|• FORM 10-Q • SALE AND PURCHASE AGREEMENT • CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 • CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 • CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 • CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 25, 2012
For the transition period from to
Commission File Number 001-34747
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and small reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No ¨
Indicate the number of shares outstanding of each of the registrants classes of common stock as of the close of business on April 26, 2012:
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
See accompanying notes.
Condensed Consolidated Statements of Comprehensive Loss
See accompanying notes.
Condensed Consolidated Balance Sheets
(in thousands, except par value and share amounts)
See accompanying notes.
Condensed Consolidated Statements of Cash Flows
See accompanying notes.
Notes to Condensed Consolidated Financial Statements
1. Basis of Presentation
The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and notes required by U.S. GAAP for annual financial statements. In the opinion of management, the unaudited interim financial statements reflect all adjustments consisting of normal and recurring entries considered necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. The December 25, 2011 condensed consolidated balance sheet data was derived from audited consolidated financial statements included in the Companys Annual Report on Form 10-K for the fiscal year ended December 25, 2011 but does not include all disclosures required by U.S. GAAP for annual periods. The Company also adopted fresh start accounting (FSA) for financial reporting purposes upon emergence from bankruptcy proceedings on May 10, 2010.
These condensed consolidated financial statements and related notes are unaudited and should be read in conjunction with the Companys audited financial statements and related notes included in the Companys Annual Report on Form 10-K for the fiscal year ended December 25, 2011 as filed on February 23, 2012 with the SEC. The results of operations for the three months ended March 25, 2012 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.
The Companys fiscal year is the 52- or 53-week period ending on the Sunday closest to December 31. The additional week in a 53-week year is added to the second quarter to realign the Companys fiscal quarters more closely to calendar quarters. Fiscal 2012 and fiscal 2011 are comprised of 53-week and 52-week periods, respectively.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries and a variable interest entity (VIE) of which the Company was the primary beneficiary. The VIEs financial statements are not significant to the Companys condensed consolidated financial statements for the periods presented. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of the Companys consolidated financial statements and disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of commitments and contingencies and the reported amounts of revenues and expenses during the reporting periods. Estimates are used to account for the fair value of certain marketable securities, revenue reserves, the allowance for doubtful accounts, inventory reserves, valuation of intangible assets, impairment of long-lived assets, legal contingencies, income taxes, stock-based compensation expenses, the fair value of the debt, and product warranties. Actual results may differ from those estimates, and such differences may be material to the Companys consolidated financial statements.
There have been no significant changes in the Companys critical accounting estimates or significant accounting policies during the three months ended March 25, 2012 as compared to the discussion in Part II, Item 7 and in Note 3 to the Companys financial statements in Part II, Item 8 of the Companys Annual Report on Form 10-K for the year ended December 25, 2011.
Notes to Condensed Consolidated Financial Statements - (Continued)
2. Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued an amendment to its guidance regarding the presentation of comprehensive income. The amended guidance gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amended guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. In December 2011, the FASB further modified the guidance by deferring until further notice the requirement of presenting the effects of reclassification adjustments on accumulated other comprehensive income as both components of net income and of other comprehensive income. This guidance is effective on a retrospective basis for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance in the first quarter of fiscal 2012 did not have a material impact on the Companys financial position, results of operations or cash flows as it only impacted the presentation of the financial statements. The Company has opted to present this information in two separate but consecutive statements.
In September 2011, the FASB issued an amendment to the guidance regarding the testing of goodwill for impairment. The amended guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amended guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of this guidance in the first quarter of fiscal 2012 did not have a material impact on the Companys financial position, results of operations or cash flows.
3. Balance Sheet Components
The Companys cash balances are held in numerous locations throughout the world but primarily held in the United States. As of March 25, 2012, the Company had cash, cash equivalents, and short-term investments of $246.7 million held within the United States and $14.2 million held outside of the United States. As of December 25, 2011, the Company had cash, cash equivalents, and short term investments of $252.2 million held within the United States and $10.5 million held outside of the United States.
Notes to Condensed Consolidated Financial Statements - (Continued)
All securities other than the Federal Deposit Insurance Corporation (FDIC) insured certificates of deposit were designated as available-for-sale. FDIC insured certificates of deposits are held to maturity. Gross unrealized gains and losses on cash equivalents and short term investments were not material for the three months ended March 25, 2012 and December 25, 2011. Gross realized gains and losses on cash equivalents and short term investments were not material for the three months ended March 25, 2012 and March 27, 2011.
4. Equity Incentive Plan and Stock-Based Compensation
Equity Incentive Plan
The Companys 2010 Equity Incentive Award Plan (2010 Plan) provides for the grant of stock options, stock appreciation rights, restricted stock units, restricted stock, performance awards, and deferred stock to its employees, consultants and non-employee members of its Board of Directors.
Generally, annual restricted stock unit (RSU) awards for employees vest in four substantially equal annual installments on the anniversary date of the grant. In the first quarter of fiscal 2012, the Company issued three-year RSU awards which vest in three substantially equal annual installments on the anniversary date of the grant.
Notes to Condensed Consolidated Financial Statements - (Continued)
The key executive RSU awards generally have a four-year performance period, with 50 percent of each target award (base shares) subject to performance goals in each of the four fiscal years following the date of grant. In the first quarter of fiscal 2012, the Company issued three-year key executive RSU awards with a three year performance period with one-third of each target award (base shares) subject to performance goals in each of the three fiscal years following the date of grant. A minimum of 50 percent and a maximum of 150 percent of base shares may vest over a three-year period, subject to performance. If the performance goals are not met in a particular year, the unvested shares will be carried forward and will be forfeited if not earned by the last performance year. If performance is above target in a particular year, base shares earned will be accelerated after shares carried forward from prior years are used.
In the first quarter of fiscal 2012, the Company issued additional two-year key executive RSU awards to certain executives in lieu of participation in the Companys annual cash bonus plan, with 100 percent of each award (base shares) subject to performance goals in each of the two fiscal years following the date of grant. 25 percent of these awards are eligible for accelerated vesting on July 31, 2012 based on achievement of the first six months performance targets in fiscal 2012. The annual performance goals for these awards are the same as those for the three and four-year key executive RSU awards. A minimum of 0% and maximum of 100% of base shares vest each year, subject to performance. Unvested shares will not be carried forward and will be forfeited if not earned in any particular year.
The numbers of shares of common stock available for grant at March 25, 2012 under the 2010 Plan are shown in the following table:
Notes to Condensed Consolidated Financial Statements - (Continued)
The following table sets forth the total recorded stock-based compensation expense by financial statement caption resulting from the Companys stock options and RSU awards:
The weighted average fair value of the Companys stock options granted in the three months ended March 25, 2012 and March 27, 2011 was $4.04 and $9.23 per share, respectively. The fair value of each stock option was estimated at the date of grant using a Black-Scholes option pricing model, with the following assumptions for grants:
As of March 25, 2012, the total unrecognized compensation cost related to unvested stock options and RSU awards was approximately $58.2 million after reduction for estimated forfeitures, and such stock options and RSU awards will generally vest ratably through 2015.
Notes to Condensed Consolidated Financial Statements - (Continued)
Stock Option and Restricted Stock Unit Activity
The following table summarizes stock option activities and related information under the 2010 Plan for the periods presented:
No income tax benefit was realized from stock option exercises for the three months ended March 25, 2012.
The following table summarizes RSU and key executive RSU award activities and related information for the three months ended March 25, 2012:
As described above, key executive RSUs granted during the quarter ended March 25, 2012 have both service and performance conditions for vesting.
5. Net Income Per Share
Basic net income (loss) per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is calculated by using the weighted average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Companys outstanding dilutive stock options, RSUs and other similar equity instruments had been issued. The dilutive effect of outstanding options and RSUs is
Notes to Condensed Consolidated Financial Statements - (Continued)
reflected in diluted net income per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.
For the three months ended March 25, 2012 and March 27, 2011, the Company excluded from its diluted per share computation approximately 2.3 million and 4.6 million, respectively, of potential shares of common stock issuable upon exercise of outstanding stock options and vesting of outstanding RSUs because they had an anti-dilutive effect.
6. Intangible Assets and Goodwill
The following tables present intangible assets balances as of the dates indicated below:
Amortization expense for intangible assets was $6.7 million and $5.2 million for the three months ended March 25, 2012 and March 27, 2011, respectively. The estimated future amortization expenses for intangible assets arising from FSA are summarized below:
In-Process Research and Development (IP R&D)
As of March 25, 2012, approximately $38.8 million of the total capitalized IP R&D of $43.0 million relating to Spansion GL NOR Flash memory projects reached technological feasibility and were transferred to developed technology. Of the $38.8 million, $ 7.0 million was capitalized during the three month ended March 25, 2012. The Company estimated the useful life for developed technology at 7 years and
Notes to Condensed Consolidated Financial Statements - (Continued)
amortization of $1.4 million was recorded for the three months ended March 25, 2012 for this developed technology. The Company expects the remaining projects (relating to the development of process technologies to manufacture flash memory products associated with Spansion GL and FL product families) to attain technological feasibility and commence commercial production during the second quarter of fiscal 2012.
