SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
Or
| ¨ | 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: 000-22339
RAMBUS INC.
(Exact name of registrant as specified in its charter)
| Delaware | 94-3112828 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
| 4440 El Camino Real Los Altos, California |
94022 | |
| (Address of principal executive offices) | (Zip Code)) |
Registrant’s telephone number, including area code: (650) 947-5000
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class |
Name of Each Exchange on Which Registered | |
| Common Stock, $.001 Par Value Preferred Share Purchase Rights |
The NASDAQ Stock Market LLC (The Nasdaq Global Select Market) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 ¨ No x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant as of June 30, 2006 was approximately $1.64 billion based upon the closing price reported for such date on The Nasdaq Global Select Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the Registrant have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of outstanding shares of the Registrant’s Common Stock, $.001 par value, was 103,820,383 as of May 31, 2007.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (Annual Report) contains forward-looking statements. These forward-looking statements include, without limitation, predictions regarding the following aspects of our future:
| • | Outcome and effect of current and potential future intellectual property litigation; |
| • | Resolution of the Federal Trade Commission and European Commission matters involving us; |
| • | Accounting, tax, regulatory, legal and other outcomes and effects of the stock option investigation; |
| • | Consequences of the derivative, class-action and other lawsuits related to the stock option investigation; |
| • | The actions of our Special Litigation Committee; |
| • | Actions of governmental authorities and other regulators, including Nasdaq, the SEC and the IRS; |
| • | Sources, amounts and concentration of revenue, including royalties; |
| • | Product development; |
| • | Improvements in technology; |
| • | Engineering, marketing and general and administration expenses; |
| • | Litigation expenses; |
| • | Success in the markets of our or our licensees’ products; |
| • | Terms of our licenses; |
| • | Success in renewing license agreements; |
| • | Pricing policies of our licensees; |
| • | Sources of competition; |
| • | Protection of intellectual property; |
| • | International licenses and operations, including our design facility in Bangalore, India; |
| • | Indemnification and technical support obligations; |
| • | Likelihood of paying dividends; |
| • | Cash and cash equivalents position; |
| • | Lease commitments; |
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| • | Ability to attract and retain qualified personnel; |
| • | Internal control environment; |
| • | Adoption of new accounting pronouncements; |
| • | Trading price of our Common Stock; |
| • | Continued listing of our Common Stock on The Nasdaq Global Select Market; |
| • | Operating results; |
| • | Realization of deferred tax assets; |
| • | Accounting estimates and procedures; |
| • | The level and terms of our outstanding debt; |
| • | Interest and other income, net; |
| • | Effective tax rates; and |
| • | Amortization of intangible assets. |
You can identify these and other forward-looking statements by the use of words such as “may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.
Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 1A, “Risk Factors.” All forward-looking statements included in this document are based on our assessment of information available to us at this time. We assume no obligation to update any forward-looking statements.
EXPLANATORY NOTE REGARDING RESTATEMENTS
This Annual Report on Form 10-K for our fiscal year December 31, 2006 includes restatements of: (1) previously filed consolidated financial statements, financial data and related disclosures as of December 31, 2005 and for our fiscal years ended December 31, 2005 and 2004; (2) our selected consolidated financial data as of and for our fiscal years ended December 31, 2005, 2004, 2003, our quarter ended December 31, 2002 and our fiscal year ended September 30, 2002; (3) our management’s discussion and analysis of financial condition and results of operations as of and for our fiscal years ended December 31, 2005 and 2004 contained in Item 7 of this Form 10-K; and (4) our unaudited quarterly financial data for the first quarter of fiscal year ended December 31, 2006 and for all quarters in our fiscal year ended December 31, 2005 located at the end of Item 15 of this Form 10-K. The restatements are the result of errors in the way we accounted for certain historical stock option grants that were discovered through our independent stock option investigation conducted by the Audit Committee of the Board of Directors. See Note 3, “Restatement of Consolidated Financial Statements,” of Notes to Consolidated Financial Statements and Exhibit 99.1 for a detailed discussion of the effect of the restatements.
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Our previously issued consolidated financial statements for the fiscal years 2005 and prior, which are included in our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q filed with respect to each of the applicable quarters in these fiscal years and the consolidated financial statements included in our Quarterly Report on Form 10-Q for the first quarter of fiscal year 2006, should no longer be relied upon.
As a result of an investigation of our historical stock option practices by the Audit Committee of our Board of Directors, and a concurrent internal review by our management under the oversight of the Audit Committee, we determined that our previous accounting should be adjusted for: (a) stock option grants for which the Audit Committee determined that the actual grant date for accounting purposes was different from the stated grant date for new hire grants to employees, annual and other grants to employees, and any grants to officers; (b) grants made to individuals who had extensions of option termination dates and, in some cases, extensions of vesting periods pursuant to separation agreements under which the individuals did not perform any significant duties during the separation period but were still listed as employees; (c) payroll tax withholding liabilities for certain repriced stock grants that no longer qualify for Incentive Stock Option (“ISO”) tax treatment; and (d) other miscellaneous adjustments for modifications and errors, including adjustments for grants to non-employees providing consulting services and adjustments for continued vesting after an individual converted from an employee to a consultant role. For further information on the details of the investigation and related findings, see Note 3 “Restatement of Consolidated Financial Statements” of the Notes to Consolidated Financial Statements.
We previously applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and its related interpretations and provided the required pro forma disclosures under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), through the fiscal year ended December 31, 2005. Under the provisions of APB 25, a non-cash, stock-based compensation expense was required to be recognized for any option granted for which the exercise price was below the market price on the actual grant date. Because most of our remeasured options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the options. Starting in fiscal year 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” (“SFAS 123(R)”). As a result, beginning in fiscal year 2006, the stock-based compensation expense required to be recorded for each remeasured option is equal to the fair value of the option on the actual grant date, amortized over the remaining expected requisite service period of the option. We did not record these stock-based compensation expenses under APB 25 or SFAS 123(R) in our previously issued consolidated financial statements and that is why we are restating them in this filing.
As a result of the issues identified, we recorded additional pre-tax, non-cash, stock-based compensation expense of $169.4 million under APB 25 for the period between May 13, 1997 (the date of our initial public offering) and December 31, 2005, comprised of $146.9 million related to remeasured stock options and $22.5 million related to other stock compensation adjustments. The cumulative tax benefit from the recording of these adjustments was $67.0 million. The impact of these adjustments, net of taxes, decreased our previously reported cumulative net income by $102.4 million for the same period. The tax benefit amount differs from the statutory tax benefit principally as a result of limitations on our ability to deduct certain executive stock-based compensation and changes in geographical mix of expenses.
For the year ended December 31, 2006, in accordance with SFAS 123(R), we recorded additional pre-tax, non-cash, stock-based compensation expense of $6.8 million, comprised of $6.3 million related to remeasured stock options and $0.5 million related to other stock compensation adjustments. As of December 31, 2006, we had $6.6 million of unrecognized pre-tax stock-based compensation costs calculated under SFAS 123(R) related to remeasured stock option grants that will be recorded as compensation expense over the remaining expected requisite service period of the options.
