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Silicon Storage Technology 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Graphic
  7. Graphic

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

 

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended March 31, 2008

 

 

 

 

OR

 

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from             to             .

 

 

Commission File Number 0-26944

 

 

SILICON STORAGE TECHNOLOGY, INC.

(Exact name of Registrant as Specified in its Charter)

 

California
(State or Other Jurisdiction of
Incorporation or Organization)

 

77-0225590
(I.R.S. Employer
Identification Number)

 

 

 

1171 Sonora Court, Sunnyvale, CA

 

94086

(Address of Principal Executive Offices)

 

(Zip Code)

 

(408) 735-9110

(Registrant’s 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 o

 

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 “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes 
o  No x

 

Number of shares outstanding of Common Stock, no par value, as of the latest practicable date May 2, 2008: 102,204,557.

 

 



 

SILICON STORAGE TECHNOLOGY, INC.

 

FORM 10-Q: QUARTER ENDED MARCH 31, 2008

TABLE OF CONTENTS

 

Part I—FINANCIAL INFORMATION

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited):

 

 

Condensed Consolidated Statements of Operations

3

 

Condensed Consolidated Balance Sheets

4

 

Condensed Consolidated Statements of Cash Flows

5

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

25

 

 

 

Item 4.

Controls and Procedures

26

 

 

 

Part II—OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

27

 

 

 

Item 1A.

Risk Factors

27

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

39

 

 

 

Item 6.

Exhibits

40

 

 

 

Signatures

 

41

 

2



 

PART I—FINANCIAL INFORMATION

 

Item 1.  Condensed Consolidated Financial Statements

 

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2007

 

2008

 

Net revenues:

 

 

 

 

 

Product revenues - unrelated parties

 

$

39,133

 

$

30,469

 

Product revenues - related parties

 

49,078

 

39,229

 

Technology licensing

 

9,223

 

11,305

 

Technology licensing - related parties

 

90

 

82

 

Total net revenues

 

97,524

 

81,085

 

Cost of revenues:

 

 

 

 

 

Cost of revenues - unrelated parties

 

28,785

 

21,299

 

Cost of revenues - related parties

 

42,218

 

34,077

 

Total cost of revenues

 

71,003

 

55,376

 

Gross profit

 

26,521

 

25,709

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

13,491

 

15,612

 

Sales and marketing

 

6,765

 

7,483

 

General and administrative

 

7,038

 

7,183

 

Total operating expenses

 

27,294

 

30,278

 

Loss from operations

 

(773

)

(4,569

)

Interest income

 

1,830

 

1,302

 

Other income (expense), net

 

(20

)

(364

)

Interest expense

 

(89

)

(64

)

 

 

 

 

 

 

Income (loss) before provision for income taxes and pro rata share of loss from equity investments

 

948

 

(3,695

)

Provision for (benefit from) income taxes

 

746

 

(7,050

)

Income before pro rata share of loss from equity investments

 

202

 

3,355

 

Pro rata share of loss from equity investments

 

1,516

 

1,896

 

 

 

 

 

 

 

Net income (loss)

 

$

(1,314

)

$

1,459

 

 

 

 

 

 

 

Net income (loss) per share - basic

 

$

(0.01

)

$

0.01

 

 

 

 

 

 

 

Shares used in per share calculation - basic

 

103,943

 

103,602

 

 

 

 

 

 

 

Net income (loss) per share - diluted

 

$

(0.01

)

$

0.01

 

 

 

 

 

 

 

Shares used in per share calculation - diluted

 

103,943

 

104,014

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3



 

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands)

 

 

 

December 31,

 

March 31,

 

 

 

2007

 

2008

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

118,157

 

$

88,323

 

Short-term available-for-sale investments

 

44,067

 

58,089

 

Trade accounts receivable-unrelated parties, net of allowance for doubtful accounts of $20 at December 31, 2007 and $16 at March 31, 2008

 

19,301

 

15,040

 

Trade accounts receivable-related parties

 

37,012

 

19,160

 

Inventories

 

50,178

 

59,718

 

Other current assets

 

6,055

 

7,222

 

Total current assets

 

274,770

 

247,552

 

 

 

 

 

 

 

Property and equipment, net

 

18,247

 

18,087

 

Long-term available-for-sale investments

 

36,160

 

53,335

 

Equity investments, GSMC

 

23,150

 

23,150

 

Equity investments, ACET

 

20,756

 

20,574

 

Equity investments, others

 

10,645

 

10,561

 

Goodwill

 

11,221

 

11,221

 

Intangible assets, net

 

7,391

 

6,659

 

Other assets

 

1,125

 

1,755

 

Total assets

 

$

403,465

 

$

392,894

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Borrowing under line of credit facility

 

$

6,836

 

$

 

Trade accounts payable-unrelated parties

 

23,572

 

21,832

 

Trade accounts payable-related parties

 

18,495

 

19,308

 

Accrued expenses and other liabilities

 

21,457

 

18,225

 

Deferred revenue

 

3,004

 

3,312

 

Total current liabilities

 

73,364

 

62,677

 

 

 

 

 

 

 

Taxes payable

 

6,194

 

6,689

 

Other liabilities

 

1,354

 

1,114

 

Total liabilities

 

80,912

 

70,480

 

 

 

 

 

 

 

Commitments (Note 7) and Contingencies (Note 8)

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, no par value:

 

 

 

 

 

Authorized: 7,000 shares

 

 

 

 

 

Series A Junior Participating Preferred Stock, no par value

 

 

 

 

 

Designated: 450 shares

 

 

 

 

 

Issued and outstanding: none

 

 

 

 

 

Common stock, no par value:

 

 

 

 

 

Authorized: 250,000 shares

 

434,905

 

430,497

 

Issued and outstanding: 104,198 shares at December 31, 2007 and 102,156 shares at March 31, 2008

 

 

 

 

 

Accumulated other comprehensive income

 

31,239

 

34,049

 

Accumulated deficit

 

(143,591

)

(142,132

)

Total shareholders’ equity

 

322,553

 

322,414

 

Total liabilities and shareholders’ equity

 

$

403,465

 

$

392,894

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4



 

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2007

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(1,314

)

$

1,459

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,664

 

2,749

 

Stock-based compensation expense

 

1,574

 

1,113

 

Credits from doubtful accounts receivable

 

(46

)

(4

)

Provision for (release from) sales returns

 

82

 

(64

)

Provision for excess and obsolete inventories, write-down of inventories and adverse purchase commitments

 

2,838

 

1,511

 

Pro rata share of loss from equity investments

 

1,516

 

1,915

 

Impairment of notes receivable and interest

 

 

216

 

Gain on disposal of equipment

 

 

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Trade accounts receivable-unrelated parties

 

(379

)

4,319

 

Trade accounts receivable-related parties

 

15,976

 

17,862

 

Inventories

 

5,103

 

(10,685

)

Other current and non-current assets

 

(730

)

(1,363

)

Trade accounts payable-unrelated parties

 

(11,116

)

(1,741

)

Trade accounts payable-related parties

 

(14,518

)

813

 

Accrued expenses and other liabilities

 

(923

)

(3,149

)

Deferred revenue

 

534

 

307

 

Net cash provided by operating activities

 

1,261

 

