California Micro Devices 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended June 30, 2008
For The Transition Period from to
Commission File Number 0-15449
CALIFORNIA MICRO DEVICES CORPORATION
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
(Former name, former address, and former fiscal year if changed since last report)
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 is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See definition of “accelerated filer, large accelerated filer and smaller 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 in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of July 31, 2008 was 23,408,920.
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Form 10-Q for the Quarter Ended June 30, 2008
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
See Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
See Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited 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 with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The condensed consolidated financial statements should be read in conjunction with the financial statements included with our annual report on Form 10-K for the fiscal year ended March 31, 2008. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of California Micro Devices Corporation (the “Company”, “CMD”, “we”, “us” or “our”) as of June 30, 2008, and the results of operations for the three month periods ended June 30, 2008 and 2007, and cash flows for the three month periods ended June 30, 2008 and 2007. Results for the three month periods are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending March 31, 2009. Certain prior year amounts in the financial statements and notes thereto have been reclassified to conform to the current 2009 presentation.
The unaudited condensed consolidated financial statements include the accounts of CMD and its wholly owned subsidiary. Intercompany accounts and transactions have been eliminated.
2. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates are based on historical experience, input from sources outside of the company, and other relevant facts and circumstances. Actual results could differ from those estimates.
3. Recent Accounting Pronouncements
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements" (SFAS 157). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial assets and liabilities on financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FASB Staff Position No. 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FASB Staff Position No. 157-2 (FSP No. 157-2) delays the effective date for non-financial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The provisions of SFAS No. 157 should be applied prospectively as of the beginning of the fiscal year in which SFAS No. 157 is initially applied, except in limited circumstances. We have adopted SFAS No. 157 beginning April 1, 2008, and there was no material impact on our condensed consolidated financial statements. See Note 5 for further discussion.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” Under SFAS No. 159, a company may elect to use fair value to measure eligible items at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. If elected, SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We have adopted SFAS 159 beginning April 1, 2008 and we did not elect the fair value option to measure eligible financial assets and financial liabilities.
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In December 2007, the FASB issued Statement No. 141(R), “Business Combinations” (SFAS 141(R)) which expands the definition of transactions and events that qualify as business combinations; requires that the acquired assets and liabilities, including contingencies, be recorded at the fair value determined on the acquisition date and changes thereafter reflected in earnings, not goodwill; changes the recognition timing for restructuring costs; and requires acquisition costs to be expensed as incurred. In addition, acquired in-process research and development (IPR&D) is capitalized as an intangible asset and amortized over its estimated useful life. Adoption of SFAS 141(R) is required for fiscal years beginning after December 15, 2008. Early adoption and retroactive application of SFAS 141(R) to fiscal years preceding the effective date are not permitted. We believe that there is no impact of SFAS 141(R) on our financial position and results of operations.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interest in Consolidated Financial Statements” (SFAS 160) which re-characterizes minority interests in consolidated subsidiaries as non-controlling interests and requires the classification of minority interests as a component of equity. Under SFAS 160, a change in control will be measured at fair value, with any gain or loss recognized in earnings. The effective date for SFAS 160 is for annual periods beginning on or after December 15, 2008. Early adoption and retroactive application of SFAS 160 to fiscal years preceding the effective date are not permitted. We believe that there is no impact of SFAS 160 on our financial position and results of operations.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162). This statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in accordance with GAAP. With the issuance of this statement, the FASB concluded that the GAAP hierarchy should be directed toward the entity and not its auditor, and reside in the accounting literature established by the FASB as opposed to the American Institute of Certified Public Accountants (AICPA) Statement on Auditing Standards No. 69, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” This statement is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” We have evaluated the new statement and have determined that it will not have a significant impact on the determination or reporting of our financial results.
4. Cash, Cash Equivalents and Short-Term Investments
Cash and cash equivalents represent cash and money market funds as follows (in thousands);
Short-term investments represent investments in certificates of deposits and debt securities with remaining maturities less than 360 days. We invest our excess cash in high quality financial instruments. We have classified our marketable securities as available for sale securities. Our available for sale securities are carried at fair value, with unrealized gains and losses reported in a separate component of stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary, if any, on available for sale securities are included in interest income. Interest on securities classified as available for sale is also included in interest and other income, net. The cost of securities sold is based on the specific identification method.
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Short-term investments were as follows (in thousands):
On April 1, 2008, we adopted Statement of Financial Accounting Standards 157, “Fair Value Measurements,” (SFAS No. 157). SFAS No. 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and we consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance.
Fair Value Hierarchy>
SFAS No. 157 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. SFAS No. 157 establishes three levels of inputs that may be used to measure fair value:
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 - Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows models and similar techniques.
Determination of Fair Value
The Company’s cash and investment instruments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, market prices received from industry standard pricing data providers or alternative pricing sources with reasonable levels of price transparency. Money market funds are classified as Level 1 because these securities are valued based on quoted market prices in active markets. Agency notes, commercial papers and asset backed securities are classified as Level 2 because markets for these securities are less active or valuations for such securities utilize significant inputs which are directly or indirectly observable.
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The table below presents the balances of assets measured at fair value on a recurring basis (in thousands):
6. Goodwill and Other Intangible Assets
In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets: ("SFAS 142") goodwill is tested for impairment on annual basis, or earlier if indicators of impairment exist. We perform our annual test for impairment of goodwill during our fourth fiscal quarter.
The components of intangible assets, net were as follows (in thousands):
Developed and core technology and distributor relationships were amortized on a straight-line basis over their estimated useful lives of four years and two years, respectively. The amortization expense for intangible assets was $34,000 and $41,000 for the three months ended June 30, 2008 and 2007, respectively. Based on intangible assets recorded at June 30, 2008, and assuming no subsequent additions to, or impairment of, the underlying assets, the future estimated amortization expense is approximately $97,000, $131,000 and $5,000 in remainder of fiscal 2009, fiscal 2010 and fiscal 2011, respectively.