Restated selected quarterly unaudited consolidated financial data for the three months ended March 31, 2006 and 2005, the related revised management’s discussion and analysis of financial condition and results of operations for these periods and restated tables and disclosures related to APB 25, SFAS 123 and SFAS 123(R) are included in Exhibit 99.1 of this Annual Report on Form 10-K. The previously filed consolidated financial statements for the quarters ended June 30 and September 30, 2005, are restated in the Quarterly Reports on Form 10-Q for the quarters ended June 30 and September 30, 2006, respectively.
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Rambus, RDRAM, XDR, FlexIO and FlexPhase are trademarks or registered trademarks of Rambus Inc. Other trademarks that may be mentioned in this annual report on Form 10-K are the property of their respective owners.
Industry terminology, used widely throughout this annual report, has been abbreviated and, as such, these abbreviations are defined below for your convenience:
| Advanced Backplane | ABP | |
| Double Data Rate | DDR | |
| Dynamic Random Access Memory | DRAM | |
| Fully Buffered-Dual In-line Memory Module | FB-DIMM | |
| Gigabytes per second | Gb/s | |
| Graphics Double Data Rate | GDDR | |
| Input/Output | I/O | |
| Peripheral Component Interconnect | PCI | |
| Rambus Dynamic Random Access Memory | RDRAM | |
| Single Data Rate | SDR | |
| Synchronous Dynamic Random Access Memory | SDRAM | |
| eXtreme Data Rate | XDR |
From time to time we will refer to the abbreviated names of certain entities and, as such, have provided a chart to indicate the full names of those entities for your convenience.
| Advanced Micro Devices Inc. | AMD | |
| ARM Holdings plc | ARM | |
| Cadence Design Systems, Inc. | Cadence | |
| Cisco Systems, Inc. | Cisco | |
| Elpida Memory, Inc. | Elpida | |
| Fujitsu Limited | Fujitsu | |
| GDA Technologies, Inc. | GDA | |
| Hewlett-Packard Company | Hewlett-Packard | |
| Hynix Semiconductor, Inc. | Hynix | |
| Infineon Technologies AG | Infineon | |
| Inotera Memories, Inc. | Inotera | |
| Intel Corporation | Intel | |
| International Business Machines Corporation | IBM | |
| Joint Electron Device Engineering Council | JEDEC | |
| Juniper Networks, Inc. | Juniper | |
| Matsushita Electrical Industrial Co. | Matsushita | |
| Micron Technologies, Inc. | Micron | |
| Nanya Technology Corporation | Nanya | |
| NEC Electronics Corporation | NECEL | |
| Optical Internetworking Forum | OIF | |
| Qimonda AG (formerly Infineon’s DRAM operations) | Qimonda | |
| Peripheral Component Interconnect – Special Interest Group | PCI-SIG | |
| Renesas Technology Corporation | Renesas | |
| S3 Graphics, Inc. | S3 Graphics | |
| Samsung Electronics Co., Ltd. | Samsung |
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| Sony Computer Electronics |
Sony | |
| Spansion, Inc. |
Spansion | |
| ST Microelectronics |
ST Micro | |
| Synopsys Inc. |
Synopsys | |
| Tessera Technologies, Inc. |
Tessera | |
| Texas Instruments Inc. |
Texas Instruments | |
| Toshiba Corporation |
Toshiba | |
| Velio Communications |
Velio |
| Item 1. | Business |
Rambus Inc. (“we” or “Rambus”) was founded in 1990 and reincorporated in Delaware in March 1997. Our principal executive offices are located at 4440 El Camino Real, Los Altos, California. Our Internet address is www.rambus.com. You can obtain copies of our Forms 10-K, 10-Q, 8-K, and other filings with the SEC, and all amendments to these filings, free of charge from our website as soon as reasonably practicable following our filing of any of these reports with the SEC. In addition, you may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy, and information statements, and other information regarding registrants that file electronically with the SEC at www.sec.gov.
We design, develop and license chip interface technologies and architectures that are foundational to nearly all digital electronics products. Our chip interface technologies are designed to improve the time-to-market, performance, and cost-effectiveness of our customers’ semiconductor and system products for computing, communications and consumer electronics applications.
As of May 31, 2007, our chip interface technologies are covered by more than 600 U.S. and international patents. Additionally, we have approximately 500 patent applications pending. These patents and patent applications cover important inventions in memory and logic chip interfaces, in addition to other technologies. We believe that our chip interface technologies provide a higher performance, lower risk, and more cost-effective alternative for our customers than can be achieved through their own internal research and development efforts.
We offer our customers two alternatives for using our chip interface technologies in their products:
First, we license our broad portfolio of patented inventions to semiconductor and system companies who use these inventions in the development and manufacture of their own products. Such licensing agreements may cover the license of part, or all, of our patent portfolio. Patent license agreements are royalty bearing.
Second, we develop “leadership” (which are Rambus-proprietary products widely licensed to our customers) and industry-standard chip interface products that we provide to our customers under license for incorporation into their semiconductor and system products. Because of the often complex nature of implementing state-of-the art chip interface technology, we offer our customers a range of engineering services to help them successfully integrate our chip interface products into their semiconductors and systems. Product license agreements may have both a fixed price (non-recurring) component and ongoing royalties. Engineering services are customarily bundled with our product licenses, and are performed on a fixed price basis. Further, under product licenses, our customers may receive licenses to our patents necessary to implement the chip interface in their products with specific rights and restrictions to the applicable patents elaborated in their individual contracts with us.
Background
The performance of computers, consumer electronics and other electronic systems is often constrained by the speed of data transfer between the chips within the system. Ideally, the rate of the data transfer between chips should support the rate of data transfer on-chip. However, on-chip frequencies continue to exceed the frequency of communication between chips at a growing rate. The incorporation of multiple-cores in processor chips drives an even
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greater need for higher rates of data transfer. Further, the inability to scale packaging technology (number of signal pins on a package) at the rate at which transistor counts scale through improvements in semiconductor process technology only worsens the chip interface “bottleneck.” As a result, continued advances to increase on-chip frequencies, number of cores or transistor densities face potentially diminishing returns in increasing overall system performance. Our technologies help semiconductor and system designers speed the performance of chip interfaces, thus helping to boost the overall performance of electronic systems.
Our Offerings
Patent Licensing
We derive the majority of our annual revenues by licensing our broad portfolio of patents for chip interfaces to our customers. Such licenses may cover part or all of our patent portfolio. Leading semiconductor and system companies such as AMD, Elpida, Fujitsu, Qimonda, Intel, Matsushita, NECEL, Renesas, Spansion and Toshiba have taken licenses to our patents for use in their own products. Examples of the many patented innovations in our portfolio include:
Fully Synchronous DRAM which is designed to allow precise timing from a DRAM system, improving memory transfer efficiency.
Dual Edge Clocking which is designed to allow data to be sent on both the leading and trailing edge of the clock pulse, effectively doubling the transfer rate out of a memory core without the need for higher system clock speeds.
Variable Burst Length which is designed to improve data transfer efficiency by allowing varying amounts of data to be sent per a memory read or write request in DRAMs and Flash memory.
FlexPhase™ technology which synchronizes data output and compensates for circuit timing errors.
Channel Equalization which is designed to improve signal integrity and system margins by reducing inter-symbol interference in high speed parallel and serial link channels.
Product Licensing
We license our leadership and industry-standard chip interface products to our customers for use in their semiconductor and system products. Our customers include leading companies such as Elpida, Fujitsu, IBM, Intel, Matsushita, Texas Instruments, Sony, ST Micro, Qimonda and Toshiba. Due to the complex nature of implementing our technologies, we provide engineering services under certain of these licenses to help successfully integrate our chip interface products into their semiconductors and systems. Additionally, product licensees receive, as an adjunct to their chip interface license agreements, patent licenses as necessary to implement the chip interface in their products with specific rights and restrictions to the applicable patents elaborated in their individual contracts.
Our leadership chip interface products include the XDR™, XDR2 and RDRAM™ memory chip interface products and the FlexIO™ processor bus.
The XDR Memory Architecture enables what we believe to be the world’s fastest production DRAM with operation up to 6.4 Gb/s. XDR DRAM is the main memory solution for Sony Computer Entertainment’s PLAYSTATION®3 as well as for Texas Instrument’s latest generation of DLP front projectors.
The XDR2 Memory Architecture incorporates our DRAM micro-threading innovation and delivers the world’s highest performance for graphics intensive applications such as gaming and digital video.
RDRAM Memory has shipped in the Sony PlayStation®2, Intel-based PCs, Texas Instruments DLP TVs and in Juniper routers. Our customers have sold over 500 million RDRAM devices across all applications to date. This product is approaching end-of-life, and we anticipate revenues from RDRAM will continue to decline.
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The FlexIO Processor Bus is a high speed chip-to-chip interface. It is one of our two key chip interface products that enable the Cell BE processor co-developed by Sony, Toshiba and IBM. In the PLAYSTATION®3, FlexIO provides the interface between the Cell BE, the RSX graphics processor and the SouthBridge chip.
In addition to our leadership products, we offer industry-standard chip interface products for versions of DDRx (where the “x” is a number that represents a version), GDDRx (where the “x” is a number that represents a version), and PCI Express. We also offer digital logic controllers for PCI Express and DDRx memory.
Target Markets, Applications and Customers
We work with leading and emerging semiconductor and system customers to enable their next-generation products. We engage with our customers across the entire product life cycle, from system architecture development, to chip design, to system integration, to production ramp up through product maturation. Our chip interface technologies and patented inventions are incorporated into a broad range of high-volume applications in the computing, consumer electronics and communications markets. System level products that utilize our patented inventions and/or products include personal computers, servers, printers, video projectors, video game consoles, digital TVs, set-top boxes and mobile phones manufactured by such companies as Fujitsu, Hewlett-Packard, Matsushita, Toshiba and Sony.
Our Strategy
The key elements of our strategy are as follows:
Develop Core Technology: Develop and patent our core technology to provide us with a fundamental competitive advantage in memory and logic chip interfaces and architectures.
Develop Products: Develop products which incorporate our core technology and provide our customers with the benefits of superior performance, faster time-to-market, lower risk and greater cost effectiveness for a range of applications in computing, communications and consumer electronics.
Engage With Leading Companies: Engage with leading semiconductor and system customers to solve their critical chip interface design problems and incorporate our high performance, low-risk, silicon-proven chip interfaces into their solutions.
License our Chip Interface Patents and Technologies: License our patented inventions and specific chip interface products to customers for use in their semiconductor and system products.
Design and Manufacturing
Our chip interface technologies are developed with high-volume complementary metal-oxide semiconductor (CMOS) manufacturing processes in mind. Typically, our chip interface products are delivered as an implementation package or a custom development. We provide implementation packages to licensees who wish to port our chip interface designs to a manufacturing process being used to develop their semiconductor products. This package typically includes a specification, a generalized circuit layout database and test parameter software. We do custom development when licensees have contracted with us to produce a specific design implementation optimized for the licensee’s manufacturing process. In such cases, the licensee provides specific design rules and transistor models for the licensee’s process.
Research and Development
Our ability to compete in the future will be substantially dependent on our ability to advance our chip interfaces and patented inventions in order to meet changing market needs. To this end, we have assembled a team of highly skilled engineers whose activities are focused on further development of our chip interfaces and patented inventions as well as adaptation of current chip interfaces to specific customers’ processes. Our engineers are developing new chip interfaces and new versions of existing chip interfaces that we expect will allow chip data transfer at higher speeds, as well as
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provide other improvements and benefits. Our design and development process is a multi-disciplinary effort requiring expertise in system architecture, digital and analog circuit design and layout, semiconductor process characteristics, packaging, printed circuit board routing, signal integrity and high-speed testing techniques.
As of May 31, 2007, we had approximately 270 employees in our engineering departments, representing 65% of our total employees. A significant number of our engineers spend all or a portion of their time on research and development. For the years ended December 31, 2006, 2005, and 2004, research and development expenses were $69.0 million, $49.1 million and $38.3 million, respectively, including stock-compensation of $14.9 million, $8.1 million and $5.7 million, respectively. We expect to continue to invest substantial funds in research and development activities. In addition, because our license and customer service agreements often call for us to provide engineering support, a portion of our total engineering costs are allocated to the cost of contract revenues, even though some of these engineering efforts may have direct applicability to our technology development.
Competition
The semiconductor industry is intensely competitive and has been impacted by price erosion, rapid technological change, short product life cycles, cyclical market patterns and increasing foreign and domestic competition. Some semiconductor companies have developed and support competing logic chip interfaces including their own serial link chip interfaces and parallel bus chip interfaces. We also face competition from semiconductor and intellectual property companies who provide their own DDR memory chip interface technology and solutions. In addition, most DRAM manufacturers, including our XDR licensees, produce versions of DRAM such as SDR, DDRx and GDDRx SDRAM which compete with XDR chips. We believe that our principal competition for memory chip interfaces may come from our licensees and prospective licensees, some of which are evaluating and developing products based on technologies that they contend or may contend will not require a license from us. In addition, our competitors are also taking a system approach similar to ours in seeking to solve the application needs of system companies. Many of these companies are larger and may have better access to financial, technical and other resources than we possess.
JEDEC has standardized what it calls extensions of DDR, known as DDR2 and DDR3. Additional efforts are underway to create other products including those sometimes referred to as GDDR4 and GDDR5, as well as new ways to integrate products such as system-in-package DRAM. To the extent that these alternatives might provide comparable system performance at lower than or similar cost to XDR memory chips, or are perceived to require the payment of no or lower royalties, or to the extent other factors influence the industry, our licensees and prospective licensees may adopt and promote alternative technologies. Even to the extent we determine that such alternative technologies infringe our patents, there can be no assurance that we would be able to negotiate agreements that would result in royalties being paid to us without litigation, which could be costly and the results of which would be uncertain.
In the serial link chip interface business, we face additional competition from semiconductor companies that sell discrete transceiver chips for use in various types of systems, from semiconductor companies that develop their own serial link chip interfaces, as well as from competitors, such as ARM and Synopsys, who license similar serial link chip interface products and digital controllers. At the 10 Gb/s speed, competition will also come from optical technology sold by system and semiconductor companies. There are standardization efforts underway or completed for serial links from standard bodies such as PCI-SIG and OIF. We may face increased competition from these types of consortia in the future that could negatively impact our serial link chip interface business.
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In the FlexIO processor bus chip interface market, we face additional competition from semiconductor companies who develop their own parallel bus chip interfaces, as well as competitors who license similar parallel bus chip interface products. As with our memory chip interface products, to the extent that competitive alternatives to our serial or parallel logic chip interface products might provide comparable system performance at lower or similar cost, or are perceived to require the payment of no or lower royalties, or to the extent other factors influence the industry, our licensees and prospective licensees may adopt and promote alternative technologies.
Employees
As of May 31, 2007, we had approximately 415 full-time employees. We believe that our future success is dependent on our continued ability to identify, attract, motivate and retain qualified personnel. To date, we believe that we have been successful in recruiting qualified employees and that our relationship with our employees is excellent.
Patents and Intellectual Property Protection
We maintain and support an active program to protect our intellectual property, primarily through the filing of patent applications and the defense of issued patents against infringement. As of May 31, 2007, we have more than 600 U.S. and international patents on various aspects of our technology, with expiration dates ranging from 2010 to 2025, and we have approximately 500 pending patent applications. In addition, we attempt to protect our trade secrets and other proprietary information through agreements with current and prospective licensees, and confidentiality agreements with employees and consultants and other security measures. We also rely on trademarks and trade secret laws to protect our intellectual property.
Business Segment Data, Customers and Our Foreign Operations
We operate in a single industry segment, the design, development and licensing of chip interface technologies and architectures. Information concerning revenues, results of operations and revenues by geographic area is set forth in Item 6, “Selected Financial Data,” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in Note 13, “Business Segments, Exports and Major Customers,” of Notes to Consolidated Financial Statements, all of which are incorporated herein by reference. Information concerning identifiable assets is also set forth in Note 13 of Notes to Consolidated Financial Statements. Information on customers that comprise 10% or more of our consolidated revenues and risks attendant to our foreign operations is set forth below in Item 1A, “Risk Factors.”
| Item 1A. | Risk Factors |
RISK FACTORS
Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. See also “Special Note Regarding Forward-looking Statements” elsewhere in this report.
Risks Related to Litigation and Regulation; Business Risks Related to our Intellectual Property
We face current and potential adverse determinations in litigation stemming from our efforts to protect and enforce our patents and intellectual property, which could broadly impact our intellectual property rights, distract our management and cause a substantial decline in our revenues and stock price.
We seek to diligently protect our intellectual property rights. In connection with the extension of our licensing program to SDR SDRAM-compatible and DDR SDRAM-compatible products in 2000 and 2001, we became involved in litigation related to such efforts. As of the date of this report, we are in litigation with four such potential SDR SDRAM-compatible and DDR SDRAM-compatible licensees. In each of these cases, we have claimed infringement of our
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patents, while the potential licensees have generally sought damages and a determination that certain of our patents at suit are invalid, unenforceable, and not infringed. These potential licensees have relied or may rely upon defenses and counterclaims (some not yet formally asserted) that our patents are unenforceable based on various allegations concerning our alleged conduct in the 1990’s and early 2000’s, including that we engaged in document spoliation, litigation misconduct and/or acted improperly during our 1991 to 1995 participation in the JEDEC standard setting organization (including allegations of antitrust violations and unfair competition).
For example, Hynix’s claims attempt to include our 1990’s relationship with Intel and our alleged disparagement of SDRAM and DDR SDRAM products in the 1990’s and early 2000’s. As further discussed below, Hynix has also asserted that the Federal Trade Commission’s (the “FTC”) finding that we acted improperly at JEDEC should be given prima facie evidentiary effect in the private action and/or should entitle it to summary judgment on certain counterclaims. Micron, Samsung, and Nanya (collectively with Hynix, the “Manufacturers”) recently asserted similar arguments in support of their respective counterclaims. While we have opposed the Manufacturers’ attempt to use the FTC’s findings in private litigation, there can be no assurance that we will succeed. If any Manufacturer prevails, we could be limited in our ability to enforce certain of our patents. Furthermore, in August of 2007, the Company received a Statement of Objections from the European Commission, alleging violations of competition law arising from the same basic facts as the FTC decision. There is no assurance that the ultimate decision in that case will not restrict our ability to enforce certain of our patents. In addition, Micron, Hynix, Samsung and Nanya have alleged that we have unclean hands based on alleged litigation misconduct and document spoliation, allegations that overlap with those successfully used by Infineon to obtain the early 2005 dismissal of our patent claims in our case against Infineon in Virginia. Micron has also attempted to assert claims against us for violation of the federal civil Racketeer Influenced and Corrupt Organizations Act (“RICO”) and Virginia state conspiracy laws based in part on the same allegations. Although we defeated Hynix’s unclean hands and spoliation claims based on a subset of these allegations, a federal district court in Virginia subsequently found that we had spoliated evidence and engaged in litigation misconduct in the course of deciding, and ultimately denying, Samsung’s motion for attorneys’ fees. There can be no assurance that such claims or counterclaims will not again be reasserted or successfully used to defeat or limit our patent or other claims.
There can be no assurance that parties will not succeed, either at the trial or appellate level, with such claims or counterclaims against us or that they will not in some other way establish broad defenses against our patents, achieve conflicting results, or otherwise avoid or delay paying what we believe to be appropriate royalties for the use of our patented technology. In addition, there is the risk that the pending litigations and other circumstances may cause us to accept less than what we now believe to be fair consideration in settlement. Among other things, there can be no assurance that we will succeed in negotiating future settlements or licenses on terms better than those extended in our Infineon settlement. There can be no assurances that the circumstances under which we negotiated our Infineon settlement will turn out to be significantly different from the circumstances of future cases and future settlements, although we currently believe that significant differences do exist.
Any of these matters, whether or not determined in our favor or settled by us, is costly, may cause delays, will tend to discourage future design partners, will tend to impair adoption of our existing technologies and divert the efforts and attention of our management and technical personnel from other business operations. In addition, we may be unsuccessful in our litigation if we have difficulty obtaining the cooperation of former employees and agents who were involved in our business during the relevant periods related to our litigation and are now needed to assist in cases or testify on our behalf. Furthermore, any adverse determination or other resolution in litigation could result in our losing certain rights beyond the rights at issue in a particular case, including, among other things: our being effectively barred from suing others for violating certain or all of our intellectual property rights; our patents being held invalid or unenforceable or not infringed; our being subjected to significant liabilities; our being required to seek licenses from third parties; our being prevented from licensing our patented technology; or our being required to renegotiate with current licensees on a temporary or permanent basis. Delay or any or all of these adverse results could cause a substantial decline in our revenues and stock price.
Litigation or other third-party claims of intellectual property infringement could require us to expend substantial resources and could prevent us from developing or licensing our technology on a cost-effective basis.
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Our research and development programs are in highly competitive fields in which numerous third parties have issued patents and patent applications with claims closely related to the subject matter of our research and development programs. We have also been named in the past, and may in the future be named, as a defendant in lawsuits claiming that our technology infringes upon the intellectual property rights of third parties. In the event of a third-party claim or a successful infringement action against us, we may be required to pay substantial damages, to stop developing and licensing our infringing technology, to develop non-infringing technology, and to obtain licenses, which could result in our paying substantial royalties or our granting of cross licenses to our technologies. We may not be able to obtain licenses from other parties at a reasonable cost, or at all, which could cause us to expend substantial resources, or result in delays in, or the cancellation of, new product.
An adverse resolution by or with a governmental agency, such as the Federal Trade Commission or the European Commission, could result in severe limitations on our ability to protect and license our intellectual property, and would cause our revenues to decline substantially .
If there were an adverse determination by, or other resolution with, a government agency, it might limit our ability to enforce our intellectual property rights or to obtain licenses, which would cause our revenues to decline substantially. For example, in June 2002, the FTC filed a complaint against us alleging, among other things, that we had failed to disclose certain patents and patent applications during our membership in JEDEC while it established SDRAM standards and that we, therefore, should be precluded from enforcing certain of our intellectual property rights in patents with a priority date prior to June 1996. In August 2006, the FTC found that our conduct at JEDEC was improper. On February 2, 2007, the FTC issued its remedy order, which among other things, imposes maximum royalty rates that we can charge for certain SDR and DDR SDRAM products made, used or sold in the United States; the FTC subsequently granted a partial stay of this order, which allows us to charge but not collect royalties above the FTC-imposed maximums, pending our anticipated appeal of the FTC’s decision. The FTC has required that royalties above these maximums be placed into an escrow account or held through a contingent contractual agreement. Despite this partial stay, the FTC’s remedy order may significantly limit our ability to enforce or license our patents or collect royalties from existing or potential licensees. The European Commission has issued a Statement of Objections, similar to the filing of a complaint under U.S. law, relating to similar topics. Proceedings by one of these agencies, or any other governmental agency, have already and may result in outcomes that could limit our ability to enforce or license our intellectual property, and could cause our revenues to decline substantially.
In addition, third parties have and may attempt to use the FTC’s findings to limit our ability to enforce our patents in private litigations and to assert claims for monetary damages against us. Several class actions were filed in various federal courts against us alleging violations of federal and state antitrust laws, violations of state consumer protection laws and various common law claims based almost entirely on the same conduct as the FTC’s findings. There can be no assurance that such third parties will not be successful or that additional claims or actions arising out of the FTC’s findings will not be asserted against us.
Further, in Fall 2006, Samsung filed three inter partes reexamination requests with respect to three of our patents: U.S. Patent Nos. 6,426,916; 6,182,184; and 6,324,120. These requests ask the United States Patent & Trademark Office (the “PTO”) to reconsider the patentability of the inventions claimed in the patents. An adverse decision by the PTO could invalidate some or all of these patent claims and could also result in additional adverse consequences affecting other related U.S. patents. If a sufficient number of such patents are impaired, our ability to enforce or license our intellectual property would be significantly weakened and this could cause our revenues to decline substantially. There can be no assurance that Samsung will not be successful or that additional inter partes reexamination requests will not be filed by Samsung or other third parties against us.
On May 13, 2004, a Technical Appeals Board of the European Patent Office issued its written opinion as to the revocation of European Patent No. 0525068. In addition, on January 13, 2005, an opposition board of the European Patent Office revoked our European Patent No. 1 004 956, and issued its written decision on February 9, 2005. We are appealing this decision to an appellate panel of the European Patent Office. While this result still leaves us with additional issued patents in Europe relating to one or both of SDR and DDR SDRAM memory products, there are similar pending opposition proceedings with respect to some of those patents as well. If a sufficient number of such patents are similarly impaired or revoked, our ability to enforce or license our intellectual property would be significantly impaired and this could cause our revenues to decline substantially.
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If we are unable to successfully protect our inventions through the issuance and enforcement of patents, our operating results could be adversely affected.
We have an active program to protect our proprietary inventions through the filing of patents. There can be no assurance, however, that:
| • | any current or future U.S. or foreign patent applications will be approved and not be challenged by third parties; |
| • | our issued patents will protect our intellectual property and not be challenged by third parties; |
| • | the validity of our patents will be upheld; |
| • | our patents will not be declared unenforceable; |
| • | the patents of others will not have an adverse effect on our ability to do business; |
| • | the Congress or the U.S. courts or foreign countries will not change the nature or scope of rights afforded patents or patent owners or alter in an adverse way the process for seeking patents; |
| • | new legal theories and strategies utilized by our competitors will not be successful; or |
| • | others will not independently develop similar or competing chip interfaces or design around any patents that may be issued to us. |
If any of the above were to occur, our operating results could be adversely affected.
Our inability to protect and own the intellectual property we create would cause our business to suffer.
We rely primarily on a combination of license, development and nondisclosure agreements, trademark, trade secret and copyright law, and contractual provisions to protect our non-patentable intellectual property rights. If we fail to protect these intellectual property rights, our licensees and others may seek to use our technology without the payment of license fees and royalties, which could weaken our competitive position, reduce our operating results and increase the likelihood of costly litigation. The growth of our business depends in large part on the use of our intellectual property in the products of third party manufacturers, and our ability to enforce intellectual property rights against them to obtain appropriate compensation. In addition, effective trade secret protection may be unavailable or limited in certain foreign countries. Although we intend to protect our rights vigorously, if we fail to do so, our business will suffer.
We might experience payment disputes for amounts owed to us under our licensing agreements, and this may harm our results of operations.
Many of our license agreements require our licensees to document the manufacture and sale of products that incorporate our technology and report this data to us on a quarterly basis. While licenses with such terms give us the right to audit books and records of our licensees to verify this information, audits can be expensive, time consuming, and potentially detrimental to our ongoing business relationship with our licensees. We have performed royalty audits from time to time, using accounting firms other than our independent registered public accounting firm, but we primarily rely on the accuracy of the reports from licensees without independently verifying the information in them. Our failure to audit our licensees’ books and records may result in our receiving more or less royalty revenues than we are entitled to under the terms of our license agreements. The result of such royalty audits could result in an increase, as a result of a licensee’s underpayment, or decrease, as a result of a licensee’s overpayment, to previously reported royalty revenues. Such adjustments are recorded in the period they are determined. Any adverse material adjustments resulting from royalty audits or dispute resolutions may result in us missing analyst estimates and causing our stock price to decline. Royalty audits may also trigger disagreements over contract terms with our licensees and such disagreements could hamper customer relations, divert the efforts and attention of our management from normal operations and impact our business operations and financial condition.
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We may not be able to satisfy the requirements under the Qimonda settlement and license agreement that would require Qimonda to pay us up to an additional $100.0 million in royalty payments.
On March 21, 2005, we entered into a settlement and license agreement with Infineon (and its former parent Siemens), which was assigned to Qimonda in October 2006 in connection with Infineon’s spin-off of Qimonda. The settlement and license agreement, among other things, requires Qimonda to pay to us aggregate royalties of $50.0 million in quarterly installments of approximately $5.85 million, which started on November 15, 2005. The settlement and license agreement further provides that if we enter into licenses with certain other DRAM manufacturers, Qimonda will be required to make additional royalty payments to us that may aggregate up to $100.0 million. We may not succeed in entering into these additional license agreements necessary to trigger Qimonda’s obligations under the settlement and license agreement to pay to us additional royalty payments, thereby reducing the value of the settlement and license agreement to us.
An acquisition of all of Qimonda’s DRAM operations could make it more difficult for us to obtain royalty rates we believe are appropriate and could reduce the number of companies in our antitrust litigation.
Our license with Qimonda (formerly Infineon’s DRAM operations), which was part of our settlement with Infineon, provides for the extension of certain benefits under that license to a successor in interest that, under certain conditions, acquires all of Qimonda’s DRAM operations. If such an acquisition were to occur, such successor would be entitled to the extension of such benefits, including the ability to pay a royalty calculated by multiplying the Qimonda rate by the percentage increase in DRAM volume represented by the successor company’s combined operations. Such an extension of benefits could also make it more difficult for us to obtain the royalty rates we believe are appropriate from the market as a whole. Such an extension of benefits would, in addition, also operate to extend a release of claims to such successor, thus reducing the number of companies from which we may seek compensation for the antitrust injury alleged by us in our pending price-fixing action in San Francisco.
Any dispute regarding our intellectual property may require us to indemnify certain licensees, the cost of which could severely hamper our business operations and financial condition.
In any potential dispute involving our patents or other intellectual property, our licensees could also become the target of litigation. While we generally do not indemnify our licensees, some of our license agreements provide limited indemnities, some require us to provide technical support and information to a licensee that is involved in litigation involving use of our technology, and we may agree to indemnify others in the future. Our indemnification and support obligations could result in substantial expenses. In addition to the time and expense required for us to indemnify or supply such support to our licensees, a licensee’s development, marketing and sales of licensed semiconductors could be severely disrupted or shut down as a result of litigation, which in turn could severely hamper our business operations and financial condition.
Risks Related to the Investigation of Past Stock Option Practices and the Related Restatement of our Prior Financial Results.
The matters relating to the independent investigation of our historical stock option granting practices and the restatement of our financial statements have required, and may continue to require, a significant amount of management time and accounting, financial and legal resources, which could adversely affect our business, financial condition and results of operations.
On May 30, 2006, we announced the commencement of our Audit Committee’s internal investigation of the timing of stock option grant practices and related accounting issues. The Audit Committee has determined that a significant number of our historical stock option grants were not correctly dated and our previous accounting should be adjusted. As a result of the Audit Committee’s investigation and our own review of our historical financial statements, we concluded that our previously filed financial statements should no longer be relied upon. We have restated the affected periods by filing this Annual Report on Form 10-K for the year ended December 31, 2006, which includes restatements of the various previously filed financial statements as detailed herein. For a discussion of the investigation, its findings and the effects of this restatement on our previously filed financial statements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Restatement of Consolidated Financial Statements, Audit Committee, Special Litigation Committee and Company Findings, Remedial Measures and Related Proceedings,” Note 3, “Restatement of Consolidated Financial Statements,” of Notes to Consolidated Financial Statements and Exhibit 99.1.
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On October 18, 2006, our Board of Directors established a Special Litigation Committee (the “SLC”) to evaluate potential claims or other actions arising from our stock option granting activities. The SLC has now concluded its review of claims relating to stock option practices that are asserted in derivative actions against a number of our present and former officers and directors and filed a written report setting out its findings with the U.S. District Court for the Northern District of California. For additional information about the findings of the SLC, please see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Shareholder Litigation Related to Historical Stock Option Practices.”
Addressing all the matters related to the Audit Committee’s investigation, the SLC’s work and the financial restatement has and will continue to require significant management and financial resources which could otherwise be devoted to the operation of our business. The costs of becoming current with our periodic reports and any settlements, payment of claims, fines, taxes and other costs of the stock option investigation as detailed throughout these risk factors and this report will cause us to incur substantial expenses and could materially affect our cash balance and cash flow from operations. In addition, the recent restatement of our financial results, the ongoing investigations and any negative outcome that may occur from these investigations could impact our reputation, including our relationships with our investors and our licensees, our ability to hire and retain qualified personnel, our ability to acquire new licensees and other business partners and, ultimately, our ability to generate revenue. Furthermore, considerable legal and accounting expenses related to these matters have been incurred to date and significant expenditures may continue to be incurred in the future.
We have been named as a party to several lawsuits arising from matters relating to the investigation which may result in unfavorable outcomes and significant judgments, settlements and legal expenses which could cause our business, financial condition and results of operations to suffer.
Several shareholder derivative actions were filed in state and federal courts against certain of our current and former officers and directors related to the stock option granting actions under investigation by the Audit Committee and the SLC. The actions were brought by persons identifying themselves as shareholders and purporting to act on our behalf. We are named solely as a nominal defendant against whom the plaintiffs seek no recovery. The complaints allege that certain of these defendants violated securities laws and/or breached their fiduciary duties to us and obtained unjust enrichment in connection with grants of stock options to certain of our officers that were allegedly improperly dated. The SLC was formed to evaluate potential claims or other actions arising from the stock option granting activities. The complaints seek unspecified monetary damages and disgorgement from the defendants, as well as unspecified equitable relief.
Additionally, several securities fraud class actions and individual lawsuits were filed in federal court against us and certain of our current and former officers and directors. The complaints generally allege that the defendants violated the federal securities laws by filing documents with the SEC containing false statements regarding our accounting treatment of the stock option granting actions under investigation. The complaints seek unspecified monetary relief from the defendants. The class actions have been consolidated into a single proceeding. The individual lawsuits allege not only federal and state securities law violations, but also state law claims for fraud and breach of fiduciary duty.
There can be no assurance that further lawsuits by parties who allege they suffered injury as a consequence of our past stock option granting practices will not be filed in the future. The amount of time to resolve these current and any future lawsuits is uncertain, and these matters could require significant management and financial resources which could otherwise be devoted to the operation of our business. Although we have accrued an estimate of certain liabilities that we believe will result from certain of these actions, the actual costs and expenses to defend and satisfy all of these lawsuits and any potential future litigation will exceed our current estimated accruals, possibly significantly. Unfavorable outcomes and significant judgments, settlements and legal expenses in the litigation related to our past stock option granting practices could have material adverse impacts on our business, financial condition, results of operations and the trading price of our Common Stock.
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We are subject to the risk of regulatory proceedings, actions or litigation in connection with the investigation and the restatement of our financial statements, which could require significant management time and result in unfavorable outcomes and significant judgments, settlements and legal expenses which could have an adverse effect on our business, financial condition and results of operations.
We have periodically met and discussed the results of the stock option investigation with the staff of the SEC and the United States Attorney’s Office for the Northern District of California. Such government agencies will likely review such findings and may pursue inquiries of their own, which could lead to further investigations and government action, such as fines or injunctions. At this time, we cannot predict what, if any, government actions may result from the completion of the investigation of stock option grants. We are also under remote examination by the Internal Revenue Service (“IRS”) on the various tax reporting implications resulting from the investigation. There is no assurance that other regulatory inquiries will not be commenced by other U.S. federal, state or foreign regulatory agencies, including the IRS and other tax authorities. In addition, while we believe that we have made appropriate judgments in determining the correct measurement dates for our stock option grants, the SEC may disagree with the manner in which we accounted for and reported, or failed to report, the corresponding financial impact. Accordingly, there is a risk that we may have to further restate our prior financial statements, amend prior filings with the SEC, or take other actions not currently contemplated. Any potential regulatory proceeding or action may be time consuming, expensive and distracting from the conduct of our business. An unfavorable outcome or significant judgments, settlements and legal expenses related to resolution of any potential regulatory proceeding or action, or further restatement of our financial statements, could have a material adverse effect on our business, financial condition and results of operations.
We may suffer adverse tax consequences in connection with our historical stock option practices, which could have a negative impact on our results of operations and financial condition.
As a result of our investigation into historical stock option practices, we have determined that certain options that had formerly been classified as ISO grants did not qualify for such ISO tax treatment because the grants had an exercise price below the fair market value of our Common Stock on the actual grant date. The IRS is currently auditing us with respect to this issue. In addition, we could face penalties, certain payment obligations for our employees or other costs in connection with the treatment of certain stock options impacted by the deferred compensation rules under Section 409A of the Internal Revenue Code (and other similar provisions of the California and other state tax laws).Also, we were unable to record additional deferred tax assets related to stock-based compensation in accordance with limits imposed by Section 162(m) of the Internal Revenue Code which reduced our available tax net operating loss carry-forwards for certain historical periods. These and other tax consequences related to our historical stock option practices could give rise to monetary liabilities for us and/or our current and former employees which may have to be satisfied in a future period. There can be no assurance that further regulatory inquiries or actions will not be commenced by the IRS or other state or foreign regulatory taxation authorities regarding the tax implications of our historical stock option practices. The unfavorable resolution of any potential tax regulatory proceeding or action could require us to make significant payments in overdue taxes, penalties and fines or otherwise record charges (or reduce tax assets) that may adversely affect our results of operations and financial condition.
We may be required to indemnify our current and former directors, officers and employees in connection with the litigation and other actions related to the investigation which could result in significant legal expenses and other costs to us.
Our bylaws and certain indemnification agreements require us to indemnify our current and former directors, officers, employees and agents against most actions of a civil, criminal, administrative or investigative nature unless such person acted criminally, in a manner opposed to our best interests or did not act in good faith. Generally, we are required to advance indemnification expenses prior to any final adjudication of an individual’s culpability. Therefore, the expense of indemnifying our current and former directors, officers and employees and agents in their defense or related expenses as a result of the derivative, class action and any regulatory actions related to the investigation and financial restatement may be significant. While we have a director and officer insurance policy that in some circumstances limits our exposure and enables us to recover a portion of any amounts to be paid, our insurance coverage will not be sufficient to cover our liabilities in all of the current actions. Furthermore, the underwriters of our directors and officer insurance
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policy may seek to rescind or otherwise deny coverage in some or all of these matters, in which case we may be required to pay the indemnification amounts owed to such directors and officers without any insurance coverage. Finally, we may be delayed or otherwise unable to recover any indemnification that we advanced to persons that are finally determined not to be protected by our indemnification obligations due to their actions. Therefore, our indemnification obligations could result in the diversion of our financial resources that adversely affects our business, financial condition and results of operations.
It may be difficult or costly to obtain director and officer insurance coverage in the future as a result of our stock options problems.
We expect that the issues arising from our historical stock option granting practices will make it more difficult to obtain director and officer insurance coverage in the future. If we are able to obtain this coverage, it could be significantly more costly than in the past, which would have an adverse effect on our financial results and cash flow. In the event that we are unable to obtain sufficient director and officer insurance coverage, as a result of this and related factors, our directors and officers could face increased risks of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors and officers, which could adversely affect our business.
We have not been in compliance with SEC reporting requirements and The Nasdaq Global Select Market listing requirements and may continue to face compliance issues with both. If we are unable to return to or remain in compliance with SEC reporting requirements and The Nasdaq Global Select Market listing requirements, there may be a material adverse effect on the Company and our stockholders.
Due to the stock option investigation and resulting restatements, we have not been able to file all of our periodic reports with the SEC on a timely basis and face the possibility of delisting of our stock from The Nasdaq Global Select Market. We have not yet filed our required Quarterly Report on Form 10-Q for the quarters ended March 31 and June 30, 2007. The Nasdaq Board has determined to grant us until October 17, 2007 to file all delinquent periodic reports necessary for us to regain compliance with our Nasdaq filing requirements. Even after filing all required reports with the SEC and receiving concurrence from Nasdaq that we are in compliance with applicable listing requirements, we may still face comments from the SEC that may require us to file amended reports. As a result, we may not be able to maintain an effective listing of our Common Stock on The Nasdaq Global Select Market or any other national securities exchange. A delisting would likely reduce the liquidity in the market for our Common Stock. Any possible delisting may adversely affect the market price of our Common Stock, which may make it difficult for holders to resell their shares when desired or at attractive prices. In addition, we would be subject to a number of restrictions or delays regarding the registration of our Common Stock under federal securities laws, and we may not be able to issue certain equity awards to our employees or allow them to exercise their outstanding options, which could adversely affect our ability to hire and retain our employees and, thus, our business.
Risks Associated With Our Business, Industry and Market Conditions
If market leaders do not adopt our chip interface products, our results of operations could decline.
An important part of our strategy is to penetrate market segments for chip interfaces by working with leaders in those market segments. This strategy is designed to encourage other participants in those segments to follow such leaders in adopting our chip interfaces. If a high profile industry participant adopts our chip interfaces but fails to achieve success with its products or adopts and achieves success with a competing chip interface, our reputation and sales could be adversely affected. In addition, some industry participants have adopted, and others may in the future adopt, a strategy of disparaging our memory solutions adopted by their competitors or a strategy of otherwise undermining the market adoption of our solutions.
By way of example, we target system companies to adopt our chip interface technologies, particularly those that develop and market high volume business and consumer products such as PCs and video game consoles. We are subject to many risks beyond our control that influence whether or not a particular system company will adopt our chip interfaces, including, among others:
| • | competition faced by a system company in its particular industry; |
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| • | the timely introduction and market acceptance of a system company’s products; |
| • | the engineering, sales and marketing and management capabilities of a system company; |
| • | technical challenges unrelated to our chip interfaces faced by a system company in developing its products; |
| • | the financial and other resources of the system company; |
| • | the supply of semiconductors from our licensees in sufficient quantities and at commercially attractive prices; |
| • | the ability to establish the prices at which the chips containing our chip interfaces are made available to system companies; and |
| • | the degree to which our licensees promote our chip interfaces to a system company. |
Our strategy also includes gaining acceptance of our technology in high volume consumer applications, including video game consoles, such as the Sony PlayStation®2 and Sony PLAYSTATION®3, digital TVs and set top boxes. There can be no assurance that consumer products that currently use our technology will continue to do so, nor can there be any assurance that the consumer products that incorporate our technology will be successful in their segments thereby generating expected royalties, nor can there be any assurance that any of our technologies selected for licensing will be implemented in a commercially developed or distributed product.
If any of these events occur and market leaders do not successfully adopt our technologies, our strategy may not be successful and, as a result, our results of operations could decline.
Our revenue is concentrated in a few customers, and if we lose any of these customers, our revenues may decrease substantially.
For the years ended December 31, 2006, 2005 and 2004, revenues from our top five licensees accounted for approximately 63%, 73% and 74% of our revenues, respectively. For the year ended December 31, 2006, revenues from Fujitsu, Elpida, Qimonda and Intel each accounted for greater than 10% of our total revenues. For the year ended December 31, 2005, revenues from Intel, Elpida Toshiba and Matsushita each accounted for greater than 10% of our total revenues. For the year ending December 31, 2004, revenues from Intel, Toshiba and Elpida each accounted for greater than 10% of our total revenues. We may continue to experience significant revenue concentration for the foreseeable future.
Substantially all of our licensees have the right to cancel their licenses. Failure to renew licenses and/or the loss of any of our top five licensees would cause revenues to decline substantially. Intel has been one of our largest customers and is an important catalyst for the development of new memory and logic chip interfaces in the semiconductor industry. We have a patent cross-license agreement with Intel for which we received quarterly royalty payments through the second quarter of 2006. The patent cross-license agreement expired in September 2006. Intel now has a paid up license for the use of all of our patents which claimed priority prior to September 2006. We have other licenses with Intel, in addition to the patent cross-license agreement, for the development of serial link chip interfaces. If we do not continue to replace the revenues we previously received under the Intel contract, our results of operations may decline significantly.
In addition, some of our commercial agreements require us to provide certain customers with the lowest royalty rate that we provide to other customers for similar technologies, volumes and schedules. These clauses may limit our ability to effectively price differently among our customers, to respond quickly to market forces, or otherwise to compete on the basis of price. The particular licensees which account for revenue concentration have varied from period to period as a result of the addition of new contracts, expiration of existing contracts, industry consolidation, the expiration of deferred revenue schedules under existing contracts, and the volumes and prices at which the licensees have recently sold licensed semiconductors to system companies. These variations are expected to continue in the foreseeable future, although we anticipate that revenue will continue to be concentrated in a limited number of licensees.
We are in negotiations with licensees and prospective licensees to reach SDR and DDR patent license agreements. We expect SDR and DDR patent license royalties will continue to vary from period to period based on our success in renewing existing license agreements and adding new licensees, as well as the level of variation in our licensees’
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reported shipment volumes, sales price and mix, offset in part by the proportion of licensee payments that are fixed. If we are unsuccessful in renewing any of our SDR and DDR-compatible contracts, our results of operations may decline significantly.
If we cannot respond to rapid technological change in the semiconductor industry by developing new innovations in a timely and cost effective manner, our operating results will suffer.
The semiconductor industry is characterized by rapid technological change, with new generations of semiconductors being introduced periodically and with ongoing improvements. We derive most of our revenue from our chip interface technologies that we have patented. We expect that this dependence on our fundamental technology will continue for the foreseeable future. The introduction or market acceptance of competing chip interfaces that render our chip interfaces less desirable or obsolete would have a rapid and material adverse effect on our business, results of operations and financial condition. The announcement of new chip interfaces by us could cause licensees or system companies to delay or defer entering into arrangements for the use of our current chip interfaces, which could have a material adverse effect on our business, financial condition and results of operations. We are dependent on the semiconductor industry to develop test solutions that are adequate to test our chip interfaces and to supply such test solutions to our customers and us.
Our continued success depends on our ability to introduce and patent enhancements and new generations of our chip interface technologies that keep pace with other changes in the semiconductor industry and which achieve rapid market acceptance. We must continually devote significant engineering resources to addressing the ever increasing need for higher speed chip interfaces associated with increases in the speed of microprocessors and other controllers. The technical innovations that are required for us to be successful are inherently complex and require long development cycles, and there can be no assurance that our development efforts will ultimately be successful. In addition, these innovations must be:
| • | completed before changes in the semiconductor industry render them obsolete; |
| • | available when system companies require these innovations; and |
| • | sufficiently compelling to cause semiconductor manufacturers to enter into licensing arrangements with us for these new technologies. |
Finally, significant technological innovations generally require a substantial investment before their commercial viability can be determined. There can be no assurance that we have accurately estimated the amount of resources required to complete the projects, or that we will have, or be able to expend, sufficient resources required for these types of projects. In addition, there is market risk associated with these products, and there can be no assurance that unit volumes, and their associated royalties, will occur. If our technology fails to capture or maintain a portion of the high volume consumer market, our business results could suffer.
If we cannot successfully respond to rapid technological changes in the semiconductor industry by developing new products in a timely and cost effective manner our operating results will suffer.
We face intense competition that may cause our results of operations to suffer.
The semiconductor industry is intensely competitive and has been impacted by price erosion, rapid technological change, short product life cycles, cyclical market patterns and increasing foreign and domestic competition. Some semiconductor companies have developed and support competing logic chip interfaces including their own serial link chip interfaces and parallel bus chip interfaces. We also face competition from semiconductor and intellectual property companies who provide their own DDR memory chip interface technology and solutions. In addition, most DRAM manufacturers, including our XDR licensees, produce versions of DRAM such as SDR, DDRx and GDDRx SDRAM which compete with XDR chips. We believe that our principal competition for memory chip interfaces may come from our licensees and prospective licensees, some of which are evaluating and developing products based on technologies that they contend or may contend will not require a license from us. In addition, our competitors are also taking a system approach similar to ours in seeking to solve the application needs of system companies. Many of these companies are larger and may have better access to financial, technical and other resources than we possess.
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JEDEC has standardized what it calls extensions of DDR, known as DDR2 and DDR3. Other efforts are underway to create other products including those sometimes referred to as GDDR4 and GDDR5, as well as new ways to integrate products such as system-in-package DRAM. To the extent that these alternatives might provide comparable system performance at lower or similar cost than XDR memory chips, or are perceived to require the payment of no or lower royalties, or to the extent other factors influence the industry, our licensees and prospective licensees may adopt and promote alternative technologies. Even to the extent we determine that such alternative technologies infringe our patents, there can be no assurance that we would be able to negotiate agreements that would result in royalties being paid to us without litigation, which could be costly and the results of which would be uncertain. In the industry standard and leadership serial link chip interface business, we face additional competition from semiconductor companies that sell discrete transceiver chips for use in various types of systems, from semiconductor companies that develop their own serial link chip interfaces, as well as from competitors, such as ARM and Synopsys, who license similar serial link chip interface products and digital controllers. At the 10 Gb/s speed, competition will also come from optical technology sold by system and semiconductor companies. There are standardization efforts under way or completed for serial links from standard bodies such as PCI-SIG and OIF. We may face increased competition from these types of consortia in the future that could negatively impact our serial link chip interface business.
In the FlexIO processor bus chip interface market segment, we face additional competition from semiconductor companies who develop their own parallel bus chip interfaces, as well as competitors who license similar parallel bus chip interface products. We may also see competition from industry consortia or standard setting bodies that could negatively impact our FlexIO processor bus chip interface business.
As with our memory chip interface products, to the extent that competitive alternatives to our serial or parallel logic chip interface products might provide comparable system performance at lower or similar cost, or are perceived to require the payment of no or lower royalties, or to the extent other factors influence the industry, our licensees and prospective licensees may adopt and promote alternative technologies, which could negatively impact our memory and logic chip interface business.
If for any of these reasons we cannot effectively compete in these primary market segments, our results of operations could suffer.
Some of our revenue is subject to the pricing policies of our licensees over whom we have no control.
We have no control over our licensees’ pricing of their products and there can be no assurance that licensee products using or containing our chip interfaces will be competitively priced or will sell in significant volumes. One important requirement for our memory chip interfaces is for any premium charged by our licensees in the price of memory and controller chips over alternatives to be reasonable in comparison to the perceived benefits of the chip interfaces. