory write-downs due to expected orders that fail to materialize |
| Our success depends on our ability to attract and retain key personnel |
| Our performance depends in significant part on our ability to attract and retain talented senior management and other key personnel |
| Our key personnel include Dana Kammersgard, our Chief Executive Officer and President, Patrick Collins, our Chief Operating Officer, and Preston Romm, our Chief Financial Officer |
| If any of these individuals were to terminate his employment with us, we would be required to locate and hire a suitable replacement |
| For example, James Lambert retired as our Vice Chairman and Chief Executive Officer in March 2006 and Mr |
| Kammersgard was appointed as our Chief Executive Officer to replace Mr |
| Competition for attracting talented employees in the technology industry is intense |
| We may be unable to identify suitable replacements for any employees that we lose |
| In addition, even if we are successful in locating suitable replacements, the time and cost involved in recruiting, hiring, training and integrating new employees, particularly key employees responsible for significant portions of our operations, could harm our business by delaying our production schedule, our research and development efforts, our ability to execute on our business strategy and our client development and marketing efforts |
| Many of our customer relationships are based on personal relationships between the customer and our sales representatives |
| If these representatives terminate their employment with us, we may be forced to expend substantial resources to attempt to retain the customers that the sales representatives serviced |
| Ultimately, if we were unsuccessful in retaining these customers, our net revenue would decline |
| Our executive officers and directors and their affiliates own a significant percentage of our outstanding shares, which could prevent us from being acquired and adversely affect our stock price |
| As of December 31, 2005, our executive officers, directors and their affiliates beneficially owned approximately 11dtta2prca of our outstanding shares of common stock |
| These individual stockholders may be able to influence matters requiring approval by our stockholders, including the election of a majority of our directors |
| The voting power of these stockholders under certain circumstances could have the effect of delaying or preventing a change in control of us |
| This concentration of ownership may also make it more difficult or expensive for us to obtain financing |
| Further, any substantial sale of shares by these individuals could depress the market price of our common stock and impair our ability to raise capital in the future through the sale of our equity securities |
| 22 _________________________________________________________________ [73]Table of Contents Protective provisions in our charter and bylaws and the existence of our stockholder rights plan could prevent a takeover which could harm our stockholders |
| Our certificate of incorporation and bylaws contain a number of provisions that could impede a takeover or prevent us from being acquired, including, but not limited to, a classified board of directors, the elimination of our stockholders’ ability to take action by written consent and limitations on the ability of our stockholders to remove a director from office without cause |
| Our board of directors may issue additional shares of common stock or establish one or more classes or series of preferred stock with such designations, relative voting rights, dividend rates, liquidation and other rights, preferences and limitations as determined by our board of directors without stockholder approval |
| In addition, we adopted a stockholder rights plan in May 2003 that is designed to impede takeover transactions that are not supported by our board of directors |
| Each of these charter and bylaw provisions and the stockholder rights plan gives our board of directors, acting without stockholder approval, the ability to prevent, or render more difficult or costly, the completion of a takeover transaction that our stockholders might view as being in their best interests |
| The exercise of outstanding warrants may result in dilution to our stockholders |
| Dilution of the per share value of our common stock could result from the exercise of outstanding warrants |
| As of December 31, 2005 there were outstanding warrants to purchase 1cmam720cmam696 shares of our common stock |
| The warrants have exercise prices ranging from dlra2dtta97 to dlra4dtta50 per share and expire at various dates through March 14, 2008 |
| When the exercise price of the warrants is less than the trading price of our common stock, exercise of the warrants would have a dilutive effect on our stockholders |
| The possibility of the issuance of shares of our common stock upon exercise of the warrants could cause the trading price of our common stock to decline |
| Our stock price may be highly volatile and could decline substantially and unexpectedly |
| The trading price of our shares of common stock has been affected by the factors disclosed in this section as well as prevailing economic and financial trends and conditions in the public securities markets |
| Share prices of companies in technology-related industries, such as ours, tend to exhibit a high degree of volatility |
| The announcement of financial results that fall short of the results anticipated by the public markets could have an immediate and significant negative effect on the trading price of our shares in any given period |
| Such shortfalls may result from events that are beyond our immediate control, can be unpredictable and, since a significant proportion of our sales during each fiscal quarter tend to occur in the latter stages of the quarter, may not be discernible until the end of a financial reporting period |
| These factors may contribute to the volatility of the trading value of our shares regardless of our long-term prospects |
| The trading price of our shares may also be affected by developments, including reported financial results and fluctuations in trading prices of the shares of other publicly held companies, in our industry generally and our business segment in particular, which may not have any direct relationship with our business or prospects |
| In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities |
| For example, in late January and early February 2006, numerous complaints against us purporting to be class actions were filed in the United States District Court for the Southern District of California |
| The complaints allege violations of federal securities laws related to alleged inflation in our stock price in connection with various statements and alleged omissions to the public and to the securities markets and declines in our stock price in connection with the restatement of certain of our quarterly financial statements for fiscal year 2004, and seeking damages therefore |
| In addition, two complaints purporting to be derivative actions have been filed in California state court against certain of our directors and executive officers |
| These complaints are based on the same facts and circumstances described in the federal class action complaints and generally allege that the named directors and officers breached their fiduciary duties by failing to oversee adequately our financial reporting |
| Each of the complaints generally seek an unspecified amount of damages |
| The cases are in the very preliminary stages |
| We believe the allegations against us and certain of our directors and executive officers in this action are without merit and we intend to vigorously defend against these claims |
| Securities litigation could result in the expenditure of substantial 23 _________________________________________________________________ [74]Table of Contents funds, divert management’s attention and resources, harm our reputation in the industry and the securities markets and reduce our profitability |
| Future sales of our common stock may hurt our market price |
| A substantial number of shares of our common stock may become available for resale |
| If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decline |
| These sales might also make it more difficult for us to sell equity securities in the future at times and prices that we deem appropriate |
| In addition, we are obligated to file a registration statement with respect to the resale of up to 1cmam394cmam269 shares of our common stock issuable upon exercise of warrants held by Sun |
| Geopolitical military conditions, including terrorist attacks and other acts of war, may materially and adversely affect the markets on which our common stock trades, the markets in which we operate, our operations and our profitability |
| Terrorist attacks and other acts of war, and any response to them, may lead to armed hostilities and such developments would likely cause instability in financial markets |
| Armed hostilities and terrorism may directly impact our facilities, personnel and operations that are located in the United States and internationally, as well as those of our channel partners, suppliers, third party manufacturer and customers |
| Furthermore, severe terrorist attacks or acts of war may result in temporary halts of commercial activity in the affected regions, and may result in reduced demand for our products |
| These developments could have a material adverse effect on our business and the trading price of our common stock |
| Compliance with Sarbanes-Oxley Act of 2002 |
| We are exposed to significant costs and risks associated with complying with increasingly stringent and complex regulation of corporate governance and disclosure standards |
| Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules require growing expenditure of management time and external resources |
| In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal controls, and attestations of the effectiveness of our internal controls by our independent auditors |
| This process has required us to hire additional personnel and outside advisory services and has resulted in significant accounting and legal expenses |
| We expect to continue to incur significant expense in future periods to comply with regulations pertaining to corporate governance as described above |
| In addition, we are in the process of implementing an ERP system |
| This process is extremely complicated, time consuming and expensive, and while we believe the implementation will be successful, it may not be sufficient to address all of our accounting system management needs |