| PIXELWORKS INC Item 1A Risk Factors |
| Investing in our shares of common stock involves a high degree of risk |
| If any of the following risks occur, the market price of our shares of common stock could decline and investors could lose all or part of their investment |
| (Dollars in thousands, except per share data) RISKS RELATED TO OUR OPERATIONS We face considerable business and financial risks related to our acquisition of Equator Technologies, Inc |
| In June 2005, we completed the acquisition of Equator Technologies, Inc |
| (“Equator”), a privately held company, for an aggregate purchase price of dlra118cmam116 |
| The acquisition of Equator required a substantial expenditure and involves substantial risks on our part |
| Equator’s current product offerings and technological developments relate to internet protocol television (“IPTV”) set-top boxes, digital media appliances, videoconferencing devices and security devices |
| These are emerging technologies and the markets they serve are developing and largely untested, and we do not have direct experience developing and selling products into these markets |
| In addition, in making the acquisition of Equator we have made certain assumptions and projections with respect to the following: Equator’s revenue for future quarters; our expectations regarding the growth of the markets Equator serves; the ability of Equator to develop and introduce new products and software and the risk that customers will not accept those new products and software; and the synergies we believe we can realize from the acquisition |
| We cannot be sure that such assumptions are correct |
| For these reasons, we cannot provide assurance that the acquisition of Equator will produce the revenues, earnings or business synergies that we anticipate, or that it will perform as expected |
| We may be unable to successfully integrate Equator Technologies, Inc, and any future acquisition or equity investment we make could disrupt our business and severely harm our financial condition |
| We may not be able to successfully integrate businesses, products, technologies or personnel of Equator, or of any other entity that we might acquire in the future, and any failure to do so could disrupt our business and seriously harm our financial condition |
| In addition, if we acquire companies with weak internal controls, it will take time to get the acquired company up to the same level of operating effectiveness as Pixelworks and to implement adequate internal control, management, financial and operating reporting systems |
| Our inability to address these risks could negatively affect our operating results |
| in January 2001, nDSP in January 2002, Jaldi Semiconductor in September 2002 and Equator in June 2005 |
| In March 2003, we announced the execution of a definitive merger agreement with Genesis Microchip, Inc |
| ; however, the merger was terminated in August of 2003, and we incurred dlra8cmam949 of expenses related to the transaction |
| We intend to continue to consider investments in or acquisitions of complementary businesses, products or technologies |
| The acquisitions of Panstera, nDSP and Jaldi contained a very high level of risk primarily because the investments were made based on in-process technological development that may not have been completed, or if completed, may not have become commercially viable |
| 16 _________________________________________________________________ [70]Table of Contents These and any future acquisitions and investments could result in: • issuance of stock that dilutes current shareholders’ percentage ownership; • incurrence of debt; • assumption of liabilities; • amortization expenses related to other intangible assets; • impairment of goodwill; • large and immediate write-offs; or • decrease in cash that could otherwise serve as working capital |
| Our operation of any acquired business will also involve numerous risks, including, but not limited to: • problems combining the acquired operations, technologies or products; • unanticipated costs; • diversion of management’s attention from our core business; • adverse effects on existing business relationships with customers; • risks associated with entering markets in which we have no or limited prior experience; and • potential loss of key employees, particularly those of the acquired organizations |
| Goodwill represents a significant portion of our total assets |
| As of December 31, 2005, goodwill amounted to dlra133cmam731 or approximately 32prca of our total assets |
| We are required to review goodwill for possible impairment on an annual basis or when events and circumstances arise which indicate a possible impairment |
| The review of goodwill for impairment may result in large write-offs of goodwill, which could have a material adverse effect on our results of operations |
| Due to the fact that the market value of our reporting unit is approaching book value, it is at least reasonably possible that we will have an impairment in the near term |
| The year ended December 31, 2004 was our first year of annual profitability since inception and we may be unable to achieve profitability in future periods |
| While we had net income of dlra21cmam781 for the year ended December 31, 2004, we incurred a net loss of dlra42cmam610 for the year ended December 31, 2005 and our accumulated deficit is dlra102cmam198 through December 31, 2005 |
| The year ended December 31, 2004 was our first year of annual profitability since inception |
| We expect our research and development and selling, general and administrative expenses to continue to increase |
| Given expected increases in operating expenses, we must increase revenues and gross profit to become profitable again |
| We cannot be certain that we will achieve profitability in the future or, if we do, that we can sustain or increase profitability on a quarterly or annual basis |
| This may in 17 _________________________________________________________________ [71]Table of Contents turn cause the price of our common stock to decline |
| In addition, if we are not profitable in the future we may be unable to continue our operations |
| Fluctuations in our quarterly operating results make it difficult to predict our future performance and may result in volatility in the market price of our common stock |
| Our quarterly operating results have varied from quarter to quarter and are likely to vary in the future based on a number of factors related to our industry and the markets for our products |
| Some of these factors are not in our control and any of them may cause the price of our common stock to fluctuate |
| These factors include, but not limited to: • our success in integrating the operations of our recently acquired subsidiary, Equator Technologies, Inc |
| ; • demand for multimedia projectors, advanced televisions, LCD panels, and digital streaming media devices; • demand for our products and the timing of orders for our products; • the deferral of customer orders in anticipation of new products or product enhancements from us or our competitors or due to a reduction in our end customers’ demand; • the loss of one or more of our key distributors or customers or a reduction, delay or cancellation of orders from one or more of these parties; • changes in the available production capacity at the semiconductor fabrication foundries that manufacture our products and changes in the costs of manufacturing; • our ability to provide adequate supplies of our products to customers and avoid excess inventory; • the announcement or introduction of products and technologies by our competitors; • changes in product mix, product costs or pricing, or distribution channels; and • general economic conditions and economic conditions specific to the advanced display and semiconductor markets |