During three months ended June 30, 2008 and 2007, we did not record any impairment charges. In assessing the recoverability of intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. It is reasonably possible that these estimates, or their related assumptions, may change in the future, in which case we may be required to record impairment charges for these assets.
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7. Balance Sheet Components
Balance sheet components were as follows (in thousands):
8. Capital Lease Obligations
Capital lease obligations consisted of the following (in thousands):
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In October 2006, we entered into three year software lease agreements with two vendors for which the capitalized amounts were $362,000 and $34,000, respectively. The imputed interest rate for each of these leases is approximately 8%. Both leases have three year durations, with three annual lease payments in October 2006, October 2007 and October 2008, totaling to $132,000 annually. Interest expense on these leases during the three months ended June 30, 2008 and 2007 was immaterial.
Future maturities of capital lease obligations at June 30, 2008 are as follows (in thousands):
* Excludes interest and maintenance payments on the capital leases aggregating to $30,000 in the remainder of fiscal 2009.
Total fixed assets purchased under capital leases and the associated accumulated amortization is classified in computer equipment and related software and was as follows (in thousands):
Amortization expense for fixed assets purchased under capital leases is included in the line item titled “depreciation and amortization” on our condensed consolidated statements of cash flows.
9. Employee Stock Benefit Plans
Our equity incentive program is a long-term retention program that is intended to attract and retain qualified management and technical employees and align stockholder and employee interests. Under our current equity incentive program, stock options have varying vesting periods typically over four years and are generally exercisable for a period of ten years from the date of issuance and are granted at prices equal to the fair market value of the Company’s common stock at the grant date. These plans are described fully in the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended March 31, 2008.
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Stock option activity for the three months ended June 30, 2008, is as follows:
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on options with an exercise price less than the Company’s closing stock price of $3.11 as of June 30, 2008, which would have been received by the option holders had all option holders with in-the-money options exercised and sold their options as of that date.
There were no exercises of stock options during the three months ended June 30, 2008 and 2007.
The following table summarizes the ranges of the exercise prices of outstanding and exercisable options at June 30, 2008:
Employee Stock Purchase Plan (ESPP)
Our ESPP provides that eligible employees may contribute up to 15% of their eligible earnings, through accumulated payroll deductions, toward the semi-annual purchase of our common stock at 85% of the fair market value of the common stock at certain defined points in the plan offering periods. We issued 106,646 and 49,007 shares under the ESPP during the three months ended June 30, 2008 and 2007, respectively. Net cash proceeds from the ESPP were $272,000 and $185,000 for the three months ended June 30, 2008 and 2007, respectively.
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Shares Available for Future Issuance under Employee Benefit Plans
As of June 30, 2008, 855,000 shares were available for future issuance, which included 210,000 shares of common stock available for issuance under our ESPP, 17,000 under our UK Sub-Plan and 628,000 under our 2004 Omnibus Incentive Compensation Plan.
Stock-Based Compensation Expense
The following table sets forth the total stock-based compensation expense for the three months ended June 30, 2008 and 2007 resulting from employee stock options and ESPP included in our condensed consolidated statements of operations in accordance with FAS 123(R) (in thousands):
The effect of recording employee stock-based compensation expense for the three months ended June 30, 2008 and 2007 was as follows (in thousands, except per share amounts):
Income tax benefit of $0 and $6,000 was realized from ESPP purchases during the three months ended June 30, 2008 and 2007, respectively.
The fair value of stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for the three months ended June 30, 2008 and 2007, respectively:
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We currently estimate our forfeiture rate to be 17%, which is based on an analysis of expected forfeiture data using our current demographics and probabilities of employee turnover. The weighted average fair value of employee stock options granted during the three months ended June 30, 2008 and 2007 was $1.57 and $2.50, respectively.
As of June 30, 2008, we had $1.6 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options that will be recognized over the weighted average period of 2.7 years.
10. Stock Issuances
During the three months ended June 30, 2008 and 2007, we issued the following shares of common stock under our ESPP (in thousands):
11. Net Loss Per Share
The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):
Basic and diluted net loss per share was computed using the net loss and weighted average number of common shares outstanding during the period. Due to our net loss for the three months ended June 30, 2008 and 2007, all of our stock options outstanding to purchase 4,777,000 and 4,333,000, respectively of the company’s common stock were excluded from the diluted net loss per share calculation because their inclusion would have been anti-dilutive.
12. Comprehensive Loss
Comprehensive loss is comprised of net loss and unrealized loss on our available for sale securities. Comprehensive loss for the three months ended June 30, 2008 and 2007 was as follows (in thousands):
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13. Income Taxes
Effective at the beginning of the first quarter of fiscal 2008, we adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold of more-likely-than-not to be sustained upon examination, specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions.
As a result of the implementation of FIN 48 on April 1, 2007, we recognized a $149,000 increase in the liability for unrecognized tax benefits related to tax positions taken in prior periods. This increase was accounted for as a cumulative effect of a change in accounting principle that resulted in an increase to accumulated deficit.
The amount of unrecognized tax benefits as of April 1, 2008 was $167,000. For the three months ended June 30, 2008, there was no significant change to the liability for unrecognized tax benefits booked at the beginning of the year.
Our policy is to include interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the amount of any accrued interest or penalties associated with any unrecognized tax positions was $49,000. The amount of interest and penalties as of April 1, 2008 was $51,000. The additional amount of interest and penalties for the three months ended June 30, 2008 was $2,000.
We estimated that it is more likely than not that approximately $1.2 million of the deferred tax assets as of June 30, 2008 and March 31, 2008 will be realized in the following year. As of June 30, 2008, a valuation allowance of approximately $23.0 million was recorded against the net deferred tax assets.
