| SYNPLICITY INC ITEM 1A RISK FACTORS You should carefully consider the following risks together with all of the other information contained in this Form 10-K The risks and uncertainties described below are not the only ones we face |
| If any of the circumstances described below were to occur, our business, financial condition and results of operations could be materially adversely affected |
| This Form 10-K contains forward-looking statements that involve risks and uncertainties |
| Our actual results may differ significantly from the results discussed in the forward-looking statements |
| Factors that might cause such differences include, but are not limited to, the risk factors set forth below |
| Factors Affecting Future Operating Results Risks Relating to Business See discussion under the caption “Recent Development” in Part 1, Item 1 of this Form 10-K We have relied and expect to continue to rely on sales of our Synplify Pro product for a substantial portion of our license revenue and a decline in sales of this product could cause our license revenue to decline Historically, we have derived a significant majority of our revenue from sales of our Synplify Pro product |
| License revenue from our Synplify Pro product accounted for 49prca, 48prca and 53prca of our total license revenue in 2005, 2004 and 2003, respectively |
| We expect that revenue from this product will continue to account for a significant share of our license revenue for at least the next 12 months |
| Any factors which adversely affect the pricing of, or demand for, our Synplify Pro and Synplify Premier products could cause our license revenue to decline and our business 16 ______________________________________________________________________ [38]Table of Contents to suffer |
| Factors that may affect sales of our Synplify Pro and Synplify Premier products, some of which are beyond our control, include the following: • overall market conditions, including an economic downturn in both domestic and foreign markets; • performance, quality and total cost of our software products relative to other logic synthesis products for FPGAs, including those offered at little or no cost by FPGA manufacturers; • quality and performance of our sales teams in individual geographic locations; • growth, changing technological requirements and degree of competition in the programmable semiconductor market, particularly with respect to FPGAs; and • maintenance and enhancement of our existing relationships with leading manufacturers of FPGAs, which may provide us advance information or detailed data about their FPGAs and software |
| Our revenue could decline substantially if our existing customers do not continue to purchase additional licenses or maintenance from us, or if existing resale agreements with FPGA manufacturers are canceled We rely on sales of additional licenses to our existing customers, as well as annual maintenance renewals for our products |
| Additional license sales to our existing customers represented 79prca of our license sales in 2005 and 78prca of our license sales in 2004 and 2003 |
| If we fail to sell additional licenses for our products to our existing customers, we would experience a material decline in revenue |
| Even if we are successful in selling our products to new customers, the level of our revenue could be harmed if our existing customers do not continue to purchase a substantial number of additional licenses from us or fail to renew their maintenance |
| Our success in generating revenue from existing customers is dependent on maintaining our relationships with those customers as well as increased need for and usage of our products by those customers |
| Additionally, we experienced lower rates of maintenance renewal during 2003 and 2002 compared to prior years for reasons including, but not limited to, customers’ business conditions or budget restrictions |
| If we were to again experience declines in maintenance renewal rates, our maintenance revenue could stop growing or decrease |
| We have agreements with certain FPGA manufacturers to resell a version of our Synplify product |
| Some of these agreements allow for cancellation with a notice period |
| If these agreements were canceled or not renewed, our revenue could decline |
| We have been experiencing and may continue to experience increased competition as a result of FPGA manufacturers competing in the design software market or investing in emerging software companies FPGA manufacturers currently compete in the FPGA design software market by licensing their own synthesis products at little or no cost and/or by distributing our competitors’ products |
| For example, both Altera and Xilinx provide synthesis products that are competitive with our Synplify and Synplify Pro products and that adversely impact the price or market for our FPGA synthesis products or harm our business and financial prospects |
| FPGA manufacturers may also choose to assist, through financial, equity investment or other support, emerging EDA software companies whose products could compete with or outperform ours |
| An increase in the number of our competitors or the quality and availability of competing products could reduce the value of our products in the market place and adversely affect our business |
| In particular, a greater improvement in the quality of results of vendor supplied synthesis tools compared to our tools may result in reduced demand for our products |
| The Structured/platform ASIC market has recently emerged and its continued development is an element of our future growth and profitability A new breed of ASIC devices called Structured/platform ASICs has emerged |
| In 2003, we introduced the first custom architecture-specific synthesis tool for NEC Electronics’ new Structured ASIC device as well as our 17 ______________________________________________________________________ [39]Table of Contents first physical synthesis product for LSI Logic’s new platform ASIC device |