15,254

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(1,724

)

(1,722

)

Proceeds from sale of equipment

 

 

15

 

Purchases of intellectual property license

 

(225

)

 

Investments in notes receivable

 

 

(533

)

Purchases of available-for-sale investments

 

(17,986

)

(32,404

)

Sales and maturities of available-for-sale investments

 

 

2,625

 

Net cash used in investing activities

 

(19,935

)

(32,019

)

Cash flows from financing activities:

 

 

 

 

 

Debt repayments

 

 

(6,943

)

Issuance of shares of common stock

 

1,236

 

337

 

Repurchases of common stock

 

 

(6,164

)

Principal payments of capital leases

 

(300

)

(299

)

Net cash provided by (used for) financing activities

 

936

 

(13,069

)

Net decrease in cash and cash equivalents

 

(17,738

)

(29,834

)

Cash and cash equivalents at beginning of period

 

100,973

 

118,157

 

Cash and cash equivalents at end of period

 

$

83,235

 

$

88,323

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5



 

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

1. Basis of Presentation

 

In the opinion of management, the accompanying unaudited condensed interim consolidated financial statements contain all adjustments, all of which are normal and recurring in nature, necessary to fairly state our financial position, results of operations and cash flows. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for any future interim periods or for the full fiscal year. These interim financial statements should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The year-end balance sheet at December 31, 2007 was derived from audited consolidated financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles. Please refer to the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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. Actual results could differ from those estimates.

 

Certain amounts previously reported have been reclassified to conform to the current period’s presentation.

 

Recent Accounting Pronouncements

 

In December 2007, Financial Accounting Standards Board, or the FASB issued Statement of Financial Accounting Standard No. 141 (Revised 2007), Business Combinations, or SFAS No. 141R. SFAS No. 141R will change the accounting for business combinations. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Accordingly, any business combinations we engage in will be recorded and disclosed following existing GAAP until January 1, 2009. We expect SFAS No. 141R will have an impact on accounting for business combinations once adopted but the effect is dependent upon acquisitions at that time. We are still assessing the impact of this pronouncement.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51, or SFAS No. 160. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. We have not completed our evaluation of the potential impact, if any, of the adoption of SFAS No. 160 on our consolidated financial position, results of operations and cash flows.

 

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement 133, or SFAS 161. SFAS 161 amends and expands the disclosure requirements of SFAS 133 with the intent to provide users of financial statements with an enhanced understanding of: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are still evaluating the impact of this standard but do not expect the adoption of SFAS 161 to have a material impact on our financial statements.

 

2. Fair Value

 

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, or SFAS 157.  In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually (fair value of reporting units for goodwill impairment tests, non-financial assets and liabilities acquired in a business combination). Therefore, we adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only.  SFAS 157 defines fair value, establishes a framework for measuring

 

6



 

fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

 

·

Level 1 - Quoted prices in active markets for identical assets or liabilities.

·

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The adoption of this statement with respect to our financial assets and liabilities, did not impact our consolidated results of operations and financial condition, but required additional disclosure for assets and liabilities measured at fair value.

 

In accordance with SFAS 157, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of March 31, 2008 (in thousands):

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Money market funds

 

$

10,464

 

 

 

$

10,464

 

Short term available-for-sale investments

 

 

58,089

 

 

 

 

58,089

 

Long term available-for-sale investments

 

53,535

 

 

 

53,535

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

121,888

 

 

 

$

121,888

 

 

Effective January 1, 2008, we adopted SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities,  or SFAS 159. SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. We did not elect to adopt the fair value option under this Statement.

 

3. Computation of Net Income (Loss) Per Share

 

We have computed and presented net income (loss) per share under two methods, basic and diluted. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the sum of the weighted average number of common shares outstanding and potential common shares (when dilutive). A reconciliation of the numerator and the denominator of basic and diluted net income (loss) per share is as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2007

 

2008

 

Numerator -basic

 

 

 

 

 

Net income (loss)

 

$

(1,314

)

$

1,459

 

 

 

 

 

 

 

Denominator - basic

 

 

 

 

 

Weighted average common stock outstanding

 

103,943

 

103,602

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

(0.01

)

$

0.01

 

 

 

 

 

 

 

Denominator - diluted

 

 

 

 

 

Weighted average common stock outstanding

 

103,943

 

103,602

 

Dilutive potential of common stock equivalents

 

 

412

 

Total

 

103,943

 

104,014

 

 

 

 

 

 

 

Diluted net income (loss) per share

 

$

(0.01

)

$

0.01

 

 

7



 

Stock options to purchase 11,606,610 shares of common stock were outstanding as of March 31, 2007 with a weighted average exercise price of $6.82. These stock options were not included in the computation of diluted net loss per share for the three months ended March 31, 2007 because we had a net loss for this period. Stock options to purchase 10,371,185 shares with a weighted average share price of $7.44 were outstanding and not included in the computation of diluted net income per share for the three months ended March 31, 2008 since the exercise price of these options exceeded the average fair market value of our common stock for the three months ended March 31, 2008.

 

4. Stock Compensation

 

Employee Stock Purchase Plan

 

Our 1995 Employee Stock Purchase Plan, or the Purchase Plan, as amended, has 6.0 million shares of common stock reserved for issuance. The Purchase Plan provides for eligible employees to purchase shares of common stock at a price equal to 90% of the fair value of our common stock six months after the option date by withholding up to 10% of their annual base earnings. As of March 31, 2008, 368,000 shares were available for purchase under the Purchase Plan. Shares issued under the Purchase Plan for the three months ended March 31, 2008 were 118,000 for $282,000.

 

Equity Incentive Plan

 

Our 1995 Equity Incentive Plan, or the Equity Incentive Plan, as amended, has 31.8 million shares of common stock reserved for issuance upon the exercise of stock options to our employees, consultants and affiliates. Under the Equity Incentive Plan, the Board of Directors has the authority to determine to whom options will be granted, the number of shares under option, the option term and the exercise price. The options generally are exercisable beginning one year from the date of grant and generally thereafter over four years from the date of grant. The term of any options issued may not exceed ten years from the date of grant.

 

Directors’ Stock Option Plan

 

Each of our non-employee directors receives stock option grants under our 1995 Non-Employee Directors’ Stock Option Plan, or the Directors’ Plan, as amended. Pursuant to the Directors’ Plan, upon each non-employee director’s initial election or appointment to the Board, such new non-employee director receives an initial stock option grant for 45,000 shares of common stock. Each initial stock option grant vests as to 25% of the shares subject to the grant on the anniversary of the grant date. In addition, each non-employee director will receive a fully vested annual stock option grant for 12,000 shares of common stock on the date of the annual shareholders meeting. As of March 31, 2008, the Directors’ Plan had 124,000 shares available for issuance.

 

Compensation Expense

 

We recognize stock-based compensation on the graded vesting method over the vesting periods of the stock options, generally four years. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in accelerated vesting as compared to the straight-line method.

 

8



 

The amount of recognized compensation expense for our stock option plans is adjusted based upon an estimated forfeiture rate which is derived from historical data.

 

The Purchase Plan provides for eligible employees to purchase shares of common stock at a price equal to 90% of the fair value of our common stock on the last day of each six-month offering period. The compensation is the difference between the fair value and purchase price on the date of purchase.