| These factors are difficult or impossible to forecast, and these or other factors could seriously harm our business |
| We anticipate the rate of new orders may vary significantly from quarter to quarter |
| Our operating expenses and inventory levels are based on our expectations of future revenues and our operating expenses are relatively fixed in the short term |
| Consequently, if anticipated sales and shipments in any quarter do not occur when expected, operating expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters may be negatively impacted |
| Any shortfall in our revenues would have a direct impact on our business |
| In addition, fluctuations in our quarterly results could adversely affect the price of our common stock in a manner unrelated to our long-term operating performance |
| Because our operating results are volatile and difficult to predict, you should not rely on the results of one quarter as an indication of our future performance |
| It is possible that in some future quarter our operating results will fall below the expectations of securities analysts and investors |
| In this event, the price of our common stock may decline significantly |
| 18 _________________________________________________________________ [72]Table of Contents Our products are characterized by average selling prices that decline over relatively short time periods, which will negatively affect financial results unless we are able to reduce our product costs or introduce new products with higher average selling prices |
| Average selling prices for our products decline over relatively short time periods while many of our product costs are fixed |
| When our average selling prices decline, our gross profits decline unless we are able to sell more units or reduce the cost to manufacture our products |
| Our operating results are negatively affected when revenue or gross profit margins decline |
| We have experienced these results and expect that we will continue to experience them in the future, although we cannot predict when they may occur or how severe they will be |
| Our highly integrated products and high-speed mixed signal products are difficult to manufacture without defects and the existence of defects could result in an increase in our costs and delays in the availability of our products |
| The manufacture of semiconductors is a complex process and it is often difficult for semiconductor foundries to produce semiconductors free of defects |
| Because many of our products are more highly integrated than other semiconductors and incorporate mixed analog and digital signal processing and embedded memory technology, they are even more difficult to produce without defects |
| The ability to manufacture products of acceptable quality depends on both product design and manufacturing process technology |
| Since defective products can be caused by design or manufacturing difficulties, identifying quality problems can occur only by analyzing and testing our semiconductors in a system after they have been manufactured |
| The difficulty in identifying defects is compounded because the process technology is unique to each of the multiple semiconductor foundries we contract with to manufacture our products |
| Failure to achieve defect-free products due to their increasing complexity may result in an increase in our cost and delays in the availability of our products |
| For example, we have experienced field failures of our semiconductors in certain customer system applications that required us to institute additional semiconductor level testing |
| As a result of these field failures we incurred costs due to customers returning potentially affected products |
| Additionally, customers have experienced delays in receiving product shipments from us that resulted in the loss of revenue and profits |
| If we do not achieve additional design wins in the future, our ability to grow would be seriously limited |
| Our future success will depend on developers of advanced display products designing our products into their systems |
| To achieve design wins we must define and deliver cost-effective, innovative and integrated semiconductors |
| Once a supplier’s products have been designed into a system, the developer may be reluctant to change its source of components due to the significant costs associated with qualifying a new supplier |
| Accordingly, the failure on our part to obtain additional design wins with leading branded manufacturers or integrators, and to successfully design, develop and introduce new products and product enhancements could harm our business, financial condition and results of operations |
| Achieving a design win does not necessarily mean that a developer will order large volumes of our products |
| A design win is not a binding commitment by a developer to purchase our products |
| Rather, it is a decision by a developer to use our products in the design process of that developer’s products |
| Developers can choose at any time to discontinue using our products in their designs or product development efforts |
| If our products are chosen to be incorporated into a developer’s products, we may still not realize significant revenues from that developer if that developer’s products are not commercially successful or if that developer chooses to qualify a second source |
| 19 _________________________________________________________________ [73]Table of Contents Because of the complex nature of our semiconductor designs and of the associated manufacturing process and the rapid evolution of our customers’ product designs, we may not be able to develop new products or product enhancements in a timely manner, which could decrease customer demand for our products and reduce our revenues |
| The development of our semiconductors, some of which incorporate mixed analog and digital signal processing, is highly complex |
| These complexities require that we employ advanced designs and manufacturing processes that are unproven |
| We have experienced increased development time and delays in introducing new products that resulted in significantly less revenue than originally expected for those products |
| We will not always succeed in developing new products or product enhancements nor will we always do so in a timely manner |
| Acquisitions have significantly added to the complexity of our product development efforts |
| We must now coordinate very complex product development programs between multiple geographically dispersed locations |
| Many of our designs involve the development of new high-speed analog circuits that are difficult to simulate and that require physical prototypes not required by the primarily digital circuits we currently design |
| The result could be longer and less predictable development cycles |
| Successful development and timely introduction of new or enhanced products depends on a number of other factors, including, but not limited to: • accurate prediction of customer requirements and evolving industry standards, including video decoding, digital interface and content piracy protection standards; • development of advanced display technologies and capabilities; • timely completion and introduction of new product designs; • use of advanced foundry processes and achievement of high manufacturing yields; and • market acceptance of the new products |