| In 2004, we customized our physical synthesis product for NEC Electronics’ Structured ASIC device |
| In 2005, we delivered a customized physical synthesis product for Fujitsu Microelectronics’ Structured ASIC device, as well as entered into a new development project with NEC Electronics where we will help develop a new capability for their Structured ASIC product |
| We are investing significant resources in customizing our products for this new market |
| Failure of the Structured/platform ASIC market to develop, or our failure to penetrate that market, would have a material adverse effect on our revenue and operating results |
| See discussion under the caption “Recent Development” in Part 1, Item 1 of this Form 10-K Our near-term revenue growth could decline as a result of increases in sales of time-based licenses Historically, we have seen an increase in the number and dollar amount of time-based license agreements |
| Time-based licenses include maintenance services for the duration of their respective terms |
| Revenue from time-based licenses is allocated between license and maintenance revenue in similar proportion to perpetual license transactions, and recognized on a straight-line basis over the period of the maintenance |
| Time-based license revenue accounted for approximately 37prca of our total license revenue in 2005 and 39prca and 29prca of our total license revenue in 2004 and 2003, respectively |
| Increases in the percentage of time-based licenses could affect our near-term revenue growth due to the delayed timing of revenue recognition for such licenses |
| If our average selling price of time-based licenses decreases, or if customers do not renew such licenses, our revenue could also decline |
| We depend on our marketing, product development and sales relationships with leading FPGA manufacturers, and if these relationships suffer, we may have difficulty introducing and selling our FPGA synthesis products and our revenue could decline We believe that our success in maintaining acceptance in the FPGA market depends in part on our ability to maintain or further develop our strategic marketing, product development and sales relationships with leading FPGA manufacturers, including Altera and Xilinx |
| We believe our relationships with leading FPGA manufacturers are important in validating our technology, facilitating broad market acceptance of our FPGA synthesis products and enhancing our sales, marketing and distribution capabilities |
| For example, we attempt to coordinate our product offerings with future releases of Altera’s and Xilinx’s FPGA components and software |
| If we are unable to maintain or enhance our existing relationships with major FPGA vendors, we may have difficulty selling our FPGA synthesis products or we may not be able to introduce products on a timely basis that capitalize on new FPGA component characteristics or software feature enhancements |
| Our sales and operating results have in the past been, and may in the future be, negatively impacted by deteriorating economic conditions in the United States and other major countries in which we operate Although revenue has increased in our United States operations in 2004 and 2005, we have in the past experienced negative effects from economic downturns in the United States and other countries |
| As recently as 2004, we have seen customers tightly control spending and reduce or delay purchase orders |
| Industry slowdowns could reemerge, and may extend to other geographic areas |
| For example, the recent increase in worldwide fuel prices could result in weakened economic conditions in the United States and other geographic areas and adversely affect our business |
| We may not succeed in continuing to develop, market and sell new or enhanced commercially acceptable logic synthesis, physical synthesis and verification products, and our operating results may decline as a result See discussion under the caption “Recent Development” in Part 1, Item 1 of this Form 10-K We develop logic synthesis, physical synthesis and verification products that leverage our core capabilities |
| We also develop new features for our existing products |
| In addition, we have developed customized tools for 18 ______________________________________________________________________ [40]Table of Contents certain Structured/platform ASIC products |
| Customizing products and developing new features for existing products that meet the needs of electronic product designers require significant investments in research and development |
| If we fail to continue to introduce customized products or enhanced versions of existing products that are commercially acceptable in a timely and cost-effective manner, our business could be negatively affected |
| Growing competition, technological changes and other market factors that negatively affect the demand for FPGAs and ASICs could also adversely affect our revenue |
| Our future growth and profitability will depend in large part on our ability to gain market acceptance of our products outside of our Synplify Pro product, especially our ASIC products, as well as recently introduced products, such as our Synplify DSP and Synplify Premier products |
| We cannot be certain that our newer products, our entry into the ASIC logic synthesis product market or other new markets, or our acquired products, will be successful |
| If customers do not widely adopt such products, our operating results could decline |
| We rely on our marketing, sales and product and library support relationships with leading ASIC manufacturers, and if we fail to maintain or expand such relationships, we may have difficulty selling our ASIC products and our revenue could be negatively impacted We believe that our success in penetrating the ASIC market depends in part on our ability to develop strategic marketing, sales and product and library support relationships with leading ASIC manufacturers |