 

The following table shows total stock-based compensation expense included in the condensed consolidated statement of operations (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2007

 

2008

 

 

 

 

 

 

 

Cost of goods sold

 

$

131

 

$

65

 

Research and development

 

784

 

477

 

Sales and marketing

 

276

 

172

 

General and administrative

 

383

 

399

 

Tax effect of stock-based compensation expense

 

 

 

Effect on net income

 

$

1,574

 

$

1,113

 

 

Stock-based compensation of $88,000 and $54,000 was capitalized in inventory as of March 31, 2008 and December 31, 2007, respectively. The tax benefit from the exercise of options was $0 for the three months ended March 31, 2007 and 2008, respectively.

 

As of March 31, 2008, we had unrecognized compensation expense from stock options of $6.8 million excluding estimated forfeitures.

 

5. Investments

 

We consider cash and all highly liquid investments purchased with an original or remaining maturity of less than three months at the date of purchase to be cash equivalents. Substantially all of our cash and cash equivalents are in the custody of three major financial institutions.

 

Short and long-term investments, which are comprised of federal, state and municipal government obligations, foreign and public corporate debt securities and marketable equity securities, are classified as available-for-sale and carried at fair value, based on quoted market prices, with the unrealized gains or losses, net of tax, reported in shareholders’ equity as other comprehensive income. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, both of which are included in interest income. Realized gains and losses are recorded on the specific identification method.

 

Investments in privately held enterprises and certain restricted stocks are accounted for using either the cost or equity method of accounting, as appropriate. Each period, we evaluate whether an event or change in circumstances had occurred that may indicate an investment has been impaired. If upon further investigation of such events we determine the investment has suffered a decline in value that is other than temporary, we write down the investment to its estimated fair value. As of March 31, 2008 and December 31, 2007 the carrying value of these investments was $54.3 million and $54.6 million, respectively.

 

King Yuan Electronics Company Limited, or KYE, Insyde Software Corporation, or Insyde, Powertech Technology, Incorporated, or PTI and Professional Computer Technology Limited, or PCT, are Taiwanese companies that are listed on the Taiwan Stock Exchange. Equity investments in these companies have been included in “Long-term available-for-sale investments.” The investments that are not available for resale due to local securities regulations within one year at the balance sheet date are recorded at cost. The investments that are available for resale within one year at the balance sheet date are recorded at fair value, with unrealized gains and losses, net of tax, reported in shareholders’ equity as other comprehensive income. If a decline in value is judged to be other than temporary, it is reported as an impairment of equity investments. Cash dividends and other distributions of earnings from the investees, if any, are included in other income when declared.

 

In September 2006, we invested an additional $15.9 million in Advanced Chip Engineering Technology Inc., or ACET, that increased our ownership share of ACET’s outstanding capital stock from 9.4% to 46.9% and required us to change from the cost method of accounting to the equity method of accounting for this investment. Under the equity method of accounting, we are required to record our ownership interest in ACET’s reported net income or loss each reporting period

 

9



 

as well as restate our prior period financial statements to reflect the equity method of accounting from the date of the initial investment. Our operating results now include a line item titled “pro rata share of loss from equity investments” on our condensed consolidated statement of operations where we record these expenses. In the third quarter of 2007 we made an additional cash investment, along with other third-party investors, of $10.3 million in ACET’s common stock. Our total investment currently represents 38.5% of the outstanding equity of ACET at March 31, 2008.

 

The table below presents unaudited summarized information regarding ACET’s results of operation without any pro-rata adjustments for our percentage ownership of the outstanding equity of ACET (in thousands):

 

 

 

For the three months
ended March 31,

 

 

 

2007

 

2008

 

Net sales

 

$

146

 

$

619

 

Gross loss

 

$

(2,082

)

$

(2,546

)

Net loss

 

$

(3,067

)

$

(3,937

)

 

We owned 9.8% of the equity of Grace Semiconductor Manufacturing Corporation, or GSMC as of March 31, 2008 with a carrying value of $23.2 million.

 

The fair values of available-for-sale investments as of March 31, 2008 were as follows (in thousands):

 

 

 

Amortized
Cost

 

Unrealized
Gain

 

Unrealized
Loss

 

Fair Value

 

Money market funds

 

$

10,464

 

$

 

$

 

$

10,464

 

Corporate bonds and notes

 

 

17,979

 

 

43

 

 

 

 

18,022

 

Government bonds and notes

 

55,798

 

316

 

 

56,114

 

Foreign listed equity securities

 

4,945

 

32,343

 

 

37,288

 

Total bonds, notes and equity securities

 

$

89,186

 

$

32,702

 

$

 

$

121,888

 

Less amounts classified as cash equivalents

 

 

 

 

 

 

 

(10,464

)

Total short and long-term available-for-sale investments

 

 

 

 

 

 

 

$

111,424

 

Contractual maturity dates for investments in bonds and notes:

 

 

 

 

 

 

 

 

 

Less than one year

 

 

 

 

 

 

 

58,089

 

One to five years

 

 

 

 

 

 

 

16,046

 

 

 

 

 

 

 

 

 

74,135

 

 

Securities are classified as current if they are expected to be realized in cash or sold or consumed during the normal operating cycle of our business.

 

The unrealized gains and losses as of March 31, 2008 are recorded in accumulated other comprehensive income, net of tax.

 

The fair value of available-for-sale investments, including restricted available-for-sale investments, as of December 31, 2007 were as follows (in thousands):

 

 

 

Amortized
Cost

 

Unrealized
Gain

 

Unrealized
Loss

 

Fair
Value

 

Money market funds

 

$

39,996

 

$

 

$

 

$

39,996

 

Corporate bonds and notes

 

 

9,955

 

 

 

 

(5

)

 

9,950

 

Government bonds and notes

 

34,055

 

62

 

 

34,117

 

Foreign listed equity securities

 

4,999

 

31,215

 

 

36,160

 

Total bonds, notes and equity securities

 

$

89,005

 

$

31,277

 

$

(5

)

$

120,223

 

Less amounts classified as cash equivalents

 

 

 

 

 

 

 

(39,996

)

Total short and long-term available-for-sale investments

 

 

 

 

 

 

 

$

80,227

 

Contractual maturity dates for investments in bonds and notes:

 

 

 

 

 

 

 

 

 

Less than one year

 

 

 

 

 

 

 

84,063

 

One to five years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

84,063

 

 

10



 

The unrealized gains and losses as of December 31, 2007 are recorded in accumulated other comprehensive income, net of tax.

We compare the carrying value of our available for sale investments with their quoted market prices at the end of each period. If the quoted market price of a marketable security has dropped significantly during a period or has been below our carrying value for an extended period of time, we review the investment to determine whether the decline is other than temporary. In making this determination, we consider among other things, the investee’s recent operating performance, cash position and revenue and earnings outlook. If we determine that the decline is other than temporary, the investment is written down to its market value as measured at the end of the period. Any resulting charge is included in our statement of operations in the related period. Future increases in the quoted market value of the investment are not recognized until the underlying securities are sold.