The changes in the carrying amount of goodwill as of March 25, 2012, are as follows:
The Company has determined that it is a single reporting unit and determined that there were no significant events or circumstances during the three months ended March 25, 2012 that would more likely than not reduce the fair value of the reporting unit below its carrying amount. As such, the Company concluded that it was not necessary to perform the two-step goodwill impairment test at this time.
The following table summarizes the Companys debt at March 25, 2012 and December 25, 2011:
Under the Companys existing debt arrangements, the Company is subject to covenants that, among other things, place certain limitations on the Companys ability to incur additional debt, make investments, pay dividends, and sell assets. The Company was in compliance with these covenants as of March 25, 2012. Additionally as of March 25, 2012, the Company had not drawn down against its Revolving Credit Facility.
Notes to Condensed Consolidated Financial Statements - (Continued)
8. Fair Value Measurement
The Company measures its cash equivalents, marketable securities, and interest rate derivative contracts at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
Level 1Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2Include other inputs that are directly or indirectly observable in the marketplace.
Level 3Unobservable inputs that are supported by little or no market activities.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The cash equivalents and marketable securities are classified within Level 1 or Level 2. This is because the Company values its cash equivalents and marketable securities using quoted market prices or alternative pricing sources and models utilizing market observable inputs. The interest rate derivative contracts are classified as Level 2 because the valuation inputs are based on quoted prices and market observable data of similar instruments. In determining the fair value of the Companys interest rate swap, the Company uses the present value of expected cash flows based on market observable interest rate yield curves and interest rate volatility commensurate with the term of each instrument.
The fair value measurements of the Companys financial assets and liabilities consisted of those categorized in the table below based upon the fair value hierarchy:
Notes to Condensed Consolidated Financial Statements - (Continued)
Fair Value of Other Financial Instruments not carried at Fair Value
Substantially all of the Companys long-term debt is traded in the market and the fair value in the table below is based on the quoted market price as of March 25, 2012 and December 25, 2011. The carrying amounts and estimated fair values of the Companys debt instruments are as follows:
The fair value of the Companys long-term debt that is not traded in the market was estimated by considering the interest rates and the terms of the debt. The fair value of the Companys cash equivalents, accounts receivable, accounts payable and other current liabilities approximates their carrying value.
9. Derivative Financial Instruments
Interest Rate Risk
The Company is currently exposed to the variability of future quarterly interest payments on its Term Loan due to changes in the LIBOR above the floor rate of 1.25 percent. To mitigate this interest rate risk and also to comply with the hedging requirement required in the initial Term Loan agreement, the Company entered into a series of interest rate swaps to manage the interest rate risk associated with its borrowings in the third quarter of 2010. This hedging requirement was removed when the Term Loan was amended in November 2010. However, the interest rate swaps remained in place as of March 25, 2012.
The Company has approximately $233.7 million outstanding under the Term Loan as of March 25, 2012. Under the swap agreements, with an aggregate notional amount of $250 million and an expiration date of May 17, 2013, the Company pays the independent swap counterparty a fixed rate of 2.42 percent and, in exchange, the swap counterparty pays the Company an interest rate equal to the floor rate of 2 percent or three-month LIBOR, whichever is higher.
As of November 9, 2010, due to the amendment of the Term Loan, the critical terms of the swaps and the Term Loan were no longer matched. Accordingly, the hedge no longer qualified as a cash flow hedge. As a result, the mark-to-market of the swaps has been reported as a component of interest expense since the fourth quarter of fiscal 2010.
Notes to Condensed Consolidated Financial Statements - (Continued)
The following table summarizes the interest expense related to the swaps :
The location and fair value amounts of the Companys derivative instruments reported in its condensed consolidated balance sheet were as follows:
10. Income Taxes
The following table presents the income tax expenses of the Company:
For the three months ended March 25, 2012, the Company recorded an income tax expense of $3.4 million which includes $1.0 million related to withholding tax on Samsung licensing revenue, compared to an income tax expense of $5.1 million for the three months ended March 27, 2011 which includes correction of uncertain income tax positions of its foreign locations from May 11, 2010 to December 26, 2010 of $2.8 million. The income tax expense recorded for these periods, excluding the correction and withholding taxes, was primarily due to operating income in the Companys foreign locations.
As of March 25, 2012, all of the Companys U.S. deferred tax assets, net of deferred tax liabilities, continue to be subject to a full valuation allowance. The valuation allowance is based on the Companys assessment that it is more likely than not that the deferred tax assets will not be realizable in the foreseeable future.
As of December 25, 2011, the Company had U.S. federal and state net operating loss carry forwards of approximately $1.0 billion and $208.0 million, respectively. Approximately $533.6 million of the federal net operating loss carry forwards are subject to an annual limitation of $27.2 million. The federal and state net operating losses, if not utilized, expire from 2016 to 2031.
Notes to Condensed Consolidated Financial Statements - (Continued)
If the Company were to undergo an ownership change for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, its ability to utilize its unlimited federal net operating loss carry forwards could be limited under certain provisions of the Internal Revenue Code. As a result, the Company could incur greater tax liabilities than it would in the absence of such a limitation and any incurred liabilities could materially adversely affect the Companys results of operations and financial condition.
11. Restructuring Charges
Fiscal 2011 Restructuring Plan
In the fourth quarter of fiscal 2011, the Company initiated a restructuring plan as part of a company-wide cost saving initiative aimed to reduce operating costs in light of global economic challenges and rapid changes in the China wireless and handset market. In the area of reducing costs and improving efficiencies, the Company announced reduction of headcount in several locations and the closure of its assembly, test, mark and pack facility in Kuala Lumpur, Malaysia (the KL facility), which was completed in the first quarter of fiscal 2012.
During the first quarter of fiscal 2012, the Company continued to implement restructuring activities under this plan. As a result of the anticipated sale of the KL facility, the Company classified the carrying value of $10.3 million for the land, building and equipment as held for sale within prepaid expenses and other current assets on the condensed consolidated balance sheet. On March 12, 2012, Spansion entered into an agreement in connection with the sale of the land and building. The sales price is 125.0 million Malaysian ringgits, approximately $40.6 million (based on currency conversion rate as of March 25, 2012), on an as is, where is basis. The sale is expected to be completed in the second quarter of fiscal 2012 subject to performance of certain terms and conditions.
Total costs incurred through March 25, 2012 are $17.6 million and costs expected to be incurred for consolidating and closing the Companys KL facility through the fourth quarter of fiscal 2012 are $2.2 million.
Fiscal 2009/10 Restructuring Plan
In fiscal 2009 and 2010, the Company implemented certain restructuring measures, including workforce reductions and the sale of its plant in Suzhou, China, leading to various charges related to termination benefits, fixed asset relocation, depreciation and disposal charges. During the quarter ended March 25, 2012, there was a restructuring credit of $0.8 million as a result of the Company having prevailed in a labor-related lawsuit in conjunction with the 2009 restructuring activities in Thailand. Total costs incurred through March 25, 2012 under this restructuring plan were $43.2 million.
Notes to Condensed Consolidated Financial Statements - (Continued)
Summary of Restructuring Plans
The following table sets forth a summary of restructuring activities related to all of the Companys restructuring plans described above during the three months ended March 25, 2012:
There were no restructuring charges for the three months ended March 27, 2011.
12. Commitments and Contingencies
The Company has $160.8 million of purchase commitments with certain suppliers, primarily for inventory and some nonproduction items as of March 25, 2012.
During the normal course of business, the Company makes certain indemnities and commitments under which it may be required to make payments in relation to certain transactions. These include indemnities to the Companys customers related to allegations the Companys products infringe third party patents or other intellectual property; indemnities to the Companys customers in connection with the delivery, design, manufacture and sale of its products; indemnities to the Companys directors and officers in connection with legal proceedings; indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease; and indemnities to other parties to certain acquisition agreements. The duration of these indemnities and commitments varies, and in certain cases, is indefinite. The Company believes that substantially all of its indemnities and commitments provide for limitations on the maximum potential future payments it is obligated to make. However, the Company is unable to estimate the maximum amount of liability related to its indemnities and commitments because such liabilities are contingent upon the occurrence of events which are not reasonably determinable.
The Company is subject to audit by the Internal Revenue Service (IRS) and various other tax authorities. The Company has reserved for potential adjustments to the provision for income taxes that may result from
Notes to Condensed Consolidated Financial Statements - (Continued)
examinations by, or any negotiated agreements with, these tax authorities, and the Company believes that the final outcome of these examinations or agreements will not have a material effect on the Companys results of operations. If events occur which indicate payment of these amounts is unnecessary, the reversal of the liabilities would result in the recognition of tax benefits in the period the Company determines the liabilities are no longer necessary. If the estimates of the federal, state, and foreign income tax liabilities are less than the ultimate assessment, a further charge to expense would result.