| We believe relationships with leading ASIC manufacturers are important in validating our technology, facilitating market acceptance of our ASIC products and enhancing our sales, marketing and distribution capabilities |
| Relationships we have established to date include Artisan Components (which was acquired by ARM Holdings PLC), Fujitsu Microelectronics, IBM Microelectronics, LSI Logic, NEC Electronics, Samsung Electronics, Virtual Silicon Technology Inc, and others |
| These ASIC and ASIC library vendors have worked with us to develop and qualify our software into all or a portion of their ASIC design flows |
| If we are unable to sustain these relationships or develop relationships with other key ASIC manufacturers or do not do so in a timely manner, we may have difficulty selling our ASIC products |
| In addition, we may not be able to enhance our products in a timely manner to capitalize on new ASIC component characteristics or software feature enhancements, which could negatively impact our revenue growth |
| See discussion under the caption “Recent Development” in Part 1, Item 1 of this Form 10-K As we enter into development agreements with semiconductor manufacturers for our products, our revenue could become more unpredictable We have entered into, and expect to continue to enter into, development agreements with semiconductor manufacturers to customize our ASIC synthesis, Structured/platform ASIC physical synthesis and FPGA synthesis tools for certain of their products |
| The timing of revenue recognition on these agreements may be affected by the following factors which involve uncertainty: • our development schedule; • our product’s performance; • delivery of our product; • customer acceptance of our product, which may not occur until some time after we first deliver the product; and • timing of payments which are associated with product acceptance |
| Difficulties in predicting revenue from these arrangements may cause revenue to vary from our forecasts, and as a result, may cause our operating results to decline |
| In addition, failure to enter into new development arrangements that replace revenue recognized from past development arrangements could cause total revenues to decline |
| See discussion under the caption “Recent Development” in Part 1, Item 1 of this Form 10-K 19 ______________________________________________________________________ [41]Table of Contents Our revenue may decline if other vendors’ products are no longer compatible with ours or other vendors bundle their products with those of our competitors and sell them at lower prices Our ability to sell our products depends in part on the compatibility of our products with other vendors’ semiconductor design software and verification products |
| These vendors may change their products so that they will no longer be compatible with our products or may restrict our access to their products, either physically or economically |
| Some vendors already bundle their products with other logic synthesis, physical synthesis or verification products and sell the bundle at lower prices, and more vendors may do so in the future |
| As a result, any of these factors may negatively affect our ability to offer commercially viable or competitive products or may reduce sales of, or increase costs for, our products |
| We may not be able to effectively compete against other providers of products used to design FPGAs and ASICs as a result of their greater financial resources, product offerings and distribution channels, which could cause our sales to decline We face significant competition from larger companies that market suites of semiconductor design software products that address all or almost all steps of semiconductor design or which incorporate intellectual property components for semiconductors |
| These competitors have greater financial resources and name recognition than we do |
| We believe that Cadence, Synopsys, Mentor Graphics and Magma, each of which is also currently competing with us by marketing certain logic synthesis or verification products, could provide suites of products or individual products that include the functionality we currently provide in our products and at lower prices, or may otherwise have more favorable relationships with customers |
| If these or other vendors provide lower cost logic synthesis, physical synthesis or verification products that outperform our products in addition to having broader applications of their existing product lines, our products could become difficult to sell |
| In addition, we believe our ASIC synthesis and physical synthesis products must provide substantially higher quality and value to potential customers for us to be successful in obtaining meaningful market share in the ASIC software tools market |
| Even if our competitors’ standard products offer functionality equivalent to that of our products, we face a substantial risk that a significant number of customers would elect to pay a premium for similar functionality rather than purchase products from a less well-known vendor |
| Increased competition may negatively affect our business and future operating results by leading to price or market share reductions, or higher selling expenses |
| Our revenue could be reduced if larger semiconductor design software companies make acquisitions in order to join their extensive distribution capabilities with our competitors’ products Larger semiconductor design software vendors, such as Cadence, Synopsys, Mentor Graphics and Magma, may acquire or establish cooperative relationships with other companies that may offer or develop competitive products |
| Because larger semiconductor design software vendors have significant financial and organizational resources, they may be able to further penetrate the logic synthesis, physical synthesis or verification markets by leveraging the technology and expertise of smaller companies and utilizing their own extensive distribution channels |