We file income tax returns in the U.S. federal jurisdiction and in several states and foreign jurisdictions. As of June 30, 2008, the federal returns for the years ended March 31, 2005 through the current period and certain state returns for the years ended March 31, 2004 through the current period are still open to examination. However, due to the fact the Company had net operating losses and credits carried forward in most jurisdictions, certain items attributable to technically closed years are still subject to adjustment by the relevant taxing authority through an adjustment to tax attributes carried forward to open years.
14. Segment Information
Our operations are classified into one operating segment. A significant portion of our net sales is derived from a relatively small number of customers. Our net sales from customers and distributors, individually representing more than 10% of total net sales during the three months ended June 30, 2008 and 2007 were as follows;
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Net sales to geographic regions reported below are based on the customers’ ship to locations (amounts in millions):
Property, plant and equipment by geographic location is summarized as follows (in millions):
We have been subject to a variety of federal, state and local regulations in connection with the discharge and storage of certain chemicals used in our manufacturing processes, which are now fully outsourced to independent contract manufacturers. We have obtained all necessary permits for such discharges and storage, and we believe that we have been in substantial compliance with applicable environmental regulations. Industrial waste generated at our facilities was either processed prior to discharge or stored in double-lined barrels until removed by an independent contractor. With the completion of our Milpitas site remediation and the closure of our Tempe facility during fiscal 2005, we now expect our environmental compliance costs to be minimal.
We enter into certain types of contracts from time to time that require us to indemnify parties against third party claims. These contracts primarily relate to (1) certain agreements with our directors and officers under which we may be required to indemnify them for the liabilities arising out of their efforts on behalf of the company; and (2) agreements under which we have agreed to indemnify our contract manufacturers and customers for claims arising from intellectual property infringement or in some instances from product defects, product recalls or other issues. The conditions of these obligations vary and generally a maximum obligation is not explicitly stated. Because the obligated amounts under these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. We have not recorded any associated obligations at June 30, 2008 and March 31, 2008. We carry coverage under certain insurance policies to protect ourselves in the case of any unexpected liability; however, this coverage may not be sufficient.
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We typically provide a one-year warranty that our products will be free from defects in material and workmanship and will substantially conform in all material respects to our most recently published applicable specifications although sometimes we provide shorter or longer warranties, especially to some of our larger OEM customers. We have experienced minimal warranty claims in the past, and we accrue for such contingencies in our sales allowances and return reserves.
16. Subsequent Event
On August 1, 2008, we sold the assets related to our line of LED drivers for mobile handsets to a third party buyer for a cash payment of $1.3 million. The transaction includes existing products, products under development and related patents. Two engineers who had worked on this product line for us have also joined the buyer.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In this discussion, “CMD,” “we,” “us” and “our” refer to California Micro Devices Corporation. All trademarks appearing in this discussion are the property of their respective owners. This discussion should be read in conjunction with the other financial information and financial statements and related notes contained elsewhere in this report.
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates, and projections about our industry; our beliefs and assumptions; and our goals and objectives. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” and “estimates,” and variations of these words and similar expressions are intended to identify forward-looking statements. Examples of the kinds of forward-looking statements in this report include statements regarding the following: (1) our expectation that our ASP (“Average Selling Prices”) for similar products will decline at the rate of 12% to 15% per year; (2) our having a target gross margin of 38% to 40%; (3) our expectation that our future environmental compliance costs will be minimal; (4) our anticipation that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs over the next 12 months; (5) our expectation not to pay dividends in the foreseeable future; (6) our plan to examine goodwill at least annually; (7) our having a long term target for research and development expenses of 9% to 10% of sales and anticipated increase in serial interface display controller expenses during the remainder of fiscal 2009; (8) our having a long term target for selling, general and administrative expenses of 15% to 16% of sales but expecting to exceed this target until our sales increase substantially; (9) our expectation of further cost reductions of our products in future; (10) our belief that due to the short duration and investment grade credit ratings of our investment portfolio, there is no material exposure to interest rate risk in our investment portfolio and (11) our expectation of future interest income to continue to be at a reduced level unless interest rates increase materially in the near future. These statements are only predictions, are not guarantees of future performance, and are subject to risks, uncertainties, and other factors, some of which are beyond our control, are difficult to predict, and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, whether our target markets continue to experience their forecasted growth and whether such growth continues to require the devices we supply; whether we will be able to increase our market penetration; whether our product mix changes, our unit volume decreases materially, we experience price erosion due to competitive pressures, or our contract manufacturers and assemblers raise their prices to us or we experience lower yields from them or we are unable to realize expected cost savings in certain manufacturing and assembly processes; whether there will be any changes in tax accounting rules; whether we will be successful developing new products which our customers will design into their products and whether design wins and bookings will translate into orders; whether we encounter any unexpected environmental clean-up issues with our former Tempe facility; whether we discover any further contamination at our former Topaz Avenue Milpitas facility; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under Item 1A, Risk Factors. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.
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We design and sell application specific protection devices and display electronics devices for high volume applications in the mobile handset, digital consumer electronics and personal computer markets as well as protection devices for applications in diversified markets, which includes protection devices for other markets including high brightness light emitting diodes (HBLEDs), communication and industrial equipment. We have one operating segment and primarily serve mobile handset, digital consumer electronics and personal computer markets. We are a leading supplier of protection devices for mobile handsets that provide Electromagnetic Interference (EMI) filtering and Electrostatic Discharge (ESD) protection, and of low capacitance ESD protection devices for digital consumer electronics and personal computers. We also offer display electronics ICs for mobile handset displays including serial interface display controllers. End customers for our semiconductor products are original equipment manufacturers (OEMs). We sell to some of these end customers through original design manufacturers (ODMs) and contract electronics manufacturers (CEMs). We use a direct sales force, manufacturers’ representatives and distributors to sell our products. Our manufacturing is completely outsourced and we use merchant foundries to fabricate our wafers and subcontractors to do backend processing and to ship to our customers. Most of our physical assets are located outside the United States including product inventories and manufacturing equipment consigned to our wafer foundries and backend subcontractors.