The Company generally offers a one-year limited warranty for its Flash memory products. Changes in the Companys liability for product warranty are as follows:
The Company is a defendant or plaintiff in various legal actions that arose in the normal course of business. In the opinion of management, the aggregate liability, if any, with respect to these matters will not have a material adverse effect on the Companys financial condition, results of operations or cash flows.
In addition to ordinary routine litigation incidental to the business, the Company is party to a material legal proceeding as described in the Companys Annual Report on Form 10-K for the fiscal year ended December 25, 2011. The outcome of any litigation is uncertain, and, should the proceeding where the Company is a defendant be successful, it may be subject to significant damages awards which could have a material adverse effect on its financial condition or cash flows.
Fast Memory Erase LLC v. Spansion Inc., et al.
On June 9, 2008, Fast Memory Erase LLC filed a complaint in the U.S. District Court for the Northern District of Texas alleging patent infringement against Spansion Inc., Spansion LLC, Intel Corp., Numonyx B. V., Numonyx, Inc., Nokia Corp., Nokia Inc., Sony Ericsson Mobile Communications AB, Sony Ericsson Mobile Communications (USA), Inc., and Motorola, Inc. The case is styled, Fast Memory Erase, LLC v. Spansion Inc., Spansion LLC, et al., Case No. 3:08-CV-00977-M (N.D. Tex.). Fast Memory Erases complaint alleges that Spansions NOR Flash memory products using floating gate technology infringe one or more claims of U.S. Patent No. 6,236,608 (the 608 patent). Fast Memory Erase has also asserted U.S. Patent No. 6,303,959 (the 959 patent) in its complaint against the products of other defendants, namely Intel and Numonyx, but it has not asserted the 959 patent against any Spansion products. On December 22, 2008, Fast Memory Erase filed an amended complaint. In its amended complaint, Fast Memory Erase added Apple, Inc. as a defendant. Spansion has answered Fast Memory Erases complaint and amended complaint. Spansions answers assert that Spansion does not infringe the 608 patent and that the 608 patent is invalid. In its answers, Spansion also asserts counterclaims against Fast Memory Erase for declaratory judgments of non-infringement and
Notes to Condensed Consolidated Financial Statements - (Continued)
invalidity The case was stayed against Spansion as a result of the Chapter 11 Cases until May 18, 2009. The U.S. Bankruptcy Court preliminarily lifted the stay and set June 23, 2009 as the date for a final determination on the stay. The parties subsequently agreed to lift the stay so that the U.S. District Court could proceed with a Markman hearing solely to determine the meaning of certain claims of the 959 patent, which was held on September 16, 2009. At the Markman hearing, the Court did not consider the claims of the 608 patent because it was subject to reexamination by the U.S. Patent and Trademark Office. The Court stayed the case with respect to the 608 patent on December 9, 2009, in view of a pending reexamination. On March 8, 2010, the 959 patent was severed from the case and assigned a separate case number. The case remains stayed. The Company believes that the potential loss or range of loss, if any, in this case cannot be estimated at this time.
13. Ongoing bankruptcy related matters
In connection with the Companys emergence from Chapter 11 bankruptcy proceedings in May 2010, a claims agent was appointed to analyze and, at its discretion, contest outstanding disputed claims totaling $1.5 billion. As of March 25, 2012, the Company had total outstanding disputed claims of $173.0 million, including reserves and 6.3 million unregistered shares of Class A Common Stock relating to resolution of those outstanding disputed claims.
This Quarterly Report on Form 10-Q, including this Managements Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. These statements relate to future events or our future financial performance. Forward-looking statements may include words such as may, will, should, expect, plan, intend, anticipate, believe, estimate, predict, potential, continue or other wording indicating future results or expectations. Forward-looking statements are subject to risks and uncertainties, and actual events or results may differ materially. Factors that could cause our actual results to differ materially include, but are not limited to, those discussed under Risk Factors in this report. We also face risks and uncertainties associated with substantial indebtedness and its impact on our financial health and operations; fluctuations in foreign currency exchange rates; the sufficiency of workforce and cost reduction initiatives; and the effect of the natural disasters in Japan and Thailand. Other risks and uncertainties relating to our business include our ability to: successfully transform our business and implement our new business strategy focused primarily on the embedded Flash memory market; maintain or increase our average selling price and lower our average costs; accurately forecast customer demand for our products; attract new customers; obtain additional financing in the future; maintain our distribution relationships and channels in the future; successfully enter new markets and manage our international expansion; successfully compete with existing and new competitors, or with new memory or other technologies; successfully develop new applications and markets for our products; maintain manufacturing efficiency; obtain adequate supplies of satisfactory materials essential to manufacture our products; successfully develop and transition to the latest technologies; negotiate patent and other intellectual property licenses and patent cross-licenses and acquire additional patents; protect our intellectual property and defend against infringement or other intellectual property claims; maintain our business operations and demand for our products in the event of natural or man-made catastrophic events; and effectively manage, operate and compete in the current sustained economic downturn. Except as required by law, we undertake no obligation to revise or update any forward-looking statements to reflect any events or circumstances that arise after the date of this report, or to conform such statements to actual results or changes in our expectations.
We are a leading designer, manufacturer and developer of Flash memory semiconductors. We are focused on a portion of the Flash memory market that relates to high-performance and high-reliability Flash memory solutions for microprocessors, controllers and other programmable semiconductors that run applications in a broad range of electronic systems. These electronic systems include automotive and industrial, computing and communications, consumer and gaming. In addition to Flash memory products, we assist our customers in developing and prototyping their designs by providing software and hardware development tools, drivers and simulation models for system-level integration.
Our Flash memory solutions are incorporated in products manufactured by leading original equipment manufacturers (OEMs). Our products are designed to accommodate various voltage, interface and density requirements for a wide range of applications and customer platforms. The majority of our NOR Flash product designs are based on our proprietary two-bit-per-cell MirrorBit® technology, which has a simpler cell architecture, higher yields and lower costs than competing floating gate NOR Flash memory technology. In addition, we license our intellectual property to third parties for revenue.
In early 2009, we emphasized our strategic efforts in the embedded portion of the Flash memory market, which is generally characterized by long design and product life cycles, relatively stable pricing, more predictable supply-demand outlook and lower capital investments. Within this embedded space, we now focus on serving customers through a differentiated, non-commodity, service-oriented model that strives to meet their needs for product performance
and commitment to quality and reliability. In connection with this strategic repositioning, in early 2009 we also began exiting a large portion of the wireless Flash memory market, and this action has helped improve operational performance and our financial results.
Our net sales for the first quarter of 2012 decreased, as compared to the first quarter of fiscal 2011, due to the continued effects of further reduced wireless sales as a result of wireless customers rapidly moving to choose mid- and low-density serial NOR products that presently we do not offer, which began in the third quarter of fiscal 2011, as well as lower consumer end market sales attributable to macro global issues surrounding consumer confidence and spending.
In the fourth quarter of 2011, we initiated a restructuring plan to align the business with current market conditions and to further reduce operating expenses. The plan encompassed the consolidation of two test and assembly manufacturing operations in Asia and resulted in the closure of our Kuala Lumpur, Malaysia facility (the KL facility), which we completed in first quarter of fiscal 2012, and the sale of the land and building related to that facility, which we expect to complete in the second quarter of fiscal 2012. In the three months ended March 25, 2012, we recognized $5.4 million of restructuring expenses largely relating to asset relocation, asset impairment and severance charges.
Refer to our Results of Operations below in this section for a quantitative and qualitative analysis and discussion of our quarterly results for the three months ended March 25, 2012 and March 27, 2011, respectively.
Critical Accounting Policies
There have been no significant changes in our critical accounting estimates or significant accounting policies during the three months ended March 25, 2012 as compared to the discussion in Part II, Item 7 and in Note 3 to our financial statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 25, 2011. We also adopted fresh start accounting (FSA) for financial reporting purposes upon emergence from bankruptcy proceedings on May 10, 2010.
Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued an amendment to its guidance regarding the presentation of comprehensive income. The amended guidance gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amended guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. In December 2011, the FASB further modified the guidance by deferring until further notice the requirement of presenting the effects of reclassification adjustments on accumulated other comprehensive income as both components of net income and of other comprehensive income. This guidance is effective on a retrospective basis for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance in the first quarter of fiscal 2012 did not have any material impact on our financial position, results of operations or cash flows as it only impacted the presentation of the financial statements. We opted to present this information in two separate but consecutive statements.
In September 2011, the FASB issued an amendment to the guidance regarding the testing of goodwill for impairment. The amended guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amended guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of this guidance in the first quarter of fiscal 2012 did not have a material impact on our financial position, results of operations or cash flows.
Results of Operations
Comparison of Net Sales, Gross Margin, Operating Expenses, Interest and Other Income, Net, Interest Expense and Income Tax Provision
The following is a summary of our operating results:
Total Net Sales
Total net sales for the three months ended March 25, 2012 decreased $74.2 million compared to the total net sales for the three months ended March 27, 2011 primarily due to $84.2 million reduction in wireless and consumer end market sales. Wireless sales declined as a result of the continued impact of wireless customers moving to mid- and low-density serial NOR products that we presently do not offer, which began in the third quarter of fiscal 2011. Decline in the consumer end market sales was attributable to macro global issues surrounding consumer confidence and spending. This decrease was partially offset by $6.3 million of Samsung license revenue recognized in connection with the June 2011 patent litigation settlement.
Our gross margin dollars for the three months ended March 25, 2012 decreased by $9.6 million compared to gross margin for the three months ended March 27, 2011. $13.7 million of this decrease was primarily due to lower wireless product revenues as discussed above, and $5.9 million was due to costs on our underutilized capacity, net of benefit from diminishing FSA adjustments. The above decrease was offset by $6.3 million relating to Samsung license revenue. Our gross margin as a percentage of sales increased from 23% to 27% due to a decrease in low margin consumer and wireless revenues, increase in higher margin licensing revenues and benefits from diminishing FSA related adjustments.
Research and Development (R&D)
R&D expenses for the three months ended March 25, 2012 decreased by $3.8 million, compared to the three months ended March 27, 2011. The decrease of R&D expenses was due to favorable impact of $2.3 million asset impairment charges relating to R&D tools and equipment resulting from the closure of our development facility located in Sunnyvale, California in the first quarter of fiscal 2011, $1.9 million lower material costs for certain projects, and $1.0 million lower FSA depreciation charges. The above decrease was offset by $2.0 million higher research and development charges related to NAND development in the first quarter of fiscal 2012.
Sales, General and Administrative (SG&A)
SG&A expenses for the three months ended March 25, 2012 decreased by $7.0 million compared to the three months ended March 27, 2011. The decrease in SG&A expense was primarily due to $3.0 million reduction in legal expense as a result of the settlement of the Samsung litigation in June 2011, $2.4 million lower bonus charges due to lower performance against target and $1.8 million lower depreciation and building allocation charges due to the diminishing impact of FSA adjustments in fiscal 2012.
Restructuring charges for the three months ended March 25, 2012 were $4.5 million, comprised of costs of $5.4 million primarily relating to asset relocation and impairment charges in our KL facility which was offset by a $0.9 million credit as a result of us having prevailed in a labor-related lawsuit in conjunction with the 2009 Restructuring Plan in Thailand. There were no restructuring charges for the first quarter of fiscal 2011.
Interest and Other Income, Net
Interest and other income, net, increased by approximately $0.8 million for the three months ended March 25, 2012 compared to the three months ended March 27, 2011 due to $1.1 million proceeds from liquidation of previously impaired auction rate securities and $1.0 million higher recoveries of cash disbursements made prior to bankruptcy. The above increase was offset by $1.1 million higher realized and unrealized net loss on foreign currency transactions.
Interest expense decreased by approximately $1.4 million for the three months ended March 25, 2012 compared to the three months ended March 27, 2011. The decrease was primarily due to a reduction in interest rate from refinancing the Term Loan in May 2011.
Income Tax Provision
For the three months ended March 25, 2012, we recorded an income tax expense of $3.4 million which includes $1.0 million related to withholding tax on Samsung licensing revenue, compared to an income tax expense of $5.1 million for the three months ended March 27, 2011 which includes correction of uncertain income tax positions of its foreign locations from May 11, 2010 to December 26, 2010 of $2.8 million. The income tax expense recorded for these periods, excluding the correction and withholding taxes, was primarily due to operating income in our foreign locations.
As of March 25, 2012, all of our U.S. deferred tax assets, net of deferred tax liabilities, continue to be subject to a full valuation allowance. The valuation allowance is based on our assessment that it is more likely than not that the deferred tax assets will not be realizable in the foreseeable future.
As of December 25, 2011, we had U.S. federal and state net operating loss carry forwards of approximately $1.0 billion and $208.0 million, respectively. Approximately $533.6 million of the federal net operating loss carry forwards are subject to an annual limitation of $27.2 million. The federal and state net operating losses, if not utilized, expire from 2016 to 2031.
If we were to undergo an ownership change for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, our ability to utilize its unlimited federal net operating loss carry forwards could be limited under certain provisions of the Internal Revenue Code. As a result, we could incur greater tax liabilities than it would in the absence of such a limitation and any incurred liabilities could materially adversely affect our results of operations and financial condition.
The following table summarizes our contractual obligations at March 25, 2012:
Liquidity and Capital Resources
As of March 25, 2012, our cash, cash equivalents and short term investments totaled $260.9 million. As of March 25, 2012, the availability under our revolving credit facility (Revolving Credit Facility) was $15.7 million after deducting the standby letters of credit of $1.3 million issued to certain vendors. As of March 25, 2012, we had not borrowed any amounts under the Revolving Credit Facility.
Our future uses of cash are expected to be primarily for working capital, debt servicing, capital expenditures and other contractual obligations. We believe our anticipated cash flows from operations, current cash balances and availability under our Revolving Credit Facility will be sufficient to fund working capital requirements and operations, service our debt, and meet our cash needs for at least the next twelve months.
Sources and Uses of Cash and Cash Equivalents
Our cash and cash equivalents consisted of demand deposits, money market fund, and FDIC-insured certificates of deposits with a total amount of $197.0 million as of March 25, 2012.
Net cash provided by operations was $15.0 million during the three months ended March 25, 2012, primarily due to net loss of $13.6 million and net decrease in operating assets and liabilities of $4.5 million offset by net non-cash items of approximately $33.1 million. The net decrease in operating assets and liabilities
was primarily due to (i) the decrease of $12.9 million in accounts payable, accrued liabilities, and accrued compensation and benefits, (ii) the increase of $3.1 million in accounts receivable and (iii) the decrease of $14.4 million in inventories. Net non-cash items primarily consisted of $25.6 million of depreciation and amortization, $2.1 million of asset impairment charges, and $6.4 million of stock compensation costs.
Net cash used for operations was $28.9 million during the three months ended March 27, 2011, primarily due to net loss of $14.1 million and net decrease in operating assets and liabilities of $78.8 million offset by net non-cash items of approximately $64.0 million. The net decrease in operating assets and liabilities was primarily due to (i) the decrease of $66.5 million in accounts payable, accrued liabilities, and accrued compensation and benefits and (ii) the increase of $13.7 million in inventories. Net non-cash items primarily consisted of $52.1 million of depreciation and amortization, $6.8 million of amortization of inventory markup relating to FSA, $4.5 million of stock compensation costs, and $2.7 million of asset impairment charges, partially offset by $1.5 million of benefit for deferred income taxes, and $0.6 million gain from sale of property, plant and equipment.
Net investing activities were cash neutral during the three months ended March 25, 2012, primarily due to $9.2 million of capital expenditures used to purchase of property, plant and equipment, $34.3 million of purchase of marketable securities, partially offset by a $4.1 million deposit received on the sale of the KL facility, proceeds from liquidation of auction rate securities of $1.1 million and $38.4 million proceeds from maturities of marketable securities. In the second quarter of fiscal 2012, we expect to consummate the sale of the KL land and building for the remaining purchase price of approximately 112.0 million Malaysian ringitts ($36.5 million based on a currency conversion rate as of March 25, 2012).
Net cash used for investing activities was $3.9 million during the three months ended March 27, 2011, primarily due to $6.0 million of capital expenditures used to purchase property, plant and equipment, offset by $2.1 million of proceeds from the sale of property, plant and equipment.
Net cash used for financing activities was $12.6 million during the three months ended March 25, 2012, primarily due to payments of $13.6 million on debt, offset by $1.3 million of proceeds from issuance of common stock upon the exercise of stock options.
Net cash used for financing activities was $13.7 million during the three months ended March 27, 2011 primarily due to $12.0 million of purchase of bankruptcy claims from Tokyo Electric LLC and payments of $1.4 million on debt and capital lease obligations.
Off-Balance Sheet Arrangements
During the normal course of business, we make certain indemnities and commitments under which we may be required to make payments in relation to certain transactions. These indemnities include non-infringement of patents and intellectual property, indemnities to our customers in connection with the delivery, design, manufacture and sale of our products, indemnities to our directors and officers in connection with legal proceedings, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to other parties to certain acquisition agreements. The duration of these indemnities and commitments varies, and in certain cases, is indefinite. We believe that substantially all of our indemnities and commitments provide for limitations on the maximum potential future payments we could be obligated to make. However, we are unable to estimate the maximum amount of liability related to our indemnities and commitments because such liabilities are contingent upon the occurrence of events which are not reasonably determinable.
We do not have any other significant off-balance sheet arrangements, as defined in Item 303(a) (4) (ii) of SEC Regulation S-K, as of March 25, 2012.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our cash deposits, invested cash and debt. At March 25, 2012, we had approximately $190.9 million held in demand deposit accounts, approximately $3.6 million held in overnight money market funds, approximately $41.4 million invested in certificates of deposits fully insured by the FDIC, and approximately $25.0 million invested in commercial paper. Our cash and short-term investment position is highly liquid. Approximately $194.9 million have maturity terms of 0 to 30 days, approximately $2.2 million have maturity terms of 31 to 90 days, approximately $29.2 million have maturity terms of 91 to 180 days, and remaining approximately $34.6 million have maturity terms of 181 to 365 days at the time of purchase. Accordingly, our interest income fluctuates with short-term market conditions but our exposure to interest rate risk is minimal due to the short term nature of our cash and investment position.
As of March 25, 2012, approximately 46 percent of the aggregate principal amounts outstanding under our third party debt obligations were fixed rate, and approximately 54 percent of our total debt obligations were variable rate comprised of the Term Loan with an outstanding balance of approximately $233.7 million as of March 25, 2012. The Term Loan has a LIBOR floor of 1.25 percent. While LIBOR is below 1.25 percent, our interest expense will not change along with short-term change in interest rate environment. When LIBOR is above 1.25 percent, changes in interest rates associated with the term loan could then result in a change to our interest expense. For example, a one percent aggregate change in interest rates would increase/decrease our contractual interest expense by approximately $2.3 million annually.
As of March 25, 2012, we have a series of interests rate swaps with a financial institution to partially economically hedge the variability of interest payments attributable to fluctuations in the LIBOR benchmark interest rate. See Note 9 to our Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report.
We intend to actively monitor market conditions and developments specific to the securities and security classes in which we invest. We believe that we take a conservative approach to investing our funds in that our policy is to invest only in highly-rated securities with relatively short maturities, and we do not invest in securities we believe involve a higher degree of risk.
Foreign Exchange Risk
Our sales, expenses, assets and liabilities denominated in Japanese yen and other foreign currencies were exposed to foreign currency exchange rate fluctuations. For example,
Consequently, movements in exchange rates could cause our net sales and our expenses to fluctuate, affecting our profitability and cash flows. We use foreign currency forward contracts to reduce our foreign exchange exposure on our foreign currency denominated assets and liabilities. The objective of these contracts is to reduce the impact of foreign currency exchange rate movements to our operating results. We do not use these contracts for speculative or trading purposes.
We had an aggregate of $23.9 million (notional amount) of short-term foreign currency forward contracts denominated in Japanese yen outstanding as of March 25, 2012. The unrealized gain related to the foreign currency forward contracts for the quarter ended March 25, 2012 was not material. We do not anticipate any material adverse effect on our consolidated financial position, results of operations or cash flows resulting from
the use of these instruments in the future. However, we cannot assure you that these strategies will be effective or that transaction losses can be minimized or forecasted accurately. In particular, we generally cover only a portion of our foreign currency exchange exposure. We cannot assure you that these activities will eliminate foreign exchange rate exposure. Failure to eliminate this exposure could have an adverse effect on our business, financial condition and results of operations.
The following table provides information about our foreign currency forward contracts as of March 25, 2012 and December 25, 2011:
Based on our managements evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act)) are effective at the reasonable assurance level to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the three months ended March 25, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
For a description of the material legal proceedings, please see our Annual Report on Form 10-K for the fiscal year ended December 25, 2011.
You should carefully consider the risks described below and the other information in this Quarterly Report on Form 10-Q. If any of the following risks materialize, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected.
The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our business, results of operations, financial condition and liquidity.
The Flash memory market is highly competitive and subject to rapid, highly volatile changes in demand, pricing and product mix that are difficult to predict. Our failure to adequately forecast our customers needs could materially adversely affect our business.
The Flash memory market is a mature one subject to business cycles that include extended periods of oversupply and constant downward price pressure, which is due, in substantial part, to the relatively large number of competing firms and technologies. Our competitors are primarily NOR Flash memory makers, including: Micron Technology, Inc., Macronix International Co., Ltd., Winbond Electronics Corp., Microchip Technology Inc., EON Silicon Solution Inc., GigaDevice Semiconductors, Inc. and Atmel Corporation. We increasingly compete with NAND Flash memory makers for applications where NAND Flash memory is suitable for use as code storage. Our NAND Flash memory competitors include Samsung Electronics Co., Ltd., Micron Technology, SK Hynix Inc. and Toshiba Semiconductor Company Inc. In the future, additional NAND Flash memory competitors may include Elpida Memory, Inc., Powerchip Technology Corporation, Macronix International Co., Ltd., Intel Corporation, Sandisk Corporation and Winbond Electronics Corporation.
During economic downturns, periods of extremely intense competition, or the presence of oversupply in the industry, the selling prices for our products have declined at a rapid rate over relatively short time periods as compared to historical rates of decline. When such pricing declines occur, we may not be able to mitigate the effects by selling more or higher margin units, or by reducing our manufacturing costs. In such circumstances, our operating results could be materially adversely affected.
To forecast demand and value inventory, we consider, among other factors, the inventory on hand, historical customer demand data, backlog data, competitiveness of product offerings, market conditions and product life cycles. If we are unable to accurately assess these factors and anticipate future demand or market conditions, inventory write-downs may be required and would be reflected in cost of sales in the period the write-down is made. Similarly, when customers change orders booked with us, our planned manufacturing capacity may be greater or less than actual demand, resulting in less than optimal capacity usage. When this occurs, we adjust our production levels, but downward adjustments may not prevent our production of excess inventory. An inability to address challenges like the ones described above would have a negative impact on our gross margin in that period. Moreover, inaccurate forecasting could also result in excess or obsolete inventory that would reduce our margins or shortages in inventory that would cause us to fail to meet customer demand. If we are unable to produce the types and quantities of products required by our customers in the timeframes and on the delivery schedules required by our customers, we may lose customers or, in certain circumstances, be liable for losses incurred by our customers, which would materially adversely affect our business and financial results.
For the reasons stated above, it is difficult to predict future growth or decline in the markets we serve, making it very difficult to estimate requirements for production capacity. If our target markets do not grow as we anticipate, we may under-utilize our manufacturing capacity or we may be contractually obligated to purchase minimum quantities of certain products from our subcontractors. This may result in write-downs or write-offs of inventories and losses on products the demand for which is lower than we anticipate. For example, in the third and fourth quarters of 2011, we wrote down our wireless inventories as a result of a product transition to serial NOR and an overall surplus of inventory in the market. In addition, during periods of industry overcapacity, customers do not generally order products as far in advance of the scheduled shipment date as they do during periods when our industry is operating closer to capacity, which can exacerbate the difficulty in forecasting capacity requirements and may result in increased inventory levels.
Our business is primarily focused on serving the embedded portion of the Flash memory market, which is both more robust and mature than the wireless segment but which is, in certain sub-segments, still subject to similar trends in terms of product mix and downward price pressure. If we fail to execute on our strategy to serve the embedded portion, our business could be materially adversely affected.
The integrated Flash memory market has two primary groups of applications, embedded and wireless. Historically, we served both groups. Beginning in 2009, however, we started focusing primarily on the embedded market due to its longer product life cycles, higher gross margins, and reduced need to incorporate third party DRAM, PSRAM and NAND into our products. Prior to our change in focus, our wireless sales typically represented 50 percent of our total sales in a quarter. By contrast, in the first quarter of fiscal 2012, wireless sales were 6 percent of total net sales.
The embedded market, however, is more mature than the wireless market and is expected to grow more slowly than some other sectors of the semiconductor industry. In addition, the embedded market, like the wireless market, historically has been, and we anticipate that it will continue to be, subject to selling price reductions. Moreover, existing trends in the wireless market (e.g., increasing downward pressure on gross margins and price per bit) are relevant and to lead similar trends in certain consumer-facing sub-segments within the embedded market (e.g., the consumer market that includes set top boxes for cable and satellite entertainment services).
If we are unable to successfully address these challenges or unable to grow our participation in the embedded portion of the Flash memory, our business could be materially adversely affected.
We primarily sell parallel NOR Flash memory products, which are being replaced in certain applications by Flash memory products that we do not currently offer. We are developing competitive Flash memory products for these applications, but our business could be materially adversely affected if we fail to bring these new products to market.
Flash memory products have either a NOR architecture (NOR Flash memory products) or a NAND architecture (NAND Flash memory products). NOR Flash memory products have either a parallel interface (parallel NOR) or a serial interface (serial NOR) and typically are more reliable and have a higher cost-per-bit than NAND Flash memory products. System designers use NOR Flash memory products primarily for code storage, while they use NAND Flash memory products primarily for data storage. Increasingly, however, for certain embedded system designs, particularly in consumer-facing market segments, higher density NAND Flash memory products are being used for code storage instead of high density, parallel NOR Flash memory products. Similarly, and also in consumer-focused markets, in which product cycles are rapid and keeping cost down is paramount, system designers are increasingly choosing low-density serial NOR Flash memory products over similar density parallel NOR offerings.
In contrast, we primarily sell parallel NOR products having medium to high density (32 megabits and above). We also primarily sell serial NOR products having medium to high density. We are currently developing NAND Flash memory products and expanding our low density (less than 32 megabits) serial NOR Flash memory product portfolio to meet the increasing demand for these products in embedded applications. However, we cannot be certain that we will successfully develop and introduce NAND Flash memory products and additional low density serial NOR Flash memory products in time and at competitive price points to counteract the falling demand for the parallel NOR Flash memory products we currently sell. If we fail to do so, our business could be materially adversely affected.
Our operating results are dependent on the performance of distributors, including Fujitsu Semiconductors Limited, who is our primary distributor for Japan.
A significant portion of our sales are through independent distributors that are not under our control. For example, sales through distributors accounted for 69 percent and 70 percent of our net sales for fiscal 2011 and 2010 respectively. Generally, our agreements with third-party distributors can be terminated for convenience by either party upon relatively short notice. These agreements generally are non-exclusive and also permit our distributors to offer our competitors products. We generally do not require letters of credit from our distributors and are not protected against accounts receivable default or bankruptcy by these distributors. Our inability to collect open accounts receivable could adversely affect our operating results. Termination of a significant distributor, whether at our initiative or the distributors initiative, could disrupt our current business, and if we are unable to find suitable replacements, our operating results could be adversely affected.
In Japan, which is an important geographic market for us, we currently rely primarily on Fujitsu Semiconductors Limited (FSL) through its subsidiary, Fujitsu Electronics Inc. (FEI), to distribute our products to customers. For example, sales of our products through FSL represented 29 percent of our total net sales for fiscal 2011. Historically, our agreement with FSL has been exclusive and FSL has not been permitted to offer our competitors Flash memory products to its customers. However, exclusivity is set to expire on May 10, 2012 and FSL may then begin to sell our competitors Flash memory products. Under the terms of our distribution agreement with FSL, either party may terminate the distribution agreement for convenience upon 60 days written notice to the other party. If FSL unexpectedly terminates its distribution agreement with us, or otherwise ceases its support of our customers in Japan, we would be required to develop and rely on a relationship with another distributor or establish our own local sales organization and support functions. We cannot be certain that we would be successful in selling our products to customers currently served by FSL or new customers and our sales in Japan might decline, and we could be materially adversely affected.
Our revenue reporting is highly dependent on sales information from our distributors, and our financial reporting could be misstated if such information is not accurate and timely.
Our revenue reporting is highly dependent on receiving accurate and timely sell-through data from our distributors. As our distributors resell products, they provide us with periodic data regarding the products sold, including prices, quantities, end customers, and the amount of our products they still have in stock. The data we receive is voluminous and complex and we must use estimates and apply judgments to reconcile distributors reported inventories to their sell-through activities. Actual results could vary unfavorably from our estimates, which could affect our operating results and could adversely affect our business.
We generally provide price protection to our distributors on the inventory they carry. Significant declines in the value of that inventory may require us to undertake inventory write-downs.
Distributors typically maintain an inventory of our products. For certain distributors, we have signed agreements that protect the value of their inventory of our products against price reductions, as well as provide for rights of return under specific conditions. Certain agreements with our distributors also contain standard stock rotation provisions permitting limited levels of product returns. We do not recognize revenue on our sales to these distributors until the applicable products are re-sold by the distributors and reported to us. However, in the event of an unexpected significant decline in the price of our products or significant return of unsold inventory, we may experience inventory write-downs, charges to reimburse costs incurred by distributors, or other charges or adjustments, any of which could result in a material adverse impact to our revenues and operating results.
We are not protected by long-term supply contracts with our customers.
We do not typically enter into long-term supply contracts with our customers, and we cannot be certain as to future order levels from our customers. When we do enter into a long-term contract, the contract is generally
terminable at the convenience of the customer. In the event of an early termination by one of our major customers, it is unlikely that we will be able to rapidly replace that revenue source, which would harm our financial results.
A number of factors, including our inventory strategy, can impact our gross margins.
Numerous factors, including yield, wafer pricing, product mix, market acceptance of our new products, competitive pricing dynamics, geographic and/or market segment pricing strategies cause our gross margins to fluctuate. In addition, forecasting our gross margins is difficult because a significant portion of our business is based on the fulfillment of orders within the same quarter the orders are placed. In the event demand does not materialize, we may be subject to incremental obsolescence costs. In addition, future product cost reductions could have an increased impact on our inventory valuation, which would then impact our operating results.
Our global operations expose us to regional risks that could materially adversely affect our business globally.
Sales to customers outside the United States were approximately 88 percent of our total net sales for fiscal 2011. Additionally, we operate in more than ten countries, and a substantial portion of our manufacturing operations and those of our third party manufacturers are located outside the United States, primarily in Japan, China, Taiwan, Korea, Thailand and Malaysia. As a result, our business is subject to a variety of risks that are specific to the regions and countries in which we operate, including:
These factors may materially adversely affect our business, results of operations or financial condition. To the extent practicable, we seek to proactively reduce our exposure to these risks where possible, but we may not be successful. For example, we use foreign currency forward contracts to reduce our exposure to foreign currency exchange rate fluctuations. The objective of these contracts is to reduce the impact of foreign currency exchange rate movements on our operating results and on our foreign currency denominated monetary assets and liabilities. We do not use these contracts for speculative or trading purposes. We cannot assure you that these activities will be successful in reducing our foreign currency exchange rate exposure. If these activities are unsuccessful, our financial condition could be materially adversely affected.
During the first and second quarters of 2011, we lost sales and experienced delays in the provision of foundry services by third parties in Japan as a result of the earthquakes and related tsunami that occurred there in March 2011. Specifically, some first and second quarter product shipments were cancelled or rescheduled for shipment during the subsequent quarter. We also incurred some minor damage to our production equipment during the first quarter of 2011. During the third quarter, the flooding in Thailand, while not directly affecting our facility, did impact some of our suppliers and customers. The impact to our operations and financial results
as a result of the events in Japan and Thailand were not material. However, if natural disasters or other business disruptions result in cancellations of customer orders or contribute to a general decrease in economic activity or demand for our products or directly impact our manufacturing and logistics functions, our net sales and financial condition will be adversely affected.
Furthermore, the operations of our suppliers could be subject to natural disasters and other business disruptions, that could cause shortages and price increases in various essential materials, which are required to manufacture our products. If we are unable to procure an adequate supply of materials that are required for us to manufacture our products, or if the operations of our other suppliers of such materials are affected by an event that causes a significant business disruption, we may have to reduce our manufacturing operations. Such a reduction could have a material adverse effect on us.
We may not satisfy the covenants, financial tests and ratios in our debt instruments, which if not met, would have a material adverse effect on us.
Our credit agreement, or Senior Secured Term Loan (Term Loan) , our loan and security agreement, or Revolving Credit Facility, and the indenture governing our 7.875 % Senior Notes due 2017, or the Notes, require us to comply with covenants, financial tests and ratios. We cannot assure you that we will be able to satisfy or comply with these covenants, financial tests and ratios, as our ability to do so may be affected by events beyond our control. If we fail to satisfy or comply with such covenants, financial tests and ratios, or if we disagree with our lenders about whether or not we are in compliance, we cannot assure you that we will be able to obtain waivers or amendments if required to avoid a default. A breach of any of the provisions, covenants, financial tests or ratios under our debt instruments could prevent us from borrowing under our Revolving Credit Facility and result in an event of default under the applicable agreement, which in turn could trigger cross-defaults under other debt instruments, any of which would materially adversely affect us.
Our reliance on third-party manufacturers entails risks that could materially adversely affect us.
We currently have, and plan in the future to enter into, foundry, subcontractor and other arrangements with third parties to meet demand for our products. Third-party manufacturers we currently use or expect to use in the future for foundry and other manufacturing services include SK Hynix Inc. or SK Hynix, Fujitsu Semiconductors Limited, or FSL, Elpida Memory, Inc., or Elpida, Semiconductor Manufacturing International Corporation, or SMIC and Dongbu HiTek Co., Ltd. We also use independent contractors to perform some of the assembly, testing and packaging of our products, including ChipMOS Technologies Limited. We depend on these manufacturers to allocate to us a portion of their manufacturing capacity sufficient to meet our needs. Third-party manufacturers are generally under no obligation to provide us with any specified minimum quantity of product. We also depend on these manufacturers to produce products of acceptable quality and at acceptable manufacturing yields and to deliver those products to us on a timely basis at acceptable prices. In addition, we rely on these manufacturers to invest capital into their facilities and process technologies to meet our needs for new products using advanced process technologies. Given our emergence in May 2010 from our Chapter 11 bankruptcy proceedings (the Chapter 11 Cases) and the volatility and disruption in the capital and credit markets worldwide, we cannot assure you that they will make the investments in their facilities previously contemplated. We also cannot assure you that these manufacturers will be able to meet our near-term or long-term manufacturing requirements and that we will be able to attain qualification from our customers, which may be required prior to production of products at a third party facility. In addition, any significant change in the payment terms we have with these manufacturers could adversely affect us.
Third party manufacturers with whom we contract also make products for other companies, including certain of our competitors, and/or for themselves and could choose to prioritize capacity for themselves or other customers beyond any minimum guaranteed amounts, reduce deliveries to us or, in the absence of price guarantees, increase the prices they charge us on short notice, such that we may not be able to pass cost increases on to our customers. The likelihood of this occurring may be greater as a result of the Chapter 11 Cases. We may be unable to secure an alternative supply for specific products in a short timeframe or at all at an acceptable cost to satisfy our production requirements. In addition, we may be required to incur additional development, manufacturing and other costs to establish alternative sources of supply. Other risks associated
with our increased dependence on third-party manufacturers include: their ability to adapt to our proprietary technology, reduced control over delivery schedules, quality assurance, manufacturing yields and cost, misappropriation of our intellectual property, their solvency, reduced ability to manage inventory and parts and risks associated with operating in foreign countries. For example, Elpida recently announced that it is seeking bankruptcy protection, and we cannot be assured that it or its successor(s) will manufacture charge trapping NAND products for us. While we have mitigated this risk by partnering with SK Hynix on floating gate NAND products, we will continue to pursue charge trapping NAND at advanced process nodes, and we may not be able to find a third-party manufacturer to make such products for us once they are developed. If we are unable to secure sufficient or reliable suppliers of wafers or obtain the necessary assembly, testing and packaging services, our ability to meet customer demand for our products may be adversely affected, which could have a material adverse effect on us.
Unless we maintain manufacturing efficiency, we may not become profitable and our future profitability could be materially adversely affected.
The Flash memory industry is characterized by rapid technological changes. For example, new manufacturing process technologies using smaller feature sizes and offering better performance characteristics are generally introduced every one to two years. The introduction of new manufacturing process technologies allows us to increase the functionality of our products while at the same time optimizing performance parameters and increasing storage capacity. In addition, the reduction of feature sizes enables us to produce smaller chips offering the same functionality and thereby considerably reducing the cost per bit. In order to remain competitive, it is essential that we secure the capabilities to develop and qualify new manufacturing process technologies. For example, our leading Flash memory products must be manufactured at 65-nanometer and more advanced process technologies. If we are delayed in transitioning to these technologies and other future technologies, we could be materially adversely affected.
Manufacturing our products involves highly complex processes that require advanced equipment. Our manufacturing efficiency is an important factor in achieving profitability, and we cannot be sure that we will be able to maintain or increase our manufacturing efficiency to the same extent as our competitors. For example, we continuously modify our manufacturing processes in an effort to improve yields and product performance and decrease costs. We are continuing to transition to 65-nanometer process technology for the manufacture of some of our products. During periods when we are implementing new process technologies, manufacturing facilities may not be fully productive. We may fail to achieve acceptable yields or may experience product delivery delays as a result of, among other things, capacity constraints, delays in the development of new process technologies, changes in our process technologies, upgrades or expansion of existing facilities, impurities or other difficulties in the manufacturing process. Any of these occurrences could adversely impact our relationships with customers, cause harm to our reputation in the marketplace, cause customers to move future business to our competitors or cause us to make financial concessions to our customers.
Improving our manufacturing efficiency in future periods is dependent on our ability to:
Our ability to generate sufficient operating cash flows depends in part on maintaining our expense reduction efforts.
Our business is capital intensive and our ability to generate operating cash flows depends in large part on the maintenance of a low cost strategy. As part of our strategy going forward, we intend to continue our cost
reduction efforts which have included restructuring and technology partnerships. For example, in the fourth quarter of fiscal 2011 and as part of a company-wide cost reduction program, we initiated a restructuring plan to align the business with current market conditions and to reduce operating expenses. The plan encompassed the consolidation of two test and assembly manufacturing operations in Asia and will result in the closure of our KL facility, which we completed in the first quarter of fiscal 2012. This and other cost reduction activities may require initial cash outlays before the anticipated benefits are realized. We cannot assure you that we will be able to achieve anticipated expense reductions. If our expense reduction efforts are unsuccessful, our operating results and business may be materially adversely affected. Furthermore, in certain instances our cost reductions may make it more difficult for us to succeed in the extremely competitive Flash memory market.
If essential equipment or adequate supplies of satisfactory materials are not available to manufacture our products, we could be materially adversely affected.
Our manufacturing operations depend upon obtaining deliveries of equipment and adequate supplies of materials on a timely basis. We purchase equipment and materials from a number of suppliers. From time to time, suppliers may extend lead times, limit supply to us or increase prices due to capacity constraints or other factors. Because the equipment that we purchase is complex, it is difficult for us to substitute one supplier for another or one piece of equipment for another. Some raw materials we use in the manufacture of our products are available from a limited number of suppliers or only from a limited number of suppliers in a particular region. In addition, we purchase raw materials such as gold for which prices on the world markets have fluctuated significantly during recent periods. Our manufacturing operations also depend upon the quality and usability of the materials we use in our products, including raw materials and wafers we receive from our suppliers. If the materials we receive from our suppliers do not meet our manufacturing requirements or product specifications, are not obtained in a timely manner or if there are significant increases in costs of materials, we may be materially adversely affected.
In addition, some of our suppliers may also be our competitors. Interruption of supply or increased demand in the industry could cause shortages and price increases in various essential materials. If we are unable to procure these materials, or if the materials we receive from our suppliers do not meet our production requirements or product specifications, we may have to reduce our manufacturing operations or our manufacturing yields may be adversely affected. Such a reduction and yield issues have in the past and could in the future have a material adverse effect on us.
We cannot be certain that we will have sufficient resources to invest in the level of research and development required to remain competitive or that our substantial research and development investments will lead to timely improvements in technology needed to successfully develop, introduce and commercialize new products and technologies.
The Flash memory industry is highly competitive and subject to rapid technological change. In order to compete, we are required to make substantial investments in research and development for product design, process technologies and production techniques in an effort to design and manufacture advanced Flash memory products. For example, in connection with our business strategy, our research and development expenses for fiscal 2010 and 2011 were $100.5 million and $106.6 million or approximately 9 percent and 10 percent of our total net sales, respectively. We cannot assure you that we will have sufficient resources independently or through joint development agreements to maintain the level of investment in research and development that is required for us to remain competitive, which could materially adversely affect us.
Our strategy is to increasingly seek to share research and development costs with third parties. For example, in 2009, we entered into a joint development agreement with Elpida for the development of products based on our charge trapping NAND architecture. However we cannot assure you that we will be able to negotiate such arrangements for more of our research and development needs, or that such arrangements will result in commercially successful technology and products in a timely manner or at all. We will be dependent on
the third parties in such agreements to continue to invest financial and skilled human resources, and we cannot assure you that such third parties will make the necessary investments, the absence of which would materially adversely affect our business. For example, Elpida recently announced that it is seeking bankruptcy protection, and we cannot be assured that it or its successor(s) will continue investing in the joint development of charge trapping NAND technology with us. While we have mitigated this risk by partnering with SK Hynix on floating gate NAND technology, we anticipate the need to find another development partner for advanced charge trapping NAND technologies, and we may not be able to find such a partner.
Our success depends to a significant extent on our ability to develop, qualify, produce, introduce and gain market acceptance of new product designs and improvements that provide value to Flash memory customers. Our ability to develop and qualify new products and related technologies to meet evolving industry requirements at prices acceptable to our customers and on a timely basis is critical to our competitiveness in our target markets. If we are delayed in developing or qualifying new products or technologies, we could be materially adversely affected.
Competitors may introduce new memory or other technologies that may make our Flash memory products uncompetitive or obsolete.
Our competitors are working on a number of potentially competitive technologies, including ferroelectric random access memory, or FRAM, magneto resistive random access memory, or MRAM, polymer, charge trapping and phase-change based memory, or PCM, technologies. These technologies provide alternative means of non-volatile storage of information. Today, where products exist using these new technologies, they exhibit different characteristics than existing NOR Flash memory products based on MirrorBit or floating gate technology. These differences, including higher cost structure, inability to support higher densities, different performance and operating behavior, currently exclude such products from addressing volume markets for NOR Flash memory. For such products to be commercially viable and attractive alternatives to todays NOR Flash memory solutions, they must either match the capabilities and characteristics at lower cost or provide additional capabilities desired and valued by customers. If such products are successfully developed and commercialized as a viable alternative to MirrorBit or floating gate NOR Flash memory, these other products could pose a competitive threat to existing Flash memory companies, including us. In addition, some of the licensees and customers of Saifun Semiconductors Ltd., or Saifun, which we purchased in 2008 and renamed Spansion Israel Ltd., are our competitors or work with our competitors and possess licenses from Spansion Israel Ltd. for intellectual property associated with charge trapping Flash memory technology. Use of this charge trapping intellectual property or use of independently developed charge trapping Flash memory technology by our competitors, if successfully developed and commercialized, may allow these competitors to develop Flash memory products that may compete with our products based on charge trapping technology. If we are unable to compete with these new technologies, we may be materially adversely affected.
Our working capital, investments and capital requirements may require us to seek additional financing, which may not be available to us.
Our debt instruments may not be sufficient for our future working capital, investments and capital requirements. We also may not be able to access additional financing resources due to a variety of reasons, including the restrictive covenants in the Term Loan, the Revolving Credit Facility and the Notes indenture and the lack of available capital due to the tight nature of global credit markets. If our financing requirements are not met and we are unable to access additional financing, our business, operations, financial condition and cash flows will be materially adversely affected.
If we cannot adequately protect our technology or other intellectual property in the United States and abroad, through patents, copyrights, trade secrets, trademarks, litigation and other measures, we may lose a competitive advantage and incur significant expenses as a result of litigation and other claims.
We rely on a combination of protections provided by contracts, including confidentiality and non-disclosure agreements, copyrights, patents, trademarks and common law rights, such as trade secrets, to protect our intellectual property. However, we cannot assure you that we will be able to adequately protect our
technology or other intellectual property from third-party infringement or from misappropriation in the United States and abroad. Any patent owned or licensed by us or issued to us could be challenged, invalidated or circumvented or rights granted under these patents or licenses may not provide a competitive advantage to us. Furthermore, patent applications that we file may not result in issuance of a patent or, if a patent is issued, the patent may not be issued in a form that is advantageous to us. Despite our efforts to protect our intellectual property rights, others may independently develop similar products, duplicate our products or design around our patents and other intellectual property rights. In addition, it is difficult to monitor compliance with, and enforce, our intellectual property rights on a worldwide basis in a cost-effective manner. Foreign laws may provide less intellectual property protection than is afforded in the United States. Our efforts to protect our intellectual property in the United States and abroad through lawsuits may be time-consuming and costly.
We expect to attempt to negotiate agreements and arrangements with third parties for the license of intellectual property and technology that are important to our business. We also expect to continue to apply for new patents as our success in negotiating patent cross-license agreements with other industry participants will depend in large part upon the strength of our patent portfolio relative to that of the third party with which we are negotiating. In 2011, we successfully settled our litigation with Samsung and negotiated a cross-license agreement with Samsung, but we can give no assurances that we will be successful in other litigation or negotiations. If we are unable to negotiate agreements or arrangements for intellectual property, or to obtain patents, necessary for the success of our business, we may be materially adversely affected.
We provide indemnities relating to non-infringement of patents and other intellectual property indemnities to certain of our customers in connection with the delivery, design, manufacture and sale of our products. If we incur substantial costs in connection with any claim pursuant to such indemnification, our business, results of operations and financial condition could be materially adversely affected.
If we cannot adequately protect our technology or other intellectual property rights in the United States and abroad, we may be materially adversely affected.
If our security measures are breached and unauthorized access is obtained to our information technology systems, we may lose proprietary data.
Our security measures may be breached as a result of third-party action, including computer hackers, employee error, malfeasance or otherwise, and result in unauthorized access to our customers data or our data, including our intellectual property and other confidential business information, or our information technology systems. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any security breach could result in disclosure of our trade secrets, confidential customer, supplier or employee data, which could result in legal liability, harm to our reputation and otherwise harm our business.
Our stock price may be volatile, and stockholders may lose all or part of their investment.
The market price of our common stock has been volatile and may in the future be subject to wide fluctuations in response to many risk factors listed in this section, and others beyond our control, including:
Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest
rate changes or international currency fluctuations, may negatively impact the market price of shares of our common stock. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our managements attention from other business concerns, which could materially adversely affect us.
Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.
We prepare our financial statements in accordance with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, or FASB, the Securities and Exchange Commission, or SEC, and various bodies formed to interpret and create appropriate accounting policies. A change in those policies or other requirements with respect to the reporting of financial statements can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced.
For example, the SEC has released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards, or IFRS. Under the proposed roadmap, we may be required to prepare financial statements in accordance with IFRS. The SEC has not finalized the timetable for the mandatory adoption of these new standards. It is unclear at this time how the Commission will propose GAAP and IFRS be harmonized if the proposed changes are adopted. If adopted, we will need to develop new systems and controls around IFRS principles. Since this would be a new endeavor, the specific costs associated with this conversion are uncertain and could have a material impact on our results of operations.
Transfers or issuances of our equity, or a debt restructuring, may impair or reduce our ability to utilize our net operating loss carry-forwards and certain other tax attributes in the future.
Pursuant to U.S. federal and state tax rules, a corporation is generally permitted to deduct from taxable income in any year net operating losses (NOLs) carried forward from prior years. We have U.S federal NOL carry forwards of approximately $1.0 billion as of December 25, 2011. Approximately $533.6 million of the federal NOL carry forwards are subject to an annual limitation of $27.2 million. These NOLs, if not utilized, expire from 2016 to 2031. In addition, our ability to utilize unlimited federal NOL carry forwards could be subject to a significant limitation if we were to undergo an "ownership change" for purposes of Section 382 of the Internal Revenue Code of 1986, as amended.
Our success depends on our key personnel and the loss of key personnel could disrupt our business.
Our success greatly depends on the continued contributions of our senior management and other key research and development, sales, marketing and operations personnel. In addition, our success will depend on our ability to recruit and retain additional highly-skilled personnel. The Chapter 11 Cases have made recruiting, hiring and retention even a greater challenge. We have relied on equity awards in the form of stock options and restricted stock units as one means for recruiting and retaining highly skilled talent and the reduction in our stock price has reduced the effectiveness of those awards used for retaining employees. The loss of key personnel could disrupt or adversely affect our business.
Costs related to defective products could have a material adverse effect on us.
One or more of our products may be found to be defective or we may initiate voluntary recalls of products after they have been shipped to customers in volume. We generally provide a limited warranty with respect to our products. Accordingly, if we recall products or are forced to replace defective products, the cost of product replacements or product returns may be substantial, and our reputation with our customers could be damaged. In addition, we could incur substantial costs to implement modifications to fix defects. Any of these problems could materially adversely affect us.
We are subject to a variety of environmental laws that could result in liabilities.
Our properties and many aspects of our business operations are subject to various domestic and international environmental laws and regulations, including those relating to materials used in our products and manufacturing processes; chemical use and handling; waste minimization; discharge of pollutants into the environment; the treatment, transport, storage and disposal of solid and hazardous wastes; and remediation of contamination. Certain of these laws and regulations require us to obtain permits for our operations, including permits related to the discharge of air pollutants and wastewater. From time to time, our facilities are subject to investigation by governmental regulators. Any failure to comply with applicable environmental laws, regulations or permits may subject us to a range of consequences, including fines, suspension of production, alteration of manufacturing processes, sales limitations, and criminal and civil liabilities or other sanctions. We could also be held liable for any and all consequences arising out of exposure to hazardous materials used, stored, released, disposed of by us or located at or under our facilities, or for other environmental or natural resource damage.
Certain environmental laws, including the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980, or the Superfund Act, impose joint and several liabilities on current and previous owners or operators of real property for the cost of removal or remediation of hazardous substances and costs related to damages to natural resources. One of our properties is listed on the U.S. Environmental Protection Agencys Superfund National Priorities List. However, other parties currently are responsible for all investigation, cleanup and remediation activities. We have not been named a responsible party at any Superfund or other contaminated site. If we were ever so named, costs associated with the cleanup of the site could be material. Additionally, contamination that has not yet been identified could exist at one or more of our facilities, and identification of such contamination could have a material adverse effect on us.
Future environmental regulations could require us to procure expensive pollution abatement or remediation equipment; to modify product designs; or to incur other expenses associated with compliance with such regulations. For example, the European Union and China recently began imposing stricter requirements regarding reduced lead content in semiconductor packaging. Therefore, we cannot assure you that our costs of complying with current and future environmental and health and safety laws, or liabilities arising from past or future releases of, or exposure to, hazardous substances, will not have a material adverse effect on our business.
Provisions in our corporate governance documents as well as Delaware law may delay or prevent an acquisition of us that stockholders may consider favorable, which could decrease the value of your shares.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include restrictions on the ability of our stockholders to remove directors, a classified board of directors and limitations on action by our stockholders by written consent. In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used to make an acquisition of us more difficult. Although we believe these provisions protect our stockholders from coercive or otherwise unfair takeover tactics and thereby provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.