| We expect that the semiconductor design software product industry will continue to consolidate, as evidenced by recent acquisitions of Nassda Corporation by Synopsys and Verisity Ltd |
| It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share, which would harm our business and financial prospects |
| Significant errors in our products or the failure of our products to conform to specifications could result in our customers demanding refunds from us or asserting claims for damages against us Because our logic synthesis, physical synthesis and verification products are complex, our products could fail to perform as anticipated or produce semiconductors that contain errors which go undetected at any point in the customers’ design cycle |
| While we continually test our products for errors and work with users through our customer support service organization to identify and correct errors in our software and other product problems, 20 ______________________________________________________________________ [42]Table of Contents errors in our products may be found in the future |
| Although a number of these errors may prove to be immaterial, many of these errors could be significant |
| The detection of any significant errors may result in: • the loss of or delay in market acceptance and sales of our products; • delays in shipping dates for our products; • diversion of development resources from new products to fix errors in existing products; • injury to our reputation; • costs of corrective actions or returns of defective products; • reduction in rates of maintenance renewals; or • product liability claims or damage awards |
| We warrant that our products will operate in accordance with certain specifications |
| If our products fail to conform to these specifications, customers could demand a refund for the purchase price or assert and collect on claims for damages |
| Although we maintain general business insurance, our coverage does not extend to product liability claims and we cannot assure that our resources would be sufficient to pay a damages award if one were to arise |
| Moreover, because our products are used in connection with other vendors’ products that are used to design complex FPGAs and ASICs, significant liability claims may be asserted against us if our products do not work properly, individually or with other vendors’ products |
| Our agreements with customers typically contain provisions intended to limit our exposure to liability claims |
| However, these limitations may not preclude all potential claims and we do not insure against such liabilities |
| Regardless of their merit, liability claims could require us to spend significant time and money in litigation and divert management’s attention from other business pursuits |
| If successful, a product liability claim could require us to pay significant damages |
| Any claim, whether or not successful, could seriously damage our reputation and our business |
| We may not be successful in integrating the businesses or technologies that we may acquire, or the expected benefits may not be realized as projected We may make additional acquisitions in the future as a part of our efforts to increase revenue and expand our product offerings |
| In addition to added direct costs, acquisitions pose a number of risks, including: • integration of the acquired products and employees into our business; • integration of sales channels and training of our sales force for new product offerings; • failure to realize expected synergies; • failure of acquired products to achieve projected sales; • assumption of unknown liabilities; and • failure to understand and compete effectively in markets in which we have limited experience |
| While we make efforts to analyze acquisition candidates carefully, we cannot be certain that any completed acquisitions will positively impact our business |
| Future acquisitions could also subject us to significant asset impairment or restructuring charges |
| We may not be able to preserve the value of our products’ intellectual property rights and other vendors could challenge our intellectual property rights Our products are differentiated from those of our competitors by our internally developed technology that is incorporated into our products |
| If we fail to protect our intellectual property rights, other vendors could sell logic 21 ______________________________________________________________________ [43]Table of Contents synthesis, physical synthesis or verification products with features similar to ours, which could reduce demand for our products |
| We protect our intellectual property rights through a combination of copyright, trade secret and trademark laws |
| We have filed a number of patent applications and to date have been issued or allowed approximately 30 patents, all of which are US patents |
| We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally seek to control access to our intellectual property rights and the distribution of our logic synthesis, physical synthesis and verification products, documentation and other proprietary information |
| However, we believe that these measures afford only limited protection |
| There is the possibility that the validity of some of our patents may be challenged in the future |
| Others may develop technologies that are similar or superior to our technology or design around the copyrights and trade secrets we own |
| Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise improperly obtain and use our products or technology |
| Policing unauthorized use of our products is difficult and expensive, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as those in the United States |
| For example, with respect to our sales and support operations in India, Indian laws do not protect proprietary rights to the same extent as the United States, and Indian statutory law does not protect service marks |
| Our means of protecting our proprietary rights may be inadequate |
| We rely on the services of key personnel, particularly those in our engineering and sales organizations whose knowledge of our business and technical expertise would be difficult to replace, and turnover or other personnel issues in those organizations could negatively impact our revenue Our products and technologies are complex and we rely on experienced and knowledgeable research and development and sales personnel |
| We depend substantially on the continued service of Gary Meyers, our President and Chief Executive Officer, and Kenneth S McElvain, our Chief Technology Officer, Vice President and a founder |
| We also depend on our sales personnel, particularly in certain areas of Europe and Asia where we employ a relatively small sales team |
| For example, in 2004 we experienced weakness in certain of our Asian sales locations due to turnover within our Asia sales force |
| There are a limited number of qualified people with the technical skills and understanding of FPGAs and ASICs and/or EDA software necessary for our business, and if we are unable to retain or find suitable replacements for turnover of key personnel in our engineering and sales organizations, our business could be adversely affected |
| Risks Relating to an Investment in Our Common Stock Our quarterly operating results and stock price may fluctuate because our ability to accurately forecast our quarterly sales is limited, our costs are relatively fixed in the short term and we expect our business to be affected by seasonality Our ability to accurately forecast quarterly sales is limited, which makes it difficult to predict the quarterly revenue that we will recognize |
| In addition, the time required to initiate and complete a sale for our FPGA products is relatively short, and our ability to foresee and react to changes in customer demand for our products may be limited and therefore inaccurate |
| Most of our costs are for personnel and facilities, which are relatively fixed in the short term |
| If we have a shortfall in revenue in relation to our expectations, we may be unable to reduce our expenses quickly to avoid lower quarterly operating results |
| Consequently, our quarterly operating results could fluctuate, and the fluctuations could adversely affect the market price of our common stock |
| In addition, in the past we have experienced fluctuations in the sale of licenses for our products due to seasonality |
| For example, sales may decline during the summer months, and we have experienced and anticipate we will continue to experience relatively lower product bookings in our first quarter due to patterns in the capital budgeting and purchasing cycles of our current and prospective customers and the economic incentives for our sales force |
| These factors may lead to fluctuations in our quarterly operating results |
| 22 ______________________________________________________________________ [44]Table of Contents We have a history of losses and may experience losses in the future, which could result in the market price of our common stock declining Although we had net income of dlra6dtta6 million in 2005 and dlra2dtta2 million in 2004, we had a net loss of dlra377cmam000 in 2003 and have had significant net losses in the past, including a net loss of dlra3dtta3 million in 2002 |
| We expect to continue to incur significant levels of operating expenses |
| If revenue does not increase or declines, we may not be able to manage our costs in time to achieve profitability for the applicable period involved |
| If we are not profitable, the market price of our common stock may decline, perhaps substantially |
| Our expenses may increase in the next 12 months as we: • hire additional employees; • increase compensation for existing employees; • increase marketing efforts; and • maintain compliance with future corporate governance regulations Any failure to increase our new product bookings and revenue as we implement our product and distribution strategies would also harm our ability to achieve or maintain profitability and could negatively impact the market price of our common stock |
| If we experience an increase in the length of our sales cycle, our quarterly operating results could become more unpredictable and our stock price may decline as a result We experience sales cycles, or the time between an initial customer contact and completion of a sale, of generally two weeks to several months for our FPGA products, depending on the product |
| When the economic downturn began in 2001, we experienced an increase in the length of our sales cycle which has since stabilized |
| If we experience such an increase in the length of our sales cycle again, our quarterly operating results could suffer and our stock price could decline as a result |
| The sales cycles for certain of our ASIC products, including Certify and Synplify ASIC, are substantially longer than those of our FPGA products, which could result in additional unpredictability of our quarterly revenue, especially if interest in our ASIC products increase |
| In addition, the timing, performance and quality of product releases from competitors as well as releases of our own products can cause sales cycles to increase as customers evaluate the new products |
| Our officers and persons affiliated with our directors hold a substantial portion of our stock and could reject mergers or other business combinations that shareholders may believe to be desirable As of December 31, 2005, our directors, officers and individuals or entities affiliated with our directors owned approximately 44prca of our outstanding common stock as a group |
| Acting together, these shareholders would be able to significantly influence all matters that our shareholders vote upon, including the election of directors or the rejection of a merger or other business combination that other shareholders may believe to be desirable |
| Our common stock may be subject to substantial price and volume fluctuations due to a number of factors, many of which will be beyond our control, which may prevent our shareholders from reselling our common stock at a profit The securities markets have experienced significant price and volume fluctuations over recent years and the market prices of the securities of technology companies have been especially volatile |
| For example, our stock had closing prices ranging between a high of dlra8dtta75 and a low of dlra4dtta05 during the 24 months ended December 31, 2005 |
| This market volatility, as well as current or future environmental, general economic, market or political conditions including; recent natural disasters in various geographic areas, pandemics or other large scale health disasters, the war in Iraq, terrorist activity or other acts of destruction could reduce the market price of our 23 ______________________________________________________________________ [45]Table of Contents common stock regardless of our operating performance |
| Furthermore, because our stock generally trades at relatively low volumes, any sudden increase in trading volumes can cause significant volatility in the stock price |
| In addition, our operating results could be below the expectations of investment analysts and investors, and in response, the market price of our common stock could decrease significantly |
| In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation |
| If we were the object of securities class action litigation, it could result in substantial costs, liabilities and a diversion of management’s attention and resources |
| Other risks Our operating results would suffer if we were subject to a protracted infringement claim or a significant damage award Although we have not been subject to infringement litigation in the past, substantial litigation and threats of litigation regarding intellectual property rights exist in our industry |
| We expect that logic synthesis, physical synthesis and verification products may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps |
| We are not aware that our products employ technology that infringes any valid proprietary rights of third parties |
| However, third parties may claim that we infringe their intellectual property rights |
| Any claims, with or without merit, could: • result in costly litigation and/or damage awards; • be time consuming to defend; • divert our management’s attention and resources; • cause product shipment delays; or • require us to seek to enter into royalty or licensing agreements |
| These royalty or licensing agreements may not be available on terms acceptable to us, if at all |
| A successful claim of product infringement against us or our failure to license the infringed or similar technology could adversely affect our business because we would not be able to sell the impacted product without exposing ourselves to litigation risk and damages |
| Furthermore, redevelopment of the product so as to avoid infringement would cause us to incur significant additional expense |
| Although we maintain general business insurance, it does not cover infringement claims |
| We would be required to pay any damages and legal expenses from a successful claim ourselves |
| In addition, because we also provide standard warranties against and indemnification for the potential infringement of third party intellectual property rights to our customers, we would be financially exposed to satisfy these obligations to our customers |
| As we continue to expand our international operations, we are subject to additional risks and exposures, including economic conditions in foreign locations, foreign exchange rate fluctuations, political and regulatory conditions and other risks Customers outside North America accounted for approximately dlra26dtta4 million, dlra24dtta2 million and dlra20dtta5 million of our total revenue in 2005, 2004 and 2003, respectively |
| Although international revenue has grown over the last few years, we experienced effects of the economic downturn during 2002 in parts of Europe and Japan, and experienced negative effects from the SARS epidemic on our Asia business during 2003 |
| A return of such economic conditions, an Avian flu outbreak or pandemic or an extension of such conditions to other international locations, would adversely impact our business |
| We have international offices in the United Kingdom, France, Germany, the Netherlands, Sweden, Israel, India, Japan, Korea, Taiwan, the People’s Republic of China and Turkey |
| We also rely on indirect sales in some areas of Asia, Europe and elsewhere |
| Our sales contracts generally provide for payment for our products in US 24 ______________________________________________________________________ [46]Table of Contents dollars |
| However, direct sales to our customers in Japan are in yen and we expect all such future sales there will be denominated in yen |
| We enter into foreign currency forward exchange contracts designed to reduce our exposure to changes in the Japanese yen |
| Our expenses incurred in foreign locations are generally denominated in the respective local currency, and as a result, our future revenue and expense levels from international operations may be unpredictable due to exchange rate fluctuations |
| Although we have increased our international sales activities, we still have limited experience in marketing and directly selling our products internationally |
| Our international operations may be subject to other risks, including: • relatively higher personnel and operating costs which may not result in additional revenue; • revenue may not be sufficient to cover the expenses associated with establishing a new or expanded international location; • the impact of local economic conditions, such as interest rate increases or inflation, which may lead to higher cost of capital and lower demand for products; • greater difficulty in accounts receivable collection and longer collection periods; • unexpected changes in regulatory requirements, including increased tariffs, government ownership of communications systems or laws relating to use of and sales over the internet; • difficulties and costs of staffing and managing foreign operations; • reduced protection for intellectual property rights in some countries; • potentially adverse tax consequences, including taxes due on the exercise of stock options or purchase of shares under employee plans by foreign employees and the impact of expiry of tax holidays or applicability of withholding or value added taxes; • foreign currency fluctuations; and • the impact of epidemic situations such as the SARS epidemic that occurred in 2003 |
| Modifications to our effective tax rates or government reviews of our tax returns could affect our results of operations We are subject to income and transaction taxes in the United States and in multiple foreign locations |
| Determining our worldwide provision for income taxes involves judgment and estimates and we cannot be certain that no subsequent adjustments will be needed should updated information become available |
| Our annual effective tax rate is calculated on the basis of our expected level of profitability and includes items such as the usage of tax loss carryforwards or credits that result in a federal and state tax minimum provision and income taxes on earnings of certain foreign subsidiaries |
| To the extent our expected profitability changes during the year, the effective tax rate would be revised to reflect any changes in the projected profitability |
| We have been subject to tax audits in the past including income, sales and property tax audits, and may be subject to additional domestic and international tax audits in the future |
| Although we believe our tax estimates are reasonable, we cannot be certain that the results of any audit will not require any adjustments to our historical income tax provisions and accruals |
| If additional taxes are assessed during an audit, our operating results or financial position could be materially affected |
| As net loss carry forwards and credits expire, our effective United States income tax rate will increase significantly |
| This decline in our profitability could negatively impact the market price of our common stock |
| Changes in financial accounting standards related to equity compensation will cause us to record additional expense in the future, which will result in a reduction in our net income In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Nodtta 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), which will be effective in the first 25 ______________________________________________________________________ [47]Table of Contents quarter of 2006 |
| SFAS 123(R) will result in our recognition of substantial compensation expense due to our employee stock options and employee stock purchase plan |
| We currently use the intrinsic value method to measure compensation expense for stock-based awards to our employees |
| Under this standard, we generally do not recognize any compensation from stock option grants we issue under our stock option plans or from the discounts we provide under our employee stock purchase plan |
| Under the new standard, we are required to adopt a fair-value-based method for measuring the compensation expense associated with employee stock awards |
| We expect to adopt the “modified prospective” approach, which will result in compensation cost for new or modified awards including cancellations or repurchases issued after the effective date of January 1, 2006 |
| Additionally, compensation cost for unvested awards that exist as of the effective date will be recognized as options vest |
| The Stock-Based Compensation section shown in Note 1 of the footnotes to the Consolidated Financial Statements provides our approximate pro forma net income (loss) and earnings per share as if we had used a fair-value-based method similar to the methods required under SFAS 123(R), although calculated without all requirements of SFAS 123(R) considered, to measure the compensation expense for newly issued and previously existing employee stock awards during 2005 |
| It is unclear how investors and analysts will react to the additional compensation expense we are required to report under SFAS 123(R), and our stock price could be negatively affected |
| In addition, we have not yet determined how, if at all, our compensation practices will change in response to SFAS 123(R) and what, if any, effects the changes will have on our ability to recruit and retain well-qualified employees |
| Corporate governance regulations have recently increased our costs and may further increase our costs Changes in laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, have imposed new requirements on us and on our officers, directors, attorneys and independent accountants |
| In order to comply with these new rules, we have added internal resources and have utilized additional outside legal, accounting and advisory services, which have increased and are likely to continue increasing our operating expenses |
| In particular, we expect to incur additional administrative expenses as we maintain compliance with Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our Independent Registered Public Accounting Firm to attest to, our internal controls |
| In addition, if we undergo significant modifications to our structure through personnel or system changes, acquisitions, or otherwise, it may be increasingly difficult to maintain compliance with the existing and evolving corporate governance regulations |
| We may also face challenges with our review and reporting of the effectiveness of internal controls over financial reporting due to changes in materiality thresholds, interpretive literature and other procedures in future reviews |