| If we are not able to successfully develop and introduce our products in a timely manner, our business and results of operations will be adversely affected |
| Integration of software in our products adds complexity and cost that may affect our ability to achieve design wins and may affect our profitability |
| Our products incorporate software and software development tools |
| The integration of software adds complexity, may extend our internal development programs and could impact our customers’ development schedules |
| This complexity requires increased coordination between hardware and software development schedules and may increase our operating expenses without a corresponding increase in product revenue |
| Some customers and potential customers may choose not to use our products because of the additional requirements of implementing our software, preferring to use a product that works with their existing software |
| This additional level of complexity lengthens the sales cycle and may result in customers selecting competitive products requiring less software integration |
| 20 _________________________________________________________________ [74]Table of Contents A significant amount of our revenue comes from a few customers and distributors |
| Any decrease in revenues from, or loss of, any of these customers or distributors could significantly reduce our total revenues |
| We are and will continue to be dependent on a limited number of large distributors and customers for a substantial portion of our revenue |
| Sales to distributors represented 46prca, 69prca and 69prca of total revenue for the years ended December 31, 2005, 2004 and 2003, respectively |
| Sales to Tokyo Electron Device, or TED, our Japanese Distributor, represented 22prca, 31prca and 39prca of our total revenue for the years ended December 31, 2005, 2004 and 2003, respectively |
| Sales to our top five end customers accounted for approximately 34prca, 33prca and 35prca of total revenue for the years ended December 31, 2005, 2004 and 2003, respectively |
| As a result of this distributor and end customer concentration, any one of the following factors could significantly impact our revenues: • a significant reduction, delay or cancellation of orders from one or more of our key distributors, branded manufacturers or integrators; or • a decision by one or more significant customers to select products manufactured by a competitor, or its own internally developed semiconductor, for inclusion in future product generations |
| The display manufacturing market is highly concentrated among relatively few large manufacturers |
| We expect our operating results to continue to depend on revenues from a relatively small number of customers |
| The concentration of our accounts receivable with a limited number of customers exposes us to increased credit risk and could harm our operating results and cash flows |
| At December 31, 2005, we had three customers that each represented more than 10prca of our accounts receivable |
| At December 31, 2004, we had two customers that each represented more than 10prca of our accounts receivable |
| TED represented 16prca and 26prca of total accounts receivable at December 31, 2005 and 2004, respectively |
| The failure to pay this balance by this or any other customer would result in an expense that would increase our operating expenses and would reduce our cash flows |
| International sales account for almost all of our revenue, and if we do not successfully address the risks associated with our international operations, our revenue could decrease |
| We anticipate that sales outside the US will continue to account for a substantial portion of our revenue in future periods |
| In addition, customers who incorporate our products into their products sell a substantial portion outside of the US, thereby exposing us indirectly to further international risks |
| In addition, all of our products are manufactured outside of the US We are, therefore, subject to many international risks, including, but not limited to: • increased difficulties in managing international distributors and manufacturers of our products and components due to varying time zones, languages and business customs; • foreign currency exchange fluctuations such as the devaluation in the currencies of Japan, People’s Republic of China (“PRC”), Taiwan and Korea that could result in an increased cost of procuring our semiconductors; • potentially adverse tax consequences; 21 _________________________________________________________________ [75]Table of Contents • difficulties regarding timing and availability of export and import licenses, which have limited our ability to freely move demonstration equipment and samples in and out of Asia; • political and economic instability, particularly in the PRC, Japan, Taiwan ,Korea and Turkey; • reduced or limited protection of our intellectual property, significant amounts of which are contained in software, which is more prone to design piracy; • increased transaction costs related to sales transactions conducted outside of the US, such as charges to secure letters of credit for foreign receivables; • difficulties in maintaining sales representatives outside of the US that are knowledgeable about our industry and products; • changes in the regulatory environment in the PRC, Japan, Taiwan, Korea and Turkey that may significantly impact purchases of our products by our customers; • outbreaks of SARS, bird flu or other pandemics in the PRC or other parts of Asia; and • difficulties in collecting accounts receivable |
| Our growing presence and investment within the Peoples Republic of China subjects us to risks of economic and political instability in the area, which could adversely impact our results of operations |
| A substantial and potentially increasing portion of our products are manufactured by foundries located in the PRC and a large number of our customers are geographically concentrated in the PRC In addition, approximately 45prca of our employees are located in this area and we made an investment of dlra10cmam000 in SMIC, located in Shanghai, China in the third quarter of 2003 |
| Disruptions from natural disasters, health epidemics (including new outbreaks of SARS or bird flu) and political, social and economic instability may affect the region, and would have a negative impact on our results of operations |
| In addition, the economy of the PRC differs from the economies of many countries in respects such as structure, government involvement, level of development, growth rate, capital reinvestment, allocation of resources, self-sufficiency, rate of inflation and balance of payments position, among others |
| In the past, the economy of the PRC has been primarily a planned economy subject to state plans |
| Since the entry of the PRC into the World Trade Organization in 2002, the PRC government has been reforming its economic and political systems |
| These reforms have resulted in significant economic growth and social change |
| We cannot assure, however, that the PRC’s policies for economic reforms will be consistent or effective |
| Our results of operations and financial position may be harmed by changes in the PRC’s political, economic or social conditions |
| Our dependence on selling through distributors and integrators increases the complexity of managing our supply chain and may result in excess inventory or inventory shortages |
| Selling through distributors and integrators reduces our ability to forecast sales and increases the complexity of our business |
| Since our distributors act as intermediaries between us and the companies using our products, we must rely on our distributors to accurately report inventory levels and production forecasts |
| Some of our products are sold to integrators, who then integrate our semiconductors into a system that is then sold to an original equipment manufacturer or “OEM” This adds another layer between us and the ultimate source of demand for our products, the consumer |
| These arrangements 22 _________________________________________________________________ [76]Table of Contents require us to manage a more complex supply chain and monitor the financial condition and creditworthiness of our distributors, integrators and customers |
| Our failure to manage one or more of these challenges could result in excess inventory or shortages that could seriously impact our operating revenue or limit the ability of companies using our semiconductors to deliver their products |
| Dependence on a limited number of sole-source, third-party manufacturers for our products exposes us to shortages based on capacity allocation or low manufacturing yield, errors in manufacturing, price increases with little notice, volatile inventory levels and delays in product delivery, which could result in delays in satisfying customer demand, increased costs and loss of revenues |
| We do not own or operate a semiconductor fabrication facility and we do not have the resources to manufacture our products internally |
| We rely on third-party foundries for wafer fabrication and other contract manufacturers for assembly and testing of our products |
| Our requirements represent only a small portion of the total production capacity of our contract manufacturers |
| Our third-party manufacturers have in the past re-allocated capacity to other customers even during periods of high demand for our products |
| We have limited control over delivery schedules, quality assurance, manufacturing yields, potential errors in manufacturing and production costs |
| We do not have long-term supply contracts with our third-party manufacturers so they are not obligated to supply us with products for any specific period of time, in any specific quantity or at any specific price, except as may be provided in a particular purchase order |
| From time to time our third-party manufacturers increase prices charged to manufacture our products with little notice |
| This requires us to either increase the price we charge for our products or suffer a decrease in our gross margins |
| We try not to maintain substantial inventories of products, but need to order products well in advance of receiving firm purchase orders for those products which could result in excess inventory or inventory shortages |
| If we are unable to obtain our products from manufacturers on schedule, our ability to satisfy customer demand will be harmed, and revenue from the sale of products may be lost or delayed |
| If orders for our products are cancelled, expected revenues would not be realized |
| In addition, if the price charged by our third-party manufacturers increases we will be required to increase our prices, which could harm our competitiveness |
| For example, in the fourth quarter of 2005, one of our third-party manufacturers experienced temporary manufacturing delays due to unexpected process problems, which caused delays in delivery of our products making it difficult for us to satisfy our customer demand |
| The concentration of our manufacturers and customers in the same geographic region increases our risk that a natural disaster, labor strike or political unrest could disrupt our operations |
| Most of our current manufacturers and customers are located in the PRC, Japan, Korea and Taiwan |
| The risk of earthquakes in the Pacific Rim region is significant due to the proximity of major earthquake fault lines in the area |
| Common consequences of earthquakes include power outages and disruption and/or impairment of production capacity |
| Earthquakes, fire, flooding, power outages and other natural disasters in the Pacific Rim region, or political unrest, labor strikes or work stoppages in countries where our manufacturers and customers are located likely would result in the disruption of our manufacturers’ and customers’ operations |
| Any disruption resulting from extraordinary events could cause significant delays in shipments of our products until we are able to shift our manufacturing from the affected contractor to another third-party vendor |
| There can be no assurance that alternative capacity could be obtained on favorable terms, if at all |
| 23 _________________________________________________________________ [77]Table of Contents We use a COT, or customer owned tooling, process for manufacturing some of our products which exposes us to the possibility of poor yields and unacceptably high product costs |
| We are building many of our products on a customer owned tooling basis, also known in the semiconductor industry as COT, where we directly contract the manufacture of wafers and assume the responsibility for the assembly and testing of our products |
| As a result, we are subject to increased risks arising from wafer manufacturing yields and risks associated with coordination of the manufacturing, assembly and testing process |
| Poor product yields would result in higher product costs, which could make our products uncompetitive with products offered by our competitors if we chose to increase our prices, or could result in low gross profit margins if we did not increase our prices |
| We are dependent on our foundries to implement complex semiconductor technologies, which could adversely affect our operations if those technologies are unavailable, delayed or inefficiently implemented |
| In order to increase performance and functionality and reduce the size of our products, we are continuously developing new products using advanced technologies that further miniaturize semiconductors |
| However, we are dependent on our foundries to develop and provide access to the advanced processes that enable such miniaturization |
| We cannot be certain that future advanced manufacturing processes will be implemented without difficulties, delays or increased expenses |
| Our business, financial condition and results of operations could be materially and adversely affected if advanced manufacturing processes are unavailable to us, substantially delayed or inefficiently implemented |
| Manufacturers of our semiconductor products periodically discontinue manufacturing processes, which could make our products unavailable from our current suppliers |
| Semiconductor manufacturing technologies change rapidly and manufacturers typically discontinue older manufacturing processes in favor of newer ones |
| Once a manufacturer makes the decision to retire a manufacturing process, notice is generally given to its customers |
| Customers will then either retire the affected part or develop a new version of the part that can be manufactured on the newer process |
| In the event that a manufacturing process is discontinued, our products could become unavailable from our current suppliers |
| Additionally, migrating to a new, more advanced process requires significant expenditures for research and development |
| A significant portion of our products use embedded DRAM technology and the required manufacturing process for this technology may only be available for the next two years |
