More excerpts from the 10Q. One caveat which may be unnecessary for many of you: If you've never read these things before, be aware that the legal environment today (euphemism for "threat of a lawsuit") requires itemizing every possible risk, which of course makes them all either irrelevant to any reader and therefore useless, or means that you will never invest in another stock if you read them and take them all seriously. Any bold is my own, not in the original.
<<We Depend on Third Party Foundries for Silicon Wafers
All of our products require silicon wafers. We rely on United Silicon Corporation ("USC") and United Semiconductor
Incorporated ("USIC") in Taiwan for supplying our silicon wafers. We depend on our foundries to allocate a portion of their
foundry capacity to meet our needs, produce acceptable quality wafers with acceptable manufacturing yields and deliver our
wafers on a timely basis at a competitive price. If our foundries are unable to satisfy these requirements, our business,
financial condition and operating results may suffer.
Recently, demand for semiconductor wafers has increased significantly, due to increased demand in the consumer
electronics and cell phone markets. Increased demand for advanced technology silicon wafers is increasing the price of these
wafers as supply becomes tight. We expect this trend to continue throughout 1999 and 2000 and it could adversely impact
the rate of growth of our business, either through reduced supply, higher wafer prices or a combination of the two.
In the second quarter of 1999, UMC announced plans to merge the USC and USIC foundries into the UMC parent
company. When the merger is complete, which is currently expected to occur in late 1999 or early 2000, we will receive
UMC shares in exchange for the USIC shares we currently own. However, we will no longer have a seat on the board of
directors. We have received assurances from the senior management of UMC that they intend to continue to supply us the
same wafer capacity at the prices we currently enjoy under our agreement with USIC. However, there can be no assurance
that we will be able to maintain our current wafer capacity and competitive pricing arrangement in our future supply
negotiations with UMC.
Under the wafer supply agreements with our foundries, we are obligated to provide monthly rolling forecasts for our
anticipated wafer purchases. Generally, the estimates for the first three months of each forecast are binding commitments.
The estimates for the remaining months may only be changed by a certain percentage from the previous month's forecast.
This limits our ability to react to fluctuations in demand for our products. For example, if customer demand falls below our
forecast and we are unable to reschedule or cancel our wafer orders, we may end up with excess wafer inventories, which
could result in higher operating expenses and reduced gross margins. Conversely, if customer demand exceeds our
forecasts, we may be unable to obtain an adequate supply of wafers to fill customer orders, which could result in lost sales
and lower revenues. In addition, if we are unable to obtain scheduled quantities of wafers with acceptable price and yields
from any foundry, our business, financial condition and results of operations could be adversely affected.
We Depend on Our Suppliers and Third Party Subcontractors
We rely on our vendors, some of which are sole source suppliers, for several of our critical components. We do not have
long-term supply agreements with some of these vendors. Our business, financial condition and operating results could be
harmed by delays or reductions in shipments if we are unable to develop alternative sources or to obtain sufficient quantities
of these components. For example, we rely on USIC and USC for all of our flash memory wafers and Motorola, Inc. and
NEC to supply certain designs of critical microcontrollers. Due to industry wide increasing demand for semiconductors, we
have recently experienced resistance to price reductions from some of our important suppliers.
We also rely on third-party subcontractors to assemble, and test the memory components for our products. We have no
long-term contracts with these subcontractors and cannot directly control product delivery schedules. This could lead to
product shortages or quality assurance problems which could increase the manufacturing costs of our products and have
adverse effects on our operating results.
During the second quarter of 1999, we transferred a substantial portion of wafer test, packaged memory final test, card
assembly and card test to subcontractors in Taiwan and China. In the third quarter of 1999, we will transfer additional
production to these subcontractors, and by the end of the year expect that they will be assembling and testing a majority of
our mature, high-volume products. This increased reliance on subcontractors is expected to reduce the cost of such
operations and give us access to increased production capacity. During the transition period, we will continue full operations
at our Sunnyvale production facility while simultaneously transferring test equipment and training personnel of our
subcontractors. Any significant problems in this complex transfer of operations may result in a disruption of production and
a shortage of product to meet customer demand in the second half of 1999.
Our Average Sales Prices Have Declined
In 1998, the average unit selling prices of our products declined 28% compared to 1997. In the first half of 1999, the
average unit selling prices of our products declined 38% compared to the same period of 1998. Because flash data storage
markets are characterized by intense competition, we expect that pricing pressures from our customers and competitors will
continue. This will likely result in a further decline in average sales prices for our products. We believe that we can offset
declining average sales prices by achieving manufacturing cost reductions and developing new products that incorporate
more advanced technology and include more advanced features and can be sold at higher average gross margins despite
declining average selling price per megabyte. However, if we are unable to achieve such cost reductions and technological
advances or remain price competitive, this could result in lost sales, declining gross margins, and as a result, our business,
financial condition and results of operations could suffer.
From time to time, the semiconductor industry has experienced a significant downturn and is currently beginning to recover
from one of its most severe down cycles. During most of 1998, the semiconductor industry experienced significant
production over capacity. This "buyers market" put margin pressures on all flash memory suppliers. We believe product
gross margins should improve in the next two quarters, provided that we are able to transition successfully to our 128Mbit
and 256Mbit flash chips which have a more favorable cost structure than our 64Mbit flash chips.
Our Business Depends Upon Consumer Products
In 1998 and the first half of 1999, we received more product revenue and shipped more units of products destined for
consumer electronics applications, principally digital cameras, than for any other applications. We believe that these products
will encounter intense competition and be more price sensitive than products sold into our other target markets. In addition,
we must spend more on marketing and promotion in consumer markets to establish brand name recognition and preference.
A significant portion of sales to the consumer electronics market is made through distributors and to retailers. Sales through
these channels typically include rights to return unsold inventory. As a result, revenue is not recognized until after the
product has been sold to the end user. If our retail customers are not successful in this market, there could be substantial
product returns, which may cause harm to our business, financial condition and results of operations.
Sales to a Small Number of Customers Represent a Significant Portion of Our Revenues
More than half of our revenue comes from a small number of customers. For example, sales to our top 10 customers
accounted for approximately 59%, 67%, and 71%, respectively, of our product revenues for 1998, 1997, and 1996. In the
second quarter of 1999, our top 10 customers represented approximately 57% of product revenue. If we were to lose any of
these customers or experience any material reduction in orders from these customers, our revenues and operating results
would suffer. Our sales are generally made by standard purchase orders rather than long-term contracts. In addition, the
composition of our major customer base changes from year to year as the market demand for our customers' products
change.>> |