 

6. Selected Balance Sheet Detail

 

Details of selected balance sheet accounts are as follows (in thousands):

 

Inventories comprise:

 

 

 

December 31,
2007

 

March 31,
2008

 

Raw materials

 

$

21,301

 

$

28,141

 

Work in-process

 

14,742

 

10,878

 

Finished goods

 

8,419

 

14,812

 

Finished goods inventories held at logistics center

 

5,716

 

5,887

 

 

 

$

50,178

 

$

59,718

 

 

Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market value. We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. The value of our inventory is dependent on our estimate of future average selling prices, and, if our projected average selling prices are over estimated, we may be required to adjust our inventory value. If we over estimate future market demand, we may end up with excess inventory levels that cannot be sold within a normal operating cycle and we may be required to record a provision for excess inventory. Our inventories include high technology parts and components that are specialized in nature or subject to rapid technological obsolescence. Some of our customers have requested that we ship them product that has a finished goods date of manufacture less than one year. In the event that this becomes a common requirement, it may be necessary for us to provide for an additional allowance for our on-hand finished goods inventory with a date of manufacture of greater than one year, which could result in a significant adjustment and could harm our financial results. We review on-hand inventory including inventory held at the logistic center for potential excess, obsolescence and lower of cost or market exposure and record provisions accordingly. Due to the large number of units in our inventory, even a small change in average selling prices could result in a significant adjustment and have a material impact on our financial position and results of operations.

 

Our allowance for excess and obsolete inventories includes a provision for finished goods inventory with a date of manufacture of greater than two years and for certain products with a date of manufacture of greater than one year. In addition, our allowance includes a provision for die, work-in-process and finished goods inventories that exceed our estimated forecast for the next twelve to twenty four months. For the obsolete inventory analysis, we review inventory items in detail and consider date code, customer base requirements, known product defects, planned or recent product revisions, end of life plans and diminished market demand. For excess inventory, we review inventory items in detail and consider our customer base requirements and market demand. While we have programs to minimize inventories on hand and we consider technological obsolescence when estimating allowances for potentially excess and obsolete inventories and those required to reduce recorded amounts to market values, it is reasonably possible that such estimates could change in the near term. Such changes in estimates could have a material impact on our financial position and results of operations. For the three months ended March 31, 2008, we sold previously written down inventory for a total of $1.6 million.

 

Accrued expenses and other liabilities comprise (in thousands):

 

 

 

December 31,
2007

 

March 31,
2008

 

Accrued compensation and related items

 

$

10,223

 

$

8,247

 

Accrued adverse purchase commitments

 

111

 

443

 

Accrued commission

 

1,859

 

1,838

 

Accrued vendor invoices

 

(42

)

212

 

Accrued income tax payable

 

180

 

142

 

Accrued warranty

 

358

 

209

 

Accrued legal and accounting fees

 

6,047

 

3,425

 

Other accrued liabilities

 

2,721

 

3,709

 

 

 

$

21,457

 

$

18,225

 

 

11



 

Changes in the warranty reserves during the three months ended March 31, 2007 and 2008 were as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2007

 

2008

 

Beginning balance

 

$

298

 

$

358

 

Provisions for warranty

 

1,074

 

43

 

Warranty returns

 

(677

)

(135

)

Rescreening, retesting and other settlements

 

(167

)

(57

)

Ending balance

 

$

528

 

$

209

 

 

Our products are generally subject to warranty and we provide for the estimated future costs of repair, replacement or customer accommodation upon shipment of the product in our condensed consolidated statements of operations. Our warranty accrual is estimated based on historical claims compared to historical revenues. For new products, we use our historical percentage for the appropriate class of product.

 

7. Commitments

 

Our technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by our proprietary technology. The terms of these guarantees approximate the terms of the technology license agreements, which typically range from five to ten years. Our current license agreements expire from 2007 through 2014. The maximum possible amount of future payments we could be required to make, if such indemnifications were required on all of these agreements, is $51.3 million. We have not recorded any liabilities as of March 31, 2008 related to these indemnities as no such claims have been made or asserted.

 

During our normal course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These include indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to our directors and officers to the maximum extent permitted under the laws of California. In addition, we have contractual commitments to some customers, which could require us to incur costs to repair an epidemic defect with respect to our products outside the normal warranty period if such defect were to occur. The duration of these indemnities, commitments and guarantees varies. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that we could be obligated to make. We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets. We do, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and the amount is reasonably estimatable.

 

8. Contingencies

 

In January and February 2005 multiple shareholder derivative complaints were filed in California Superior Court for the County of Santa Clara, purportedly on behalf of SST against certain of our directors and officers. The derivative complaints asserted claims for, among other things, breach of fiduciary duty and violations of the California Corporations Code. These derivative actions were consolidated under the caption In Re Silicon Storage Technology, Inc. Derivative Litigation, Lead Case No. 1:05CV034387 (Cal. Super. Ct., Santa Clara Co.). On April 28, 2005, the derivative action was stayed by court order. On October 19, 2007, following the dismissal with prejudice of certain federal putative class actions, the court lifted this stay. On December 6, 2007, plaintiffs filed a consolidated amended complaint reiterating some of the previous claims and asserting claims substantially identical to those contained in the Chuzhoy v. Yeh (Cal. Super. Ct., Santa Clara Co.) and In re Silicon Storage Technology, Inc., Derivative Litigation (N.D. Cal., San Jose Div.) putative derivative actions. We intend to continue to take all appropriate actions in response to this lawsuit. The impact related to the outcome of this matter is undeterminable at this time.

 

12



 

On July 13, 2006, a shareholder derivative complaint was filed in the United States District Court for the Northern District of California by Mike Brien under the caption Brien v. Yeh, et al., Case No. C06-04310 JF (N.D. Cal.). On July 18, 2006, a shareholder derivative complaint was filed in the United States District Court for the Northern District of California by Behrad Bazargani under the caption Bazargani v. Yeh, et al., Case No. C06-04388 HRL (N.D. Cal.). Both complaints were brought purportedly on behalf of SST against certain of our current directors and certain of our current and former officers and allege among other things, that the named officers and directors: (a) breached their fiduciary duties as they colluded with each other to backdate stock options, (b) violated Rule 10b-5 of the Securities Exchange Act of 1934 through their alleged actions, and (c) were unjustly enriched by their receipt and retention of such stock options. The Brien and Bazargani cases were consolidated into one case: In re Silicon Storage Technology, Inc. Derivative Litigation, Case No. C06-04310 JF and a consolidated amended shareholder derivative complaint was filed on October 30, 2006. On May 9, 2008 plaintiff filed their second consolidated shareholder derivative complaint. Our response is due May 19, 2008. On October 31, 2006, a similar shareholder derivative complaint was filed in the Superior Court of the State of California for the County of Santa Clara by Alex Chuzhoy under the caption Chuzhoy v. Yeh, et al., Case No. 1-06-CV-074026. This complaint was brought purportedly on behalf of SST against certain of our current directors and certain of our current and former officers and alleges among other things, that the named officers and directors breached their fiduciary duties as they colluded with each other to backdate stock options and were allegedly unjustly enriched by their actions. The Chuzhoy complaint also alleges that certain of our officers and directors violated section 25402 of the California Corporations Code by selling shares of our common stock while in possession of material non-public adverse information. No response is due until after the plaintiff files an amended complaint. We intend to take all appropriate action in responding to all of the complaints.

 

On or about July 13, 2007, a patent infringement suit was brought by OPTi Inc. in the United States District Court for the Eastern District of Texas alleging infringement of two United State patents related to a “Compact ISA-bus Interface”. The plaintiff seeks a permanent injunction, and damages for alleged past infringement, as well as any other relief the court may grant that is just and proper. At this time, discovery has not yet commenced, and we intend to vigorously defend the suit.

 

From time to time, we are also involved in other legal actions arising in the ordinary course of business. We have accrued certain costs associated with defending these matters. There can be no assurance that the shareholder class action complaints, the shareholder derivative complaints or other third party assertions will be resolved without costly litigation, in a manner that is not adverse to our financial position, results of operations or cash flows or without requiring payments in the future which may adversely impact net income. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies. As a result, no losses associated with these or other litigation have been accrued in our financial statements as of March 31, 2008.

 

9. Line of Credit

 

On August 07, 2007, SST China Limited entered into a one year facility agreement with Bank of America, N.A. Shanghai Branch, a U.S. bank, for RMB 58.40 million revolving line of credit. The line of credit will be used for working capital but there are no restrictions in the agreement as to how the funds may be used.  The interest rate for the line of credit is 90% of People’s Bank of China’s base rate (6.57% at March 31, 2008).  This facility line is guaranteed by the parent company, Silicon Storage Technology, Inc. SST is required to meet certain financial covenants, including have a ratio of the funded debt to EBITA less than 2.0. If not, we have to deposit with Bank of America cash collateral at all times in an amount equal to the outstanding principal balance. During the period ending March 31, 2008 we repaid the balance on this line of credit in the amount of $6.9 million and as of March 31, 2008, SST China Limited has no outstanding balance against this line. We are in compliance with all terms of this facility agreement.

 

10. Goodwill and Intangible Assets:

 

Our goodwill and intangible assets include $11.2 million of goodwill and $16.5 million of identifiable intangible assets acquired from acquisitions made in 2004 and 2005 and $3.0 million of purchased intellectual property. The goodwill is not being amortized but is tested for impairment annually, as well as when an event or circumstance occurs indicating a possible impairment in value. In the first quarter of 2008, we reclassed approximately a net $23,000 in intellectual property into operating expense.

 

As of March 31, 2008, our intangible assets consisted of the following (in thousands):

 

 

 

Cost

 

Accumulated
Amortization

 

Accumulated
Impairment

 

Net

 

Existing technology

 

$

11,791

 

$

(8,529

)

$

(384

)

$

2,878

 

Intellectual property

 

3,030

 

(128

)

 

2,902

 

Trade name

 

1,198

 

(852

)

 

346

 

Customer relationships

 

1,857

 

(1,491

)

 

366

 

Backlog

 

811

 

(811

)

 

 

Non-Compete Agreements

 

810

 

(643

)

 

167

 

 

 

$

19,497

 

$

(12,454

)

$

(384

)

$

6,659

 

 

13



 

As of December 31, 2007, our intangible assets consisted of the following (in thousands):

 

 

 

Cost

 

Accumulated
Amortization

 

Accumulated
Impairment

 

Net

 

Existing technology

 

$

11,791

 

$

(7,996

)

$

(384

)

$

3,411

 

Intellectual property

 

3,053

 

(98

)

 

2,955

 

Trade name

 

1,198

 

(792

)

 

406

 

Customer relationships

 

1,857

 

(1,446

)

 

411

 

Backlog

 

811

 

(811

)

 

 

Non-Compete Agreements

 

810

 

(602

)

 

208

 

 

 

$

19,520

 

$

(11,745

)

$

(384

)

$

7,391

 

 

All intangible assets are being amortized on a straight-line basis over their estimated useful lives. Existing technologies have been assigned useful lives of between four and five years, with a weighted average life of approximately 4.6 years. Non-compete agreements have been assigned useful lives between two and four years, with a weighted average of 3.6 years. Intellectual property has been assigned an estimated life of three to five years and will begin amortization as it is put into service. Trade names and backlogs have been assigned useful lives of five years, and one year, respectively. Customer relationships have been assigned useful lives between three and five years with a weighted average of 4.0 years. Amortization expense for intangible assets were $941,000 and $709,000 for the three months ended March 31, 2007 and 2008, respectively.

 

Estimated future intangible asset amortization expense for the next five years is as follows (in thousands):

 

Fiscal Year

 

Amortization of
Intangible Assets

 

2008 remaining nine months

 

$

2,481

 

2009

 

2,572

 

2010

 

1,040

 

2011

 

566

 

2012 and thereafter

 

 

 

 

$

6,659

 

 

There was no change in the carrying amount of goodwill for the three months ended March 31, 2008 from December 31, 2007.

 

11. Segment Reporting

 

Our Memory Product segment, which is comprised of NOR flash memory products, includes the Multi-Purpose Flash or MPF family, the Multi-Purpose Flash Plus or MPF+ family, the Concurrent SuperFlash or CSF family, the Firmware Hub or FWH family, the Serial Flash family, the ComboMemory family, the Many-Time Programmable or MTP family, and the Small Sector Flash or SSF family.

 

Our Non-Memory Products segment is comprised of all other semiconductor products including flash microcontrollers, smartcard ICs and modules, radio frequency ICs and modules, NAND controllers and NAND-controller based modules.

 

Technology Licensing includes both license fees and royalties generated from the licensing of our SuperFlash technology to semiconductor manufacturers for use in embedded flash applications.

 

14



 

We do not allocate operating expenses, interest and other income/expense, interest expense, impairment of equity investments or provision for or benefit from income taxes to any of these segments for internal reporting purposes, as we do not believe that allocating these expenses are beneficial in evaluating segment performance. Additionally, we do not allocate assets to segments for internal reporting purposes as we do not manage our segments by such metrics. The following table shows our revenues and gross profit for each segment (in thousands):

 

 

 

Three Months Ended
March 31, 2007

 

Three Months Ended
March 31, 2008

 

 

 

Revenues

 

Gross
Profit

 

Revenues

 

Gross
Profit

 

 

 

 

 

 

 

 

 

 

 

Memory

 

$

78,616

 

$

15,063

 

$

61,690

 

$

12,675

 

Non-Memory

 

9,595

 

2,145

 

8,008

 

1,647

 

Technology Licensing

 

9,313

 

9,313

 

11,387

 

11,387

 

 

 

$

97,524

 

$

26,521

 

$

81,085

 

$

25,709

 

 

12. Related Party Transactions and Balances

 

The following table is a summary of our related party revenues and purchases for the three months ended March 31, 2007 and 2008, and our related party accounts receivable and accounts payable and accruals as of December 31, 2007 and March 31, 2008 (in thousands):

 

 

 

Revenues

 

Purchases

 

 

 

March 31,

 

March 31,

 

 

 

2007

 

2008

 

2007

 

2008

 

Silicon Technology Co., Ltd.

 

$

265

 

$

 

$

 

$

 

Apacer Technology, Inc. & related entities

 

765

 

724

 

 

 

Advanced Chip Engineering Technology, Inc.

 

 

 

 

207

 

Professional Computer Technology Limited & related entities

 

48,048

 

38,505

 

 

 

Grace Semiconductor Manufacturing Corp.

 

90

 

82

 

15,841

 

21,457

 

King Yuan Electronics Company, Limited

 

 

 

7,523

 

5,415

 

Powertech Technology, Incorporated

 

 

 

4,451

 

5,183

 

 

 

$

49,168

 

$

39,311

 

$

27,815

 

$

32,262

 

 

 

 

Trade Accounts Receivable

 

Account Payable and
Accruals

 

 

 

December 31,
2007

 

March 31,
2008

 

December 31,
2007

 

March 31,
2008

 

Silicon Technology Co., Ltd.

 

$

 

$

 

$

 

$

 

Apacer Technology, Inc. & related entities

 

51

 

375

 

 

 

Advanced Chip Engineering Technology, Inc.

 

 

 

11

 

215

 

Professional Computer Technology Limited & related entities

 

36,789

 

18,644

 

624

 

375

 

Grace Semiconductor Manufacturing Corp.

 

172

 

141

 

8,490

 

11,201

 

King Yuan Electronics Company, Limited

 

 

 

5,509

 

4,068

 

Powertech Technology, Incorporated

 

 

 

3,861

 

3,449

 

 

 

$

37,012

 

$

19,160

 

$

18,495

 

$

19,308

 

 

15



 

Professional Computer Technology Limited, or PCT, earns commissions for point-of-sales transactions to customers. PCT’s commissions are paid at the same rate as all of our other stocking representatives in Asia. In addition, we pay Silicon Professional Technology Ltd., or SPT, a wholly-owned subsidiary of PCT, a fee for providing logistics center functions. This fee is based on a percentage of revenue for each product shipped through SPT to our end customers. The fee paid to SPT covers the costs of warehousing and insuring inventory and processing accounts receivable, the personnel costs required to maintain logistics and information technology functions and the costs to perform demand forecasting, billing and collection of accounts receivable.

 

13. Income Taxes

 

We maintained a full valuation allowance on our net deferred tax assets as of March 31, 2008. The valuation allowance was determined in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, or SFAS No. 109, which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable; such assessment is required on a jurisdiction by jurisdiction basis. We intend to maintain a full valuation allowance on the U.S. deferred tax assets until sufficient positive evidence exists to support reversal of the valuation allowance.

 

Our tax provision for the first quarter of 2008 was a benefit of approximately $7.1million. This consists of a $7.9 million benefit due to a refund from an IRS settlement from an amended return, and $0.8 million charge related to foreign income and withholding taxes. The tax refund of $7.9 million included $6.1 million of tax and $1.8 million of interest.  Our tax provision for the first quarter of 2007 was approximately $0.7 million. This consists primarily of foreign income and withholding taxes.

 

The provision for income tax decreased approximately $7.8 million in the first quarter of 2008 as compared to the same period in 2007. The decrease is due primarily to an IRS settlement from an amended return. Since the tax position taken in the refund claim did not meet the more likely than not recognition threshold under FIN 48, thus we had not previously recognized the tax benefit of this position. Therefore, upon settlement with the IRS the entire amount of the refund is recorded as a benefit provision in the current quarter. There were no other material changes to our unrecognized tax benefits in the quarter. We do not anticipate any material changes to our uncertain tax positions over the next 12 months. We continue to include interest and penalties, if any, in tax expense.

 

14. Stock Repurchase Program

 

On February 6, 2008, we announced that our Board of Directors authorized management to repurchase up to $30 million of our common stock at any time commencing February 11, 2008.  The program does not obligate us to acquire shares at any particular price per share and may be suspended at any time at our discretion. During the quarter ended March 31, 2008, we purchased and retired 2.2 million shares for an aggregated cost of $6.2 million.

 

15. Subsequent Event

 

On May 1, 2008, we completed our tender offer by which active employees who were option holders were offered the opportunity to amend or exchange their options to avoid the adverse tax consequences of Section 409A.  A total of 1,535,000 Section 409A shares were tendered and 4,855,000 underwater shares were tendered in exchange for a total of 1,981,000 new options issued. The new options have an exercise price of $3.19 per share, the closing price of our common stock as reported on the NASDAQ Global Market on May 1, 2008.

 

16



 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion may be understood more fully by reference to the consolidated financial statements, notes to the consolidated financial statements and management’s discussion and analysis of financial condition and results of operations contained in our Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission.

 

The following discussion contains forward-looking statements, which involve risk and uncertainties. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors which are difficult to forecast and can materially affect our quarterly or annual operating results. Fluctuations in revenues and operating results may cause volatility in our stock price. Please also see Item 1A. “Risk Factors.”

 

Overview

 

We are a leading supplier of NOR flash memory semiconductor devices for the digital consumer, networking, wireless communications and Internet computing markets. NOR flash memory is a form of nonvolatile memory that allows electronic systems to retain information when the system is turned off. NOR flash memory is now used in hundreds of millions of consumer electronics and computing products annually.

 

We produce and sell many products based on our SuperFlash design and manufacturing process technology. Our products are incorporated into products sold by many well-known companies including Apple, Asustek, Cambridge Silicon Radio, Canon, Compal, Dell, Epson, First International Computer, FIC, Foxconn, or Honhai, Fujitsu, Funai, Garmin, Gigabyte, GN Netcom, Haier, Hewlett Packard, Huawei, Infineon, Intel, IBM, Inventec, JVC, Lenovo, Lexmark, LG Electronics, Lite-On IT, Matsushita, or Panasonic, Micronas, Motorola, NEC, Nintendo, Philips, Pioneer, Quanta, Sagem, Samsung, Sanyo, Seagate, Sony, Sony Ericsson, TCL, Thomson, TiVO, Toshiba, USI, Western Digital, and ZTE.

 

We also produce and sell other semiconductor products including flash microcontrollers, smartcard ICs and modules, radio frequency, or RF, ICs and modules, NAND controllers and NAND-controller based modules.

 

One of our key initiatives is the active development of our non-memory business. Our objective is to transform SST from a pure play in flash memory to a multi-product line semiconductor company and a leading licensor of embedded flash technology. We continue to execute on our plan to derive a significant portion of our revenue from non-memory products, which includes embedded controllers, NAND-controller based modules, smartcard ICs and radio frequency ICs and modules. We believe non-memory products represent an area in which we have significant competitive advantages and also an area that can yield profitable revenue with higher and more stable gross margins than our memory products in the long run.

 

During the first quarter of 2008, we saw the first meaningful revenue from our NANDrive devices. While revenue from these devices was less than $100,000, it represented a substantial increase over the prior quarter and we expect to see further increases in the second quarter of 2008. During the first quarter of 2008, we introduced additional products to our NANDrive line to allow us to address industrial applications operating in harsh environments, including factory automation and in-cabin automotive electronics. We continue to work on many more design-in opportunities for this family of products. In the All-in-OneMemory area, we are also seeing strong interests from cell phone and industrial applications. We are focused on working with several customers to design in our first products. Due to the complexity of this product family, the design-in and qualification cycle is expected to be long. In 2007, we introduced an advanced wireless audio solution, MeleodyWing SP, which allows users to connect surround sound speakers wirelessly to their high-definition TVs at wire-equivalent sound quality. Customer interest continues to be favorable and the design-in activities are continuing. As wireless speaker products are a very new area in the consumer audio/visual industry, and several AV manufacturers had bad experience of high return rate in the past due to the poor quality of existing market wireless audio products, the potential volume accounts are very cautious in adopting any new wireless audio solutions. As such, we believe we will gradually increase shipments to small accounts to establish our track-record in quality and delivery before shipments with high volume accounts will start to occur. We continue to believe the strategy of investing in higher ASP products such as NANDrive, All-In-OneMemory and MelodyWing, will drive our revenue and gross profit growth over time.

 

During the first quarter of 2008, in addition to normal seasonality, we experienced softness in our memory business due to a combination of factors. We experienced push-outs of shipments by several of our high-volume customers, aggressive pricing due to inventory adjustments by competitors in the mobile phone market, and certain high-volume commodity customers that were turned away during the second half of 2007 due to product shortages did not purchase from us. Ongoing volatile macroeconomic conditions are prompting us to plan and guide conservatively for our business for the current quarter

 

17



 

and the rest of the year. Overall, we expect that the near-term sluggishness in the market will continue through the second quarter, keeping our revenues fairly flat.

 

In the area of memory technologies, we are continuing to reduce manufacturing costs through the transition to smaller process technologies that generally carry a lower cost per die. Wafer starts are primarily now in the 180 and 250 nanometer geometry. We began the 120-nanometer pilot production in the first quarter at Powerchip’s 8” line and began engineering lots on a 12” line. We also expect to begin the 120nm pilot production at Grace in the second quarter. As a result, the supply situation is improving and we expect to be able to meet the seasonal build in the second half of 2008.  By gradually converting a large portion of our products from 180 nanometer to 120 nanometer, we expect our unit output from both foundries to increase by the fourth quarter of this year.

 

The semiconductor industry has historically been cyclical, characterized by periodic changes in business conditions caused by product supply and demand imbalance. When the industry experiences downturns, they often occur in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. These downturns are characterized by weak product demand, excessive inventory and accelerated decline of selling prices.

 

Concentrations

 

We derived 87.7%, 88.8% and 85.2% of our net product revenues during 2006, 2007 and the first three months of 2008, respectively, from product shipments to Asia. In addition, substantially all of our wafer suppliers and packaging and testing subcontractors are located in Asia.

 

Shipments to our top ten end customers, which exclude transactions through stocking representatives and distributors, accounted for 20.1%, 17.8% and 22.5% of our net product revenues in 2006, 2007 and the first three months of 2008, respectively.

 

No single end customer, which we define as original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, contract electronic manufacturers, or CEMs, or end users, represented 10.0% or more of our net product revenues during 2006, 2007 and the first three months of 2008.

 

We ship products to, and have accounts receivable from, OEMs, ODMs, CEMs, stocking representatives, distributors, and our logistics center. Our stocking representatives, distributors and logistics center reship our products to our end customers, including OEMs, ODMs, CEMs and end users. Shipments, by us or our logistic center, to our top three stocking representatives for reshipment accounted for 48.5%, 60.3% and 51.1% of our product shipments in 2006, 2007 and the first three months of 2008, respectively. In addition, the same three stocking representatives solicited sales, for which they received a commission, for 10.3%, 9.1% and 10.2% of our product shipments to end users in 2006, 2007 and the first three months of 2008, respectively.

 

We out-source our end customer service logistics in Asia to Silicon Professional Technology Ltd., or SPT, which supports our customers in Taiwan, China and other Southeast Asia countries. SPT provides forecasting, planning, warehousing, delivery, billing, collection and other logistic functions for us in these regions. SPT is a wholly-owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology Limited, or PCT. Please see a description of our relationship with PCT under “Related Party Transactions.” Products shipped to SPT are accounted for as our inventory held at our logistics center, and revenue is recognized when the products have been delivered and are considered as a sale to our end customers by SPT. For the years ended December 31, 2006, 2007 and the three months ended March 31, 2008, SPT serviced end customer sales accounting for 59.1%, 60.1% and 55.2% of our net product revenues recognized. As of December 31, 2006, 2007 and the three months ended March 31, 2008, SPT represented 68.9%, 65.3% and 54.5% of our net accounts receivable, respectively.

 

Our product sales are made primarily using short-term cancelable purchase orders. The quantities actually purchased by the customer, as well as shipment schedules, are frequently revised to reflect changes in the customer’s needs and in our supply of product. Accordingly, our backlog of open purchase orders at any given time is not a meaningful indicator of future sales. Changes in the amount of our backlog do not necessarily reflect a corresponding change in the level of actual or potential sales.

 

Critical Accounting Estimates

 

For information related to our revenue recognition and other critical accounting estimates, please refer to the “Critical Accounting Estimates” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

18



 

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, or SFAS 157.  In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually (fair value of reporting units for goodwill impairment tests, non-financial assets and liabilities acquired in a business combination). Therefore, we adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only.  SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

 

·

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

·

 

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The adoption of this statement did not impact our consolidated results of operations and financial condition, but required additional disclosure for assets and liabilities measured at fair value.

 

Results of Operations: Three months ended March 31, 2008

 

Net Revenues (in thousands)

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

Memory Revenue

 

$

78,616

 

$

86,360

 

$

61,690

 

$

(24,670

)

(28.6

)%

$

(16,926

)

(21.5

)%

Non-Memory Revenue

 

9,595

 

9,274

 

8,008

 

(1,266

)

(13.7

)%

(1,587

)

(16.5

)%

Product revenues

 

88,211

 

95,634

 

69,698

 

(25,936

)

(27.1

)%

(18,513

)

(21.0

)%

Technology licensing

 

9,313

 

11,744

 

11,387

 

(357

)

(3.0

)%

2,074

 

22.3

%

Total net revenues

 

$

97,524

 

$

107,378

 

$

81,085

 

$

(26,293

)

(24.5

)%

$

(16,439

)

(16.9

)%

 

The following discussions are based on our reportable segments described in Note 11 of our unaudited condensed consolidated financial statements.

 

Memory Products

 

Memory revenue decreased 21.5% in the first quarter of 2008 from the fourth quarter of 2007 primarily due to a 20.7% decrease in unit shipments. Seasonal weakness in demand across all application categories from the post holiday-build season and industry over supply led to the results. Memory revenue decreased in the first quarter of 2008 compared to the first quarter of 2007 due to a 12.3% decrease in average selling prices and a 11.7% decrease in unit shipments. The decrease in average selling prices was primarily a result of product mix and continuing competitive pricing pressures in the NOR flash  markets.

 

Non-Memory Products

 

Non-memory revenue decreased 13.2% in the first quarter of 2008 from the fourth quarter of 2007 primarily due to a 26.2% decrease in unit shipments. The decrease was primarily due to lower unit shipments in first quarter of 2008 from decreased demand of smartcard ICs. The decrease in unit shipments was somewhat offset by a 21.2% increase in average selling prices due to product mix. Non-memory revenue decreased 16.5% in the first quarter of 2008 compared to the first quarter of 2007 due to a 36.1% decrease in unit shipments.  We expect revenue to fluctuate in non-memory business throughout 2008 as we expect to grow and diversify our revenue and customer base.

 

19



 

Technology Licensing Revenue

 

Technology license revenue includes a combination of up-front fees and royalties. Technology licensing revenue for the first quarter of 2008 declined from the fourth quarter of 2007 due to slightly lower royalties. Technology licensing revenue for the first quarter of 2008 increased compared to the first quarter of 2007 as a result of higher royalties received. We anticipate revenues from technology licensing may fluctuate significantly in the future.

 

Gross Profit (in thousands)

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

Memory gross profit

 

$

15,063

 

$

21,078

 

$

12,675

 

$

(8,403

)

(39.9

)%

$

(2,388

)

(15.9

)%

Memory gross margin

 

19.2

%

24.4

%

20.5

%

 

 

 

 

 

 

 

 

Non-Memory gross profit

 

$

2,145

 

$

1,586

 

$

1,647

 

$

61

 

3.8

%

$

(498

)

(23.2

)%

Non-Memory gross margin

 

22.4

%

17.2

%

20.6

%

 

 

 

 

 

 

 

 

Product gross profit

 

$

17,208

 

$

22,664

 

$

14,322

 

$

(8,342

)

(36.8

)%

$

(2,886

)

(16.8

)%

Product gross margin

 

19.5

%

23.7

%

20.5

%

 

 

 

 

 

 

 

 

Technology licensing gross profit

 

9,313

 

11,744

 

11,387

 

(357

)

(3.0

)%

2,074

 

22.3

%

Technology licensing gross margin

 

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

Total gross profit

 

$

26,521

 

$

34,408

 

$

25,709

 

$

(8,699

)

(25.3

)%

$

(812

)

(3.1

)%

Total gross margin

 

27.2

%

32.1

%

31.7

%

 

 

 

 

 

 

 

 

 

Product Gross Profit

 

Memory products

 

Gross profit for memory products decreased 39.9% in the first quarter of 2008 compared to the fourth quarter of 2007 largely due to a 20.7% decrease in the number of units shipped and a 9.5% decline in the average selling prices of these products. Serial flash devices led the declines in both units shipped and average selling prices. Compared to the first quarter of 2007, gross profit decreased by 15.9% due to a 12.3% decrease in average selling prices from product mix coupled with an 11.7% decrease in unit shipments.

 

Non-memory products

 

Gross profit for non-memory products increased 3.9% in the first quarter of 2008 compared to the fourth quarter of 2007 as average selling prices increased 21.2% offsetting a 26.2% decrease in unit shipments. In comparison to the first quarter of 2007, gross profit decreased 23.2% due to a 36.1% decline in unit shipments led by smartcard ICs. Average selling prices increased 21.2% to partially offset the decline.

 

For other factors that could affect our gross profit, please also see Item 1A. “Risk Factors—We incurred significant inventory valuation and adverse purchase commitment adjustments in 2006, 2007 and the first three months ended March 31, 2008 and we may incur additional significant inventory valuation adjustments in the future.”

 

Operating Expenses (in thousands)

 

Research and development

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

Research and development

 

$

13,491

 

$

14,694

 

$

15,612

 

$

918

 

6.2

%

$

2,121

 

15.7

%

Percent of revenue

 

13.8

%

13.7

%

19.3

%

 

 

 

 

 

 

 

 

 

Research and development expenses include costs associated with the development of new products, enhancements to existing products, quality assurance activities and occupancy costs. These costs consist primarily of employee salaries, stock-based compensation expense and other benefit-related costs and the cost of materials such as wafers and masks.

 

20



 

In comparison to the fourth quarter of 2007, research and development spending increased primarily due to an increases in masks and reticules costs of $516,000 as well as a $380,000 increase in evaluation parts as part of the ramp in new product introductions. For the three months ended March 31, 2008 in comparison to the same quarter in 2007, research and development spending increased due to higher wafer, mask and reticle costs of $741,000, evaluation parts of $349,000 and outside services of $227,000. Salaries and wages also rose $652,000 due to increased headcount. We expect that research and development expenses will fluctuate based on the timing of engineering projects for new product introductions and the development of new technologies to support future growth.

 

Sales and marketing

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

Sales and marketing

 

$

6,765

 

$

7,535

 

$

7,483

 

$

(52

)

(0.7

)%

$

718

 

10.6

%

Percent of revenue

 

6.9

%

7.0

%

9.2

%

 

 

 

 

 

 

 

 

 

Sales and marketing expenses consist primarily of commissions, employee salaries, stock-based compensation expense and other benefit-related costs, as well as travel and entertainment expenses.

 

Sales and marketing expense decreased in the first quarter of 2008 compared to the fourth quarter of 2007 due to lower logistic center fees of $355,000. This decrease was partially offset by increased commission expense of $309,000. From the same period a year ago, sales and marketing expenses increased $718,000 for the quarter ended March 31, 2008 due to higher salaries and wages of $441,000 and payroll taxes of $215,000. Partially offsetting these were lower stock-based compensation expenses of $103,000. We expect that future sales and marketing expenses may increase in absolute dollars. In addition, fluctuations in revenues will cause fluctuations in sales and marketing expenses due to our commission expenses.

 

General and administrative

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

General and administrative

 

$

7,038

 

$

6,154

 

$

7,183

 

$

1,029

 

16.7

%

$

145

 

2.1

%

Percent of revenue

 

7.2

%

5.7

%

8.9

%

 

 

 

 

 

 

 

 

 

General and administrative expenses mainly consist of salaries, stock-based compensation, and other-benefit related costs for administrative, executive and finance personnel, recruiting costs, professional services and legal fees and allowances for doubtful accounts.

 

General and administrative expenses increased in the first quarter of 2008 compared to the fourth quarter of 2007 primarily due to increased legal expenses of $237,000, a $232,000 increase in tax service fees, a $207,000 increase in executive bonuses, a $192,000 increase in stock based compensation expense and a $151,000 increase in company matching of 401k contributions.  In comparison to the first quarter of 2007, general and administrative expenses increased $145,000 for the quarter ended March 31, 2008 due to increases in salaries and wages of $132,000, payroll tax expenses of $254,000 and recurring legal expenses of $208,000. Partially offsetting these increases were decreases in outside services $213,000 and legal fees of $554,000 related to our independent stock option investigation. We anticipate that general and administrative expenses may increase in absolute dollars as we scale our facilities, infrastructure and headcount to support our overall expected growth.

 

Interest and Other income and expense, net

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007

 

2007

 

2008

 

4Q07 Change

 

1Q07 Change

 

Interest income

 

$

1,830

 

$

1,824

 

$

1,302

 

$

(522

)

(28.6

)%

$

(528

)

(28.9

)%

Percent of revenue

 

1.9

%

1.7

%

1.6

%

 

 

 

 

 

 

 

 

 

21



 

Interest income includes interest from our cash and short-term cash equivalents. For the first quarter ended March 31, 2008 in comparison to the fourth quarter of 2007, interest income declined due to decreases in short-term interest rates, For the three months ended March 31, 2008 in comparison to the same period in 2007, interest income fell due to sharply lower average interest rates. We expect that interest income will fluctuate due to changing economic conditions in the United States as well as fluctuating short-term interest rates.

 

Other income and expense, net

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

Dec 31,

 

March 31,

 

1Q08-Over-

 

1Q08-Over-

 

 

 

2007