[B. RILEY & CO. LETTERHEAD]
July 8, 2005
Alliance Semiconductor
2575 Augustine Drive
Santa Clara, CA 95054-2914
Dear Members of the Special Committee:
As the newly formed Special Committee embarks upon their deliberations regarding our shareholder proposals, we thought it would be relevant to briefly review the company's operational history.
Dan Reddy and CN Reddy founded Alliance Semiconductor in 1985. In 1991, the company filed under Chapter 11 of the US bankruptcy code. Following a reorganization, the company went public in 1993 and experienced 3 years of operating profit during which time ALSC made approximately $60 million dollars (the bulk of which took place in 1995 when the company was positioned in the face of a general shortage of semiconductor memory chips). In October of 1994 and March of 1995 the company raised approximately $160 million through secondary offerings and insiders sold over $50 million in stock. In July 1995, ALSC invested in a new Taiwanese manufacturing facility that ultimately resulted in its holdings in United Microelectronics Corporation ("UMC").
In December 1995, the company reduced its outlook due to softening demand for the company's SRAM products. This represented the beginning of a 10-year downdraft in operating income. Since fiscal year 1997, the company has an operating loss of $322 million dollars (excluding investment gains or losses). The losses have been steady and consistent with only 2000 showing a mere $195 thousand dollar operating profits. In the last 5 years the losses have accelerated, resulting in cumulative reported operating losses of approximately $210 million dollars. During that time Alliance did not report a single quarter of profitability.
The company's recent history is even more disconcerting. During the last 3 years, the R&D budget alone has approximately equaled total revenues. The decision to enter new markets while disregarding operating overhead structure has resulted in over $100 million in operating losses. The company's best operational quarter resulted in a loss of $5.5 million dollars.
Despite these results, ALSC has taken little to no action to correct operating problems and the action "taken" has been detrimental to shareholders. For example, in May 2004, in the face of daunting operating losses, the company announced plans to EXPAND the investment in its Indian Design Center by investing up to $50 million over the next 5 years with no clear indication of how it benefits ALSC or its shareholders. In my most recent conversations with ALSC, both a board representative and management expressed confidence that the company was headed in the right direction by suggesting that reduction in operational costs reduced quarterly breakeven targets to $12-$15 million. This revenue run-rate would represent a 120%-160% increase over ALSC's most recent quarter. To put this in perspective, the company's highest revenue quarter the
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last 3 years was $8.9 million in March 2004 in which the company lost $8.8 million from operations.
Beyond the negative operating history, the non-operational record of the company is also a disaster. Its shareholders have twice sued the company. The company is currently subject to a review by the SEC to determine whether it should in fact be required to register as an investment company. ALSC is also in what can be described as a major tax dispute with the IRS. The most recent 10K late filing and the noncompliance with Sarbanes Oxley are also areas of added concern, to say the least. We also want to point out that the company's current board and management has scored a 3 with Institutional Shareholder Services (ISS). This score suggests that all but 3% of public companies have better corporate governance policies.
Although the formation of a committee shows some willingness to recognize the problem, more is needed. As stated, we think ALSC needs a new board.
We believe the unrealized value of Alliance Semiconductor is in its investments. The early investment in UMC resulted in a large unrealized gain that at one point reached almost $1 billion dollars. In 2000 the book value was over $23 per share. As a result of cash burn and price deterioration the current book value is approximately $2.75 per share. ALSC's largest asset, UMC, is unencumbered and could be liquidated in short order given the trading activity of the shares. However the current board and management seem to have chosen to sell UMC to fund operating losses and support additional outside investments. We believe it is time for the Board to recognize that shareholders own the balance sheet and the time for discretionary investments is well behind you.
The current book value of Alliance Ventures is approximately $25 million. We believe that ALSC's interests in 3 investments alone are valued at over $60 million based on recent equity rounds. While we are not privy to information that would enable us to value the whole portfolio, clearly it is understated. Given the apparent current strategy there is a risk that this fact is somewhat irrelevant because operating history suggests ALSC will burn any profits that are realized in further efforts to support a questionable chip business. We feel compelled to remind you that this company is owned by the shareholders and should be managed in such a matter. We read the 8-K that announced the "special committee" formation with great interest. Not only does it include all Board Members except for CN Reddy, (a large shareholder who recognizes the need for change and has agreed to join our slate), it also cautions that the committee was only just formed and has not set a timetable for completion of the proposal review. This committee looks like merely a sham device to exclude board member CN Reddy from discussions. And the lack of urgency and candor represented in the 8-K only reinforces our concern that every day Alliance is operated in its current form approximately $80k is lost from operations.
It is time for a change at Alliance. We encourage the current Board to step down in order to recompose the board. We have presented you with an experienced slate of nominees who have extensive backgrounds in realizing shareholder value. Mike Gullard and I were both on the Board of Celeritek, a situation that is relevant to Alliance Semiconductor. In 2003 I ran an alternative Board slate to challenge the incumbent Board that had made decisions that I believed were not in the best interest of Shareholders. After settling (on the eve of a proxy vote) the dispute, the new Board conducted an expeditious, but thorough review of the company. It was determined by the truly independent board that the best way to maximize shareholder value was to proceed
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with divesting the assets of the company. Over the course of the next two years we distributed over $ 8.00 per share in cash (the shares were at $6 when we presented our Board slate) to shareholders in a tax efficient manner and sold assets intelligently to maximize shareholder value. This process is continuing today. We feel Alliance shareholders deserve a similar review of their assets followed by decisive action to preserve and enhance those assets.
Outside of the founders, the current board members have never purchased a single share of stock and only "own" a right to shares in the form of out of the money options granted to the Directors. We believe this lack of a community of interest with shareholders has led to the decisions made on the board level that have been poor in terms of asset utilization and corporate governance, and absolutely devastating to shareholder value. We believe there is incremental value for Alliance Semiconductor shareholders if there is a new team to set the company on the right track.
We would like to avoid a costly proxy contest, which could further dissipate assets that should go to shareholders, but are fully prepared to do so. In this regard, we expect a timely convened 2005 shareholder meeting. It has been almost 11 months since the last meeting, and the failure to set a 2005 record and meeting date suggests an attempt to delay the day of reckoning shareholders need and deserve.
I remain willing to discuss our concerns and seek a mutually acceptable way to return value to stockholders. I suggest a face-to-face meeting at our offices on July 12, 13 or 14. If we have not met by then and reached a solution, we are fully prepared to proceed in our efforts to protect shareholders.
I hope to hear from you soon.
Very truly yours,
/s/ Bryant Riley
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B.Riley & Co.
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