First Quarter Key Financial Highlights
The following are key financial highlights of first quarter of fiscal 2009:
Net Sales of $14.1 Million: Our net sales were $14.1 million in the first quarter of fiscal 2009, up 8% from $13.1 million in the same period a year ago. During first quarter of fiscal 2009, our sales in the mobile handset market were $0.4 million lower and sales in the digital consumer electronics and personal computer market and diversified market were $0.3 million and $1.1 million, respectively higher than the same period a year ago.
Gross Margin of $4.7 Million: Our gross margin was $4.7 million (34% of our net sales) in the first quarter of fiscal 2009 as compared to gross margin of $4.1 million (31% of our net sales) in the same period a year ago.
Net Loss of $0.04 per Share – Basic and Diluted: Our net loss per share, basic and diluted, was $0.04 in the first quarter of fiscal 2009 as compared to net loss per share, basic and diluted, of $0.05 in the same period a year ago. We were able to reduce our net loss for the first quarter of fiscal 2009 as compared to the same quarter a year ago, despite increasing research and development expenses by almost $0.4 million and receiving approximately $0.35 million less income from our investments due to reduced interest rates.
Cash Provided by Operating Activities of $0.4 Million: We generated operating cash flow of $0.4 million during the three months ended June 30, 2008 as compared to $0.6 million in the same period a year ago.
Cash* Position: We ended the first quarter of fiscal 2009 with a cash position of $52.1 million as compared to $51.6 million, as of March 31, 2008.
* Cash = Cash and cash equivalents + Short-term investments
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Results of Operations
The table below shows our net sales, cost of sales, gross margin, expenses and net loss, both in dollars and as a percentage of net sales, for the three months ended June 30, 2008 and 2007 (amounts in thousands):
Net sales by market for three months ended June 30, 2008 and 2007 were as follows (amounts in millions):
Note: We are including a new “Diversified” category for our net sales and have revised our breakdown of net sales during the first quarter of fiscal 2008 to include such category. This category includes protection devices for other markets including HBLEDs, communication and industrial equipment.
Net sales for first quarter of fiscal 2009 were $14.1 million, an increase of $1.0 million or 8% from $13.1 million of net sales in the same period a year ago. Sales from products for the mobile handset market decreased by $0.4 million or 5% in first quarter of fiscal 2009, as compared to the same period a year ago, primarily due to lower sales to our major customers and price decreases of our products. These declines were partially offset by increases in unit sales to other customers. Sales from products for the digital consumer electronics and personal computer market increased to $4.1 million in first quarter of fiscal 2009 from $3.8 million in the same period a year ago, up $0.3 million or 8%, which was primarily driven by increased sales of our low capacitance ESD products. Sales from products for the diversified market increased to $2.0 million in first quarter of fiscal 2009 from $0.9 million in the same period a year ago, up $1.1 million, which was primarily driven by increased sales of our HBLED ESD products.
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Total units sold during the three months ended June 30, 2008 decreased to approximately 156 million units from approximately 162 million units during the same period a year ago.
Gross margin increased by $0.7 million during the three months ended June 30, 2008, as compared to the same period a year ago due to the following reasons:
The gross margin increase was primarily driven by change in our product mix and product cost reductions partially offset by price declines of our products. Our ASP declined 8% based on a constant mix of products in the first quarter of fiscal 2009 as compared to the same period a year ago. In the future we expect our ASP for similar products, based on a constant mix of products, to decline at the rate of 12% to 15% per year. The cost reductions of our products were primarily due to outsourcing with lower cost subcontractors, migration of low capacitance ESD products to the lower cost sinker process and continued improvement in our assembly and testing processes. Units sold in mobile handset market decreased by 15% and units sold in digital consumer electronics and personal computer market and diversified market increased by 36% and 65%, respectively during the first quarter of fiscal 2009 as compared to the same period a year ago.
As a percentage of sales, gross margin increased to 34% for the three months ended June 30, 2008, compared to 31% for the same period a year ago. Our long-range gross margin target remains 38% to 40%. However, our gross margin could fail to achieve this target range or could decline.
Research and Development
Research and development expenses consist primarily of compensation and related costs for employees, prototypes, masks and other expenses for the development of new products, process technology and packages. The increase in research and development expenses for the three months ended June 30, 2008, compared to the same period a year ago, was due to the following reasons:
Research and development expenses increased by $0.4 million during the three months ended June 30, 2008, as compared to the same period a year ago, primarily due to increased spending for the serial interface display controller line of products which is anticipated to continue during the remainder of fiscal 2009.
As a percentage of sales, research and development expenses increased to 16% during the three months ended June 30, 2008 from 14% during the same period a year ago. Our long term target for research and development expenses is 9% to 10% of sales. However, research and development expenses may continue to exceed our target range and represent more than 10% of sales.
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Selling, General and Administrative
Selling, general and administrative expenses consist primarily of compensation and other employee related costs, sales commissions, marketing expenses, legal, accounting, other professional fees and information technology expenses. The change in selling, general, and administrative expenses for the three months ended June 30, 2008, compared to the same period year ago, is as follows:
Selling, general and administrative expenses were $3.9 million during the three months ended June 30, 2008 and 2007. There was a slight decrease of $52,000 (or 1%) of selling, general and administrative expenses during the three months ended June 30, 2008 as compared to the same period a year ago.
As a percentage of sales, selling, general and administrative expenses decreased to 27% during the three months ended June 30, 2008 from 30% during the same period a year ago. Our long term target for selling, general and administrative expenses is 15% to 16% of sales. However, selling, general and administrative expenses will continue to exceed our target range and represent more than 16% of sales until our sales increase substantially.
Amortization of Intangible Assets
Amortization of intangible assets was $34,000 and $41,000 during the three months ended June 30, 2008 and 2007, respectively related to the Arques acquisition in fiscal 2007. For additional information regarding intangible assets, see Note 6 in the notes to condensed consolidated financial statements of this Form 10-Q.