| We also utilize 0dtta18um, 0dtta15um and 0dtta13um standard logic processes, which may only be available for the next five to seven years |
| We have commitments from our suppliers to notify us in the event of a discontinuance of a manufacturing process in order to assist us with product transitions |
| If we have to qualify a new contract manufacturer or foundry for any of our products, we may experience delays that result in lost revenues and damaged customer relationships |
| None of our products are fabricated by more than one supplier |
| Additionally, our products require manufacturing with state-of-the-art fabrication equipment and techniques |
| Because the lead-time needed to establish a relationship with a new contract manufacturer is at least nine months, and the estimated time for us to adapt a product’s design to a particular contract manufacturer’s process is at least four months, there is no readily available alternative source of supply for any specific product |
| This could cause significant delays in shipping products, which may result in lost revenues and damaged customer relationships |
| 24 _________________________________________________________________ [78]Table of Contents Our future success depends upon the continued services of key personnel, many of whom would be difficult to replace and the loss of one or more of these employees could seriously harm our business by delaying product development |
| Our future success depends upon the continued services of our executive officers, key hardware and software engineers, and sales, marketing and support personnel, many of whom would be difficult to replace |
| The loss of one or more of these employees, particularly Allen Alley, our President and Chief Executive Officer, could seriously harm our business |
| In addition, because of the highly technical nature of our business, the loss of key engineering personnel could delay product introductions and significantly impair our ability to successfully create future products |
| We believe our success depends, in large part, upon our ability to identify, attract and retain qualified hardware and software engineers, and sales, marketing, finance and managerial personnel |
| Competition for talented personnel is intense and we may not be able to retain our key personnel or identify, attract or retain other highly qualified personnel in the future |
| We have experienced, and may continue to experience, difficulty in hiring and retaining employees with appropriate qualifications |
| If we do not succeed in hiring and retaining employees with appropriate qualifications, our product development efforts, revenues and business could be seriously harmed |
| Because we do not have long-term commitments from our customers, and plan purchases based on estimates of customer demand which may be inaccurate, we must contract for the manufacture of our products based on those potentially inaccurate estimates |
| Our sales are made on the basis of purchase orders rather than long-term purchase commitments |
| Our customers may cancel or defer purchase orders at any time |
| This process requires us to make multiple demand forecast assumptions, each of which may introduce error into our estimates |
| If our customers or we overestimate demand, we may purchase components or have products manufactured that we may not be able to use or sell |
| As a result, we would have excess inventory, which would negatively affect our operating results |
| Conversely, if our customers or we underestimate demand or if sufficient manufacturing capacity is unavailable, we would forego revenue opportunities, lose market share and damage our customer relationships |
| Development projects may cause us to incur substantial operating expenses without the guarantee of any associated revenue or far in advance of revenue |
| We have development projects that consume large amounts of engineering resources far in advance of product revenue |
| Our work under these projects is technically challenging and places considerable demands on our limited resources, particularly on our most senior engineering talent, and may not result in revenue for twelve to eighteen months, if at all |
| In addition, allocating significant resources to these projects may detract from or delay the completion of other development projects |
| Any of these development projects could be canceled at any time without notice |
| These factors could have a material and adverse effect on our long-term business and results of operations |
| Because of our long product development process and sales cycle, we may incur substantial expenses before we earn associated revenues and may not ultimately sell as many units of our products as we forecasted |
| We develop products based on anticipated market and customer requirements and incur substantial product development expenditures, which can include the payment of large up-front, third-party license fees and royalties, prior to generating associated revenues |
| Because the development of our products incorporates not only our complex and evolving technology, but also our customers’ specific requirements, a lengthy sales process is often required before potential customers begin the technical evaluation of our products |
| Our customers typically perform numerous tests and extensively evaluate our products before 25 _________________________________________________________________ [79]Table of Contents incorporating them into their systems |
| The time required for testing, evaluation and design of our products into a customer’s equipment can take up to nine months or more |
| It can take an additional nine months before a customer commences volume shipments of systems that incorporate our products |
| Even when we achieve a design win, the customer may never ship systems incorporating our products |
| We cannot assure that the time required for the testing, evaluation and design of our products by our customers would not exceed nine months |
| Because of this lengthy development cycle, we will experience delays between the time we incur expenditures for research and development, sales and marketing, inventory levels and the time we generate revenues, if any, from these expenditures |
| Additionally, if actual sales volumes for a particular product are substantially less than originally forecasted, we may experience large write-offs of capitalized license fees, product masks and prepaid royalties that would negatively affect our operating results |
| Shortages of other key components for our customers’ products could delay our ability to sell our products |
| Shortages of components and other materials that are critical to the design and manufacture of our customers’ products could limit our sales |
| These components include liquid crystal display panels and other display components, analog-to-digital converters, digital receivers and video decoders |
| During 2000, some of our customers experienced delays in the availability of key components from other suppliers, which, in turn, caused a delay in demand for the products that we supplied to our customers |
| Shortages of materials used in the manufacturing of our products may increase our costs or limit our revenues and impair our ability to ship our products on time |
| From time to time, shortages of materials that are used in our products may occur |
| In particular, we may experience shortages of semiconductor wafers and packages |
| If material shortages occur, we may incur additional costs or be unable to ship our products to our customers in a timely fashion, both of which could harm our business and negatively impact our earnings |
| Our products could become obsolete if necessary licenses of third-party technology are not available to us or are only available on terms that are not commercially viable |
| We license technology from third parties that is incorporated into our products or product enhancements |
| Future products or product enhancements may require additional third-party licenses that may not be available to us or on terms that are commercially reasonable |
| If we are unable to obtain any third-party license required to develop new products and product enhancements, we may have to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm the competitiveness of our products |
| We currently have access to certain key technology, owned by independent third parties, through license agreements |
| In the event of a change in control at the licensor, it may become difficult to attain access to such licensed technology |
| We may not be able to respond to the rapid technological changes in the markets in which we compete, or we may not be able to comply with industry standards in the future making our products less desirable or obsolete |
| The markets in which we compete or seek to compete are subject to rapid technological change, frequent new product introductions, changing customer requirements for new products and features, and evolving industry standards |
| The introduction of new technologies and the emergence of new industry standards could render our products less desirable or obsolete, which could harm our business |
| Examples of changing industry standards include the introduction of high-definition television (ATSC and DVB), or HDTV, new video decoding technology (such as H264 or Windows Media 9), new digital receivers and 26 _________________________________________________________________ [80]Table of Contents displays with resolutions that have required us to accelerate development of new products to meet these new standards |
| Our software development tools may be incompatible with industry standards and challenging to implement, which could slow product development or cause us to lose customers and design wins |
| Our existing products incorporate complex software tools designed to help customers bring products into production |
| Software development is a complex process and we are dependent on software development languages and operating systems from vendors that may compromise our ability to design software in a timely manner |
| Also, software development is a volatile market and new software languages are introduced to the market that may be incompatible with our existing systems and tools |
| New software development languages may not be compatible with our own, requiring significant engineering efforts to migrate our existing systems in order to be compatible with those new languages |
| Existing or new software development tools could make our current products obsolete or hard to use |
| Software development disruptions could slow our product development or cause us to lose customers and design wins |
| Our integrated circuits and software could contain defects, which could reduce sales of those products or result in claims against us |
| Despite testing by both our customers and us, errors or performance problems may be found in existing or new semiconductors and software |
| This could result in a delay in the recognition or loss of revenues, loss of market share or failure to achieve market acceptance |
| These defects may cause us to incur significant warranty, support and repair costs, and could also divert the attention of our engineering personnel from our product development efforts and harm our relationships with our customers |
| The occurrence of these problems could result in the delay or loss of market acceptance of our semiconductors and would likely harm our business |
| Defects, integration issues or other performance problems in our semiconductors and software could result in financial or other damages to our customers or could damage market acceptance of our products |
| Our customers could also seek damages from us for their losses |
| A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend |
| Others may bring infringement actions against us that could be time consuming and expensive to defend |
| We may become subject to claims involving patents or other intellectual property rights |
| For example, in early 2000, we were notified by InFocus Corporation (“InFocus”) that we were infringing on patents held by InFocus |
| In February 2000, we entered into a license agreement with InFocus granting us the right to use the technology covered by those InFocus patents |
| As a result, we recorded a charge of dlra4cmam078 for patent settlement expense in the first quarter of 2000 |
| Intellectual property claims could subject us to significant liability for damages and invalidate our proprietary rights |
| In addition, intellectual property claims may be brought against customers that incorporate our products in the design of their own products |
| These claims, regardless of their success or merit and regardless of whether we are named as defendants in a lawsuit, would likely be time consuming and expensive to resolve and would divert the time and attention of management and technical personnel |
| Any future intellectual property litigation or claims also could force us to do one or more of the following: • stop selling products using technology that contains the allegedly infringing intellectual property; • attempt to obtain a license to the relevant intellectual property, which may not be available on reasonable terms or at all; 27 _________________________________________________________________ [81]Table of Contents • attempt to redesign those products that contain the allegedly infringing intellectual property; and • pay damages for past infringement claims that are determined to be valid or which are arrived at in settlement of such litigation or threatened litigation |
| If we are forced to take any of the foregoing actions, we may be unable to manufacture and sell our products, which could seriously harm our business |
| In addition, we may not be able to develop, license or acquire non-infringing technology under reasonable terms |
| These developments could result in an inability to compete for customers or could adversely affect our results of operations |
| Our limited ability to protect our intellectual property and proprietary rights could harm our competitive position by allowing our competitors to access our proprietary technology and to introduce similar products |
| Our ability to compete effectively with other companies will depend, in part, on our ability to maintain the proprietary nature of our technology, including our semiconductor designs and software |
| We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies |
| We hold 36 patents and have 94 patent applications pending for protection of our significant technologies |
| We cannot assure you that the degree of protection offered by patents or trade secret laws will be sufficient |
| Furthermore, we cannot assure you that any patents will be issued as a result of any pending applications, or that, if issued, any claims allowed will be sufficiently broad to protect our technology |
| In addition, it is possible that existing or future patents may be challenged, invalidated or circumvented |
| Competitors in both the US and foreign countries, many of whom have substantially greater resources, may apply for and obtain patents that will prevent, limit or interfere with our ability to make and sell our products, or develop similar technology independently or design around our patents |
| Effective copyright, trademark and trade secret protection may be unavailable or limited in foreign countries |
| In addition, we provide the computer programming code for our software to selected customers in connection with their product development efforts, thereby increasing the risk that customers will misappropriate our proprietary software |
| We have incurred substantial indebtedness as a result of the sale of convertible debentures |
| In the second quarter of 2004, we issued dlra150cmam000 of 1dtta75prca convertible debentures due 2024 in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933 |
| As a result of this indebtedness, our principal obligations increased substantially |
| These debt obligations could materially and adversely affect our ability to obtain debt financing for working capital, acquisitions or other purposes, limit our flexibility in planning for or reacting to changes in our business, reduce funds available for use in our operations and could make us more vulnerable to industry downturns and competitive pressures |
| Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control |
| Failure to manage our expansion effectively could adversely affect our ability to increase our business and our results of operations |
| Our ability to successfully market and sell our products in a rapidly evolving market requires effective planning and management processes |
| We continue to increase the scope of our operations and have increased our headcount from 349 employees at the end of 2004 to 469 at December 31, 2005 |
| Our past growth, and our expected future growth, places a significant strain on our management systems and resources including our financial and managerial controls, reporting systems and procedures |
| To manage our growth effectively, we must implement and improve operational and financial systems, train and 28 _________________________________________________________________ [82]Table of Contents manage our employee base and attract and retain qualified personnel with relevant experience |
| We must also manage multiple relationships with customers, business partners, contract manufacturers, suppliers and other third parties |
| Moreover, we could spend substantial amounts of time and money in connection with our rapid growth and may have unexpected costs |
| Our systems, procedures or controls may not be adequate to support our operations and we may not be able to expand quickly enough to exploit potential market opportunities |
| While we have not, to date, suffered any significant adverse consequences due to our growth, if we do not continue to manage growth effectively our operating expenses could increase more rapidly than our revenue, adversely affecting our statement of operations |
| Risks Related to Our Industry Failure of consumer demand for advanced displays and other digital display technologies to increase would impede our growth and adversely affect our business |
| Our product development strategies anticipate that consumer demand for advanced televisions, multimedia projectors, liquid crystal display panels, digital streaming media devices and other emerging display technologies will increase in the future |
| The success of our products is dependent on increased demand for these display technologies |
| The potential size of the market for products incorporating these display technologies and the timing of its development are uncertain and will depend upon a number of factors, all of which are beyond our control |
| In order for the market in which we participate to grow, advanced display products must be widely available and affordable to consumers |
| Undercapacity in the advanced display market may limit our ability to increase our revenues because our customers may limit their purchases of our products if they cannot obtain sufficient supplies of LCD panels or other advanced display components |
| In addition, advanced display prices may remain high because of limited supply, and consumer demand may not grow |
| If products incorporating our semiconductors are not compatible with computer display protocols, video standards and other devices, the market for our products will be reduced and our business prospects could be significantly limited |
| Our products are incorporated into our customers’ products, which have different parts and specifications and utilize multiple protocols that allow them to be compatible with specific computers, video standards and other devices |
| If our customers’ products are not compatible with these protocols and standards, consumers will return these products, or consumers will not purchase these products, and the markets for our customers’ products could be significantly reduced |
| Intense competition in our markets may reduce sales of our products, reduce our market share, decrease our gross profit and result in large losses |
| Rapid technological change, evolving industry standards, compressed product life cycles and declining average selling prices are characteristics of our market and could have a material adverse effect on our business, financial condition and results of operations |
| As the overall price of advanced flat panel display screens continues to fall, we may be required to offer our products to manufacturers at discounted prices due to increased price competition |
| At the same time, new, alternative technologies and industry standards may emerge that directly compete with technologies that we offer |
| We may be required to increase our investment in research and development at the same time that product prices are falling |
| In addition, even after making this investment, we cannot assure you that our technologies will be superior to those of our competitors or that our products will achieve market acceptance, whether for performance or price reasons |
| Failure to effectively respond to these trends could reduce the demand for our products |
| 29 _________________________________________________________________ [83]Table of Contents We compete with specialized and diversified electronics and semiconductor companies that offer advanced display, digital TV and IPTV semiconductor products |
| Potential competitors may include diversified semiconductor manufacturers and the semiconductor divisions or affiliates of some of our customers, including Intel, Koninlijke Philips Electronics, LG Electronics, Matsushita Electric Industrial, Mitsubishi, National Semiconductor, NEC, nVidia, Samsung Electronics, Sanyo Electric Company, Sharp Corporation, Sony Corporation, Texas Instruments and Toshiba Corporation |
| In addition, start-up companies may seek to compete in our markets |
| Many of our competitors have longer operating histories and greater resources to support development and marketing efforts |
| Some of our competitors may operate their own fabrication facilities |
| These competitors may be able to react more quickly and devote more resources to efforts that compete directly with our own |
| In the future, our current or potential customers may also develop their own proprietary technologies and become our competitors |
| Our competitors may develop advanced technologies enabling them to offer more cost-effective and higher quality semiconductors to our customers than those offered by us |
| Increased competition could harm our business, financial condition and results of operations by, for example, increasing pressure on our profit margin or causing us to lose sales opportunities |
| We cannot assure you that we can compete successfully against current or potential competitors |
| The cyclical nature of the semiconductor industry may lead to significant variances in the demand for our products and could harm our operations |
| In the past, the semiconductor industry has been characterized by significant downturns and wide fluctuations in supply and demand |
| Also, during this time, the industry has experienced significant fluctuations in anticipation of changes in general economic conditions, including economic conditions in Asia and North America |
| The cyclical nature of the semiconductor industry has led to significant variances in product demand and production capacity |
| We may experience periodic fluctuations in our future financial results because of changes in industry-wide conditions |
| Other Risks The anti-takeover provisions of Oregon law and in our articles of incorporation could adversely affect the rights of the holders of our common stock by preventing a sale or takeover of us at a price or prices favorable to the holders of our common stock |
| Provisions of our articles of incorporation and bylaws and provisions of Oregon law may have the effect of delaying or preventing a merger or acquisition of us, making a merger or acquisition of us less desirable to a potential acquirer or preventing a change in our management, even if the shareholders consider the merger or acquisition favorable or if doing so would benefit our shareholders |
| In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock |
| The following are examples of such provisions in our articles of incorporation or bylaws: • our board of directors is authorized, without prior shareholder approval, to increase the size of the board |
| Our articles of incorporation provide that if the board is increased to eight or more members, the board will divided into three classes serving staggered terms, which would make it more difficult for a group of shareholders to quickly change the composition of our board; • our board of directors is authorized, without prior shareholder approval, to create and issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us or change our control, commonly referred to as “blank check” preferred stock; • members of our board of directors can only be removed for cause; 30 _________________________________________________________________ [84]Table of Contents • the board of directors may alter our bylaws without obtaining shareholder approval; and • shareholders are required to provide advance notice for nominations for election to the board of directors or for proposing matters to be acted upon at a shareholder meeting |
| Our principal shareholders have significant voting power and may take actions that may make it more difficult to sell our shares at a premium to take over candidates |
| Our executive officers, directors and other principal shareholders, in the aggregate, beneficially own 23cmam222cmam641 shares or approximately 48prca of our outstanding common stock and exchangeable shares as of February 28, 2006 |
| These shareholders currently have, and will continue to have, significant influence with respect to the election of our directors and approval or disapproval of our significant corporate actions |
| This influence over our affairs might be adverse to the interest of our other shareholders |
| In addition, the voting power of these shareholders could have the effect of delaying or preventing a change in control of our business or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could prevent our other shareholders from realizing a premium over the market price for their common stock |
| The price of our common stock has and may continue to fluctuate substantially |
| Investors may not be able to sell shares of our common stock at or above the price they paid due to a number of factors, including, but not limited to: • actual or anticipated fluctuations in our operating results; • actual reduction in our operating results due solely to the adoption of Statement of Financial Accounting Standards Nodtta 123R, which requires, among other things, the expensing of stock options beginning in 2006; • changes in expectations as to our future financial performance; • changes in financial estimates of securities analysts; • announcements by us or our competitors of technological innovations, design wins, contracts, standards or acquisitions; • the operating and stock price performance of other comparable companies; • announcements of future expectations by our customers; • changes in market valuations of other technology companies; and • inconsistent trading volume levels of our common stock |
| In particular, the stock prices of technology companies similar to us have been highly volatile |
| These fluctuations often have been unrelated or disproportionate to the operating performance of those companies |
| Market fluctuations as well as general economic, political and market conditions including recessions, interest rate changes or international currency fluctuations, may negatively impact the market price of our common stock |
| Therefore, the price of our common stock may decline, and the value of your investment may be reduced regardless of our performance |
| 31 _________________________________________________________________ [85]Table of Contents We may be unable to meet our future capital requirements, which would limit our ability to grow |
| We believe our current cash and marketable security balances will be sufficient to meet our capital requirements for the next twelve months |
| However, we may need, or could elect to seek, additional funding prior to that time |
| To the extent that currently available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing |
| Additional funds may not be available on terms favorable to us or our shareholders |
| Further, if we issue equity securities, our shareholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of our common stock |
| If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements |
| We may be unable to meet changing laws, regulations and standards relating to corporate governance and public disclosure |
| We are spending an increasing amount of management time and external resources to comply with 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 |
| In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems, and attestations of the effectiveness of these systems by our independent registered public accounting firm |
| The process of documenting and testing our controls has required that we hire additional personnel and outside advisory services and has resulted in additional accounting and legal expenses |
| While we invested significant time and money in our effort to evaluate and test our internal control over financial reporting, a material weakness was identified in our internal control over financial reporting in 2004 |
| In addition, there are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including cost limitations, the possibility of human error, judgments and assumptions regarding the likelihood of future events, and the circumvention or overriding of the controls and procedures |
| Accordingly, even effective disclosure controls and procedures can provide only reasonable assurance of achieving their control objectives |