Other Income, Net
Other income, net mainly includes interest income, interest expense and other expenses.
The decrease in other income is primarily due to a decrease in interest income from $0.7 million for the three months ended June 30, 2007 to $0.3 million for the three months ended June 30, 2008. The decrease in interest income resulted from a decline in interest rates. We expect interest income, in the near future, to remain at this reduced level unless interest rates increase materially.
During the three months ended June 30, 2008, we recorded an income tax benefit of $226,000 as compared with tax benefit of $11,000 for the same period a year ago. Our income tax benefit increased during the three months ended June 30, 2008 compared to the same period a year ago, primarily as a result of change in our estimates of our ability to utilize loss carryforwards, and the valuation allowance of the deferred tax assets. See Note 13 in the notes to condensed consolidated financial statements of this Form 10-Q for further discussion.
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Critical Accounting Policies and Estimates
The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes. We base our estimates on historical experience and the known facts and circumstances that we believe are relevant. We have not made any material change in the accounting methodology used to establish our estimates and assumptions during the first quarter of fiscal 2009. We do not believe there is a reasonable likelihood that there will be a material change in the accounting methodology used to establish our estimates or assumptions. However, actual results may differ materially from our estimates. Our significant accounting policies are described in Note 2 of notes to consolidated financial statements in our Annual Report on Form 10-K for fiscal 2008. The significant accounting policies that we believe are critical, either because they relate to financial line items that are key indicators of our financial performance such as revenue or because their application requires significant management judgment, are described in the following paragraphs.
We recognize revenue when persuasive evidence of an arrangement exists, delivery or customer acceptance, where applicable, has occurred, the fee is fixed or determinable, and collection is reasonably assured.
Revenue from product sales to end user customers, or to distributors that do not receive price concessions and do not have return rights, is recognized upon shipment and transfer of risk of loss, if we believe collection is reasonably assured and all other revenue recognition criteria are met. We assess the probability of collection based on a number of factors, including past transaction history and the customer’s creditworthiness. If we determine that collection of a receivable is not probable, we defer recognition of revenue until the collection becomes probable, which is generally upon receipt of cash. Reserves for sales returns and allowances from end user customers are estimated based on historical experience and management judgment, and are provided for at the time of shipment. The sufficiency of the reserves for sales return and allowances is assessed at the end of each reporting period.
Revenue from sales of our standard products to distributors whose terms provide for price concessions or for product return rights is recognized when the distributor sells the product to an end customer. For our end of life products, if we believe that collection is probable, we recognize revenue upon shipment to the distributor, because our contractual arrangements provide for no right of return or price concessions for those products.
When we sell products to distributors, we defer our gross selling price of the product shipped and its related cost and reflect such net amounts on our balance sheet as a current liability entitled “deferred margin on shipments to distributors”.
Forecasting customer demand is the factor in our inventory policy that involves significant judgments and estimates. We estimate excess and obsolete inventory based on a comparison of the quantity and cost of inventory on hand to management’s forecast of customer demand for the next twelve months. In forecasting customer demand, we make estimates as to, among other things, the timing of sales, the mix of products sold to customers, the timing of design wins and related volume purchases by new and existing customers, and the timing of existing customers’ transition to new products. We also use historical trends as a factor in forecasting customer demand, especially that from our distributors. We review our excess and obsolete inventory on a quarterly basis considering the known facts. Once inventory is written down, it is valued as such until it is sold or otherwise disposed of. To the extent that our forecast of customer demand materially differs from actual demand, our cost of sales and gross margin could be impacted.
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Impairment of long lived assets
Long lived assets are reviewed for impairment whenever events indicate that their carrying value may not be recoverable. An impairment loss is recognized if the sum of the expected undiscounted cash flows from the use of the asset is less than the carrying value of the asset. The amount of impairment loss is measured as the difference between the carrying value of the assets and their estimated fair value.
We have accounted for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment at the reporting unit level at least annually and more frequently if there are indicators of impairment. The amount of impairment loss is measured as the difference between the carrying value of the assets and their estimated fair value. An impairment loss for an intangible asset is recognized if the sum of the expected undiscounted cash flows from the use of the asset is less than the carrying value of the asset. Significant judgment required to estimate the fair value of an intangible asset includes estimating future cash flows and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value. Any impairment loss recorded in the future could have an adverse impact on our financial condition and results of operations.
Our last annual impairment analysis of goodwill, which was performed during the fourth quarter of fiscal 2008, indicated that the estimated fair value exceeded its corresponding carrying amount. Our entity is deemed as a single reporting unit for our impairment analysis. We computed fair value of our company to be equal to the market capitalization and compared it to the carrying value of the net assets of the company including goodwill and other intangible assets. The market capitalization is based on the quoted closing market price of our stock as traded on NASDAQ as of the date of our impairment analysis. As such, we determined that no impairment exists. The process for evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis. Should actual results differ from our estimates, revisions to the recorded amount of goodwill could be required. We cannot predict the occurrence of future events that might lead to impairment nor the impact such events might have on these reported asset values. We plan to examine goodwill for impairment at least annually.
In accordance with the fair value recognition provisions of SFAS 123(R), we estimate the stock-based compensation cost at the grant date based on the fair value of the award and recognize it as an expense on a graded vesting schedule over the requisite service period of the award.
We estimate the value of employee stock options on the date of grant using the Black-Scholes model. The determination of fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. The use of the Black-Scholes model requires the use of extensive actual employee exercise behavior data and a number of complex assumptions including expected volatility, risk-free interest rate and expected dividends.
Our computation of expected volatility is based on a combination of historical and market-based implied volatility. Our computation of expected life is based on a combination of historical exercise patterns and certain assumptions regarding the exercise life of unexercised options adjusted for job level and demographics. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on our history and expectation of dividend payouts.
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As stock-based compensation expense recognized in the condensed consolidated statements of operations for the three months ended June 30, 2008 and 2007 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on an average of historical forfeitures. The expense that we recognize in future periods could differ significantly from the current period and/or our forecasts due to adjustments in assumed forfeiture rates or change in our assumptions.
We account for income taxes under the asset and liability method; which requires significant judgments in making estimates for determining certain tax liabilities and recoverability of certain deferred tax assets, including the tax effects attributable to net operating loss carryforwards and temporary differences between the tax and financial statement recognition of revenue and expenses, as well as the interest and penalties relating to these uncertain tax positions.
On a quarterly basis, we evaluate our ability to recover our deferred tax assets, including but not limited to our past operating results, the existence of cumulative losses in the most recent fiscal years, and our forecast of future taxable income on a jurisdiction by jurisdiction basis. In the event that actual results differ from our estimates in the future, we will adjust the amount of the valuation allowance that may result in a decrease or increase in income tax expense in those periods.
In the first quarter of fiscal 2008, we adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement No. 109” (FIN 48). As a result of the implementation of FIN 48, we recognize liabilities for uncertain tax positions based on a two-step process prescribed within the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on examination, including resolution of any related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.
It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible outcomes. We will evaluate these uncertain tax positions on a quarterly basis. A change in recognition or measurement in the future may result in the recognition of a tax benefit or an additional charge to the tax provision in the period.
See Note 13 in the notes to condensed consolidated financial statements of this Form 10-Q for further discussion.
We are, on occasion, a party to lawsuits, claims, investigations, and proceedings, including commercial and employment matters, which are being addressed in the ordinary course of business. We review the current status of any pending or threatened proceedings with our outside counsel on a regular basis and, considering all the known relevant facts and circumstances, we recognize any loss that we consider probable and estimable as of the balance sheet date. For these purposes, we consider settlement offers we may make to be indicative of such a loss under certain circumstances. As of June 30, 2008, there was no accrual for litigation related matters.
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Liquidity and Capital Resources
We have historically financed our operations through a combination of debt and equity financing and cash generated from operations. As highlighted in the condensed consolidated statements of cash flows, the Company’s liquidity and available capital resources are impacted by the following key components: (i) cash and cash equivalents, (ii) operating activities, (iii) investing activities, and (iv) financing activities.
Cash, cash equivalents and short-term investments
Total cash, cash equivalents and short-term investments were $52.1 million as of June 30, 2008 compared to $51.6 million as of March 31, 2008, an increase of $0.5 million mainly due to positive operating cash flow and net proceeds from the issuance of common stock under our employee stock benefit plans.
Cash provided by operating activities consists of net loss adjusted for certain non-cash items and changes in assets and liabilities.
During three months ended June 30, 2008, cash provided by operating activities was $0.4 million. The net loss of $0.9 million for first quarter of fiscal 2009 included non-cash items, such as employee stock-based compensation expense of $0.6 million, and depreciation and amortization of fixed assets and amortization of intangible assets aggregating to $0.5 million.
Accounts receivable decreased to $5.5 million at June 30, 2008 compared to $6.2 million at March 31, 2008, mainly as a result of faster collections and a change in our customer mix. Receivables days of sales outstanding were 35 days and 38 days at June 30, 2008 and March 31, 2008, respectively. Net inventory was $6.8 million as of June 30, 2008, compared to $6.4 million as of March 31, 2008. Annualized inventory turns were 5.7 at June 30, 2008 as compared to 6.8 at March 31, 2008. Accounts payable and accrued liabilities totaled $8.1 million at June 30, 2008 compared to $8.3 million at March 31, 2008. Annualized days payable outstanding decreased to 47 at June 30, 2008 from 50 at March 31, 2008. Deferred margin on shipments to distributors decreased to $1.8 million as of June 30, 2008 from $1.9 million as of March 31, 2008.
Cash provided by operating activities was $0.6 million during the three months ended June 30, 2007. Net loss of $1.1 million for the three months ended June 30, 2007, included non-cash items such as employee stock-based compensation expense of $0.7 million and depreciation and amortization of fixed assets and amortization of intangible assets aggregating to $0.5 million. Accounts receivable decreased to $5.5 million at June 30, 2007 compared to $7.5 million at March 31, 2007, primarily as a result of our collection efforts and impact of lower level of sales. Receivables days of sales outstanding were 38 days and 44 days as of June 30, 2007 and March 31, 2007, respectively. Accounts payable and accrued liabilities totaled $6.0 million at June 30, 2007 compared to $7.9 million at March 31, 2007.
The most significant components of the Company’s investing activities in the three months ended June 30, 2008 and 2007 include: (i) purchases and sales/maturities of short-term investments, (ii) payments for acquisitions, and/or (iii) other capital expenditures.
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Investing activities during the three months ended June 30, 2008 provided $9.1 million of cash, primarily reflecting net maturities of short-term investments partially offset by payment towards capital expenditures.
Investing activities during the three months ended June 30, 2007 provided $8.6 million of cash, primarily reflecting our net redemption of short-term investments partially offset by purchase of fixed assets consigned to SPEL, one of our contract manufacturers in India, and the final Arques escrow payment.
The most significant components of the our financing activities during the three months ended June 30, 2008 and 2007 include proceeds from employee stock benefit plans.
Net cash provided by financing activities for the three months ended June 30, 2008 and 2007 was $0.3 million and $0.2 million, respectively and was the result of net proceeds from the issuance of common stock under our employee stock benefit plans.
Contractual Obligations and Cash Requirements
The following table summarizes our contractual obligations as of June 30, 2008 (in thousands):
* Excludes interest and maintenance payments on the capital leases aggregating to $30,000 in the reminder of fiscal 2009.
Effective April 1, 2007, we adopted the provisions of FIN 48 as described in Note 13 of notes to condensed consolidated financial statements in this Form 10-Q. As of June 30, 2008, the liability for uncertain tax positions was approximately $179,000 in addition to the interest and tax penalties of $53,000, of which none is expected to be paid within one year. We are unable to estimate when cash settlement with a taxing authority may occur.
We expect to fund all of these obligations with cash on hand or cash provided from operations.
We anticipate that our existing cash, cash equivalents and short-term investments of $52.1 million as of June 30, 2008 will be sufficient to meet our anticipated cash needs for the next twelve months. Should we desire to expand our level of operations more quickly, either through increased internal development or through the acquisition of product lines from other entities, we may need to raise additional funds through public or private equity or debt financing. The funds may not be available to us, or if available, we may not be able to obtain them on terms favorable to us.
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Recent Accounting Pronouncements
Refer to Note 3 in the notes to condensed consolidated financial statements in this Form 10-Q for a discussion of the expected impact of recently issued accounting pronouncements.
Off-Balance Sheet Arrangements
We do not have off balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K that have, or are reasonably likely to have, a current or future effect upon our financial condition, revenue, expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors, other than contractual obligations shown above.
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As of June 30, 2008 we held $9.4 million of investments in short term, liquid debt securities. Due to the short duration and investment grade credit ratings of these instruments, we do not believe that there is a material exposure to interest rate risk in our investment portfolio. We do not own derivative financial instruments nor do we own auction-rate securities.
We have evaluated the estimated fair value of our financial instruments. The amounts reported as cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short term maturities. Historically, the fair values of our short-term investments are estimated based on quoted market prices.
The table below presents principal amounts and related weighted average interest rates by year of maturity for our capital leases and the fair value as of June 30, 2008. The fair value of our capital lease is based on the estimated market rate of interest for similar instruments with the same remaining maturities.
We have little exposure to foreign currency risk as all our sales are denominated in US dollars as is most of our spending.
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ITEM 4. Controls and Procedures
(a) Disclosure Controls and Procedures.
(i) Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(ii) Limitations on the Effectiveness of Disclosure Controls. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
(iii) Evaluation of Disclosure Controls and Procedures. The Company’s principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2008, and have determined that they were effective at the reasonable assurance level taking into account the totality of the circumstances, including the limitations described above.
(b) Changes in Internal Control over Financial Reporting
Our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) is designed to provide reasonable assurance regarding the reliability of our financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles. There were no significant changes in the Company’s internal control over financial reporting that occurred during our first quarter of fiscal 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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A revised description of the risk factors associated with our business is set forth below. This description supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Form 10-K for the year ended March 31, 2008. Because of these risk factors, as well as other factors affecting the Company’s business and operating results and financial condition, including those set forth elsewhere in this report, our actual future results could differ materially from the results contemplated by the forward-looking statements contained in this report and our past financial performance should not be considered to be a reliable indicator of future performance, so that investors should not use historical trends to anticipate results or trends in future periods.
Our operating results may fluctuate significantly because of a number of factors, many of which are beyond our control and are difficult to predict. These fluctuations may cause our stock price to decline.
Our operating results may fluctuate significantly for a variety of reasons, including some of those described in the risk factors below, many of which are difficult to control or predict. While we believe that quarter to quarter and year to year comparisons of our revenue and operating results are not necessarily meaningful or accurate indicators of future performance, our stock price historically has been susceptible to large swings in response to short term fluctuations in our operating results. Should our future operating results fall below our guidance or the expectations of securities analysts or investors, the likelihood of which is increased by the fluctuations in our operating results, the market price of our common stock may decline.
We had losses in five out of the last nine most recent fiscal quarters, including the first quarters of fiscal 2009, 2008 and 2007 and fourth quarters of fiscal 2008 and 2007, although we were profitable during the second and third quarters of fiscal 2008 and 2007. We may not be able to attain or sustain profitability in the future.
We were profitable for the four quarters during fiscal 2006 until we sustained a substantial loss of nine cents per share during the first quarter of fiscal 2007. This loss would have been a one cent per share profit but for the one time in-process research and development (IPR&D) charge we incurred due to our acquisition of Arques Technology, Inc. We returned to profitability during the second and third quarters of fiscal 2007, followed by losses during fourth quarter of fiscal 2007 and first quarter of fiscal 2008. We were then profitable during the second and third quarters of fiscal 2008 followed by a loss during fourth quarter of fiscal 2008 and first quarter of fiscal 2009. There are many factors that affect our ability to sustain profitability including the health of the mobile handset, digital consumer electronics and personal computer markets on which we focus, continued demand for our products from our key customers, availability of capacity from our manufacturing subcontractors, ability to reduce manufacturing costs faster than price decreases thereby attaining a healthy gross margin, continued product innovation and design wins, competition, interest rates and our continued ability to manage our operating expenses. In order to obtain and sustain profitability in the long term, we will need to continue to grow our business in our target markets and to reduce our product costs rapidly enough to maintain our gross margin. The semiconductor industry has historically been cyclical, and we may be subject to such cyclicality, which could lead to our incurring losses again.
We currently are concentrated in terms of product types (protection devices), markets (mobile handsets), and customers (certain top tier OEMs). Our revenue could suffer materially if the demand or price for protection devices decreases, if the market for mobile handsets stops growing, or if our key customers lose market share.
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Our revenues in recent periods have been derived almost exclusively from sales of circuit protection devices. For example, during the first quarter of fiscal 2009, 96% of our revenue was derived from such sales. With the introduction of our new serial interface display controller, we have several products which could help us reduce our dependence upon circuit protection devices; although for the next several years we expect to derive most of our revenues from circuit protection devices. Should the need for such devices decline, for example because of changes in input and output circuitry, our revenues could decline.
During the first quarter of fiscal 2009, 57% of our revenue was from sales to the mobile handset market, with the balance coming from digital consumer electronics and personal computers and peripherals. In order for us to be successful, we must continue to penetrate these markets, both by obtaining more business from our current customers and by obtaining new customers. Due to our narrow market focus, we are susceptible to materially lower revenues due to material adverse changes to one of these markets, particularly the mobile handset market. We expect much of our future revenue growth to be in the mobile handset market where more complex mobile handsets have meant increased adoption of and demand for protection devices. Should the rate of adoption of protection devices decelerate in the mobile handset market, our planned rate of increase in penetration of that market would also decrease, thereby reducing our future growth in that market. In addition, a reduction in our market share of protection devices sold into that market would also decrease our future growth and could even lead to declining revenue from that market.
Our sales strategy has been to focus on customers with large market share in their respective markets. As a result, we have several large customers. During the first quarter of fiscal 2009, two customers primarily in the mobile handset market represented 37% of our net sales and in the future we expect to increase net sales to a top five OEM customer we begun selling to during the second half of fiscal 2008. There can be no assurance that these customers will purchase our products in the future in the quantities we have forecasted, or at all.
During the first quarter of fiscal 2009, two distributors represented 23% of our net sales. If we were to lose these distributors, we might not be able to obtain other distributors to represent us or the new distributors might not have sufficiently strong relationships with the current end customers to maintain our current level of net sales. Additionally, the time and resources involved with the changeover and training could have an adverse impact on our business in the short term.
The markets in which we participate are intensely competitive and our products are not sold pursuant to long term contracts, enabling our customers to replace us with our competitors if they choose. In addition, our competitors have in the past and may in the future reverse engineer our most successful products and become second sources for our customers, which could decrease our revenues and gross margins.
Our target markets are intensely competitive. Our ability to compete successfully in our target markets depends upon our being able to offer attractive, high quality products to our customers that are properly priced and dependably supplied. Our customer relationships do not generally involve long term binding commitments making it easier for customers to change suppliers and making us more vulnerable to competitors. Our customer relationships instead depend upon our past performance for the customer, their perception of our ability to meet their future need, including price and delivery and the timely development of new devices, the lead time to qualify a new supplier for a particular product, and interpersonal relationships and trust. Furthermore, many of our customers are striving to limit the number of vendors they do business with, and because of our small size and limited product portfolio they could decide to stop doing business with us.
Our most successful products are not covered by patents and have in the past and may in the future be reverse engineered. Thus, our competitors can become second sources of these products for our customers or our customers’ competitors, which could decrease our unit sales or our ability to increase unit sales and also could lead to price competition. This price competition could result in lower prices for our products, which would also result in lower revenues and gross margins. Certain of our competitors have announced products that are pin compatible with some of our most successful products, especially in the mobile handset market, where many of our largest revenue generating products have been second sourced. To the extent that the revenue secured by these competitors exceeds the expansion in market size resulting from the availability of second sources, this decreases the revenue potential for our products. Furthermore, should a second source vendor attempt to increase its market share by dramatic or predatory price cuts for large revenue products, our revenues and margins could decline materially.
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Because we operate in different semiconductor product markets, we generally encounter different competitors in our various market areas. With respect to the protection devices for the mobile handset, digital consumer electronics and personal computer markets, we compete with ON Semiconductor Corporation, NXP, Semtech Corporation and STMicroelectronics, N.V. as well as other smaller companies. For EMI filter devices used in mobile handsets, we also compete with ceramic devices based on high volume Multi-Layer Ceramic Capacitor (MLCC) technology from companies such as Amotek Company, Ltd., AVX Corporation, Innochip Technology, Inc., Murata Manufacturing Co., Ltd., and TDK Corp. MLCC devices are generally low cost and our revenues would suffer if their features and performance meet the requirements of our customers and we are unable to reduce the cost of our protection products sufficiently to be competitive. We have seen ceramic filters obtain significant design wins for low end applications in the mobile handset market and we focused on high end applications as a result. However, we have also begun to see the use of higher performance ceramic filters and if we are not able to demonstrate superior performance at an acceptable price with our devices then our revenues would also suffer. With respect to serial interface display controllers, our competitors include Toshiba Corporation, Samsung, Sharp Electronics Corporation, Renesas Technology, and Solomon Systech. Many of our competitors are larger than we are, have substantially greater financial, technical, marketing, distribution and other resources than we do and have their own facilities for the production of semiconductor components.
Deficiencies in our internal controls could cause us to have material errors in our financial statements, which could require us to restate them. Such restatement could have adverse consequences on our stock price, potentially limiting our access to financial markets.
As of March 31, 2005, management identified, and the auditors attested to, material weaknesses in the Company’s internal control over financial reporting in the operating effectiveness within a portion of the revenue cycle and in the controls over the proper recognition of subcontractor invoices related to inventory and accounts payable. Although management believed it had subsequently remediated these material weaknesses, it was later discovered that they continued through the third quarter of fiscal 2006. Management subsequently assessed and determined, and the auditors attested, that these material weaknesses had been remediated as of March 31, 2006, 2007 and 2008. However, should we or our auditors discover that we have a material weakness in our internal control over financial reporting at another time in the future, especially considering that we have had material weaknesses in the past which we incorrectly believed had been remediated, investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
Within the past five years, we have also had to restate our financial statements twice because of these material weaknesses. In part due to our new ERP system, and new personnel and training regimen, we believe that we will not have a material weakness in our internal control over financial reporting which would lead to material errors in our financial statements. Nonetheless, there can be no assurance that we will not have errors in our financial statements. Such errors, if material, could require us to restate our financial statements, having adverse effects on our stock price, potentially causing additional expense, and could limit our access to financial markets.
In the future our revenues will become increasingly subject to macroeconomic cycles and more likely to decline if there is an economic downturn.
As mobile handset protection devices penetration increases, our revenues will become increasingly susceptible to macroeconomic cycles because our revenue growth may become more dependent on growth in the overall market rather than primarily on increased penetration, as has been the case in the past.
Our reliance on foreign customers could cause fluctuations in our operating results.
During the first quarter of fiscal 2009, international sales accounted for 87% of our net sales. International sales include sales to U.S. based customers if the product was delivered outside the United States.
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International sales subject us to the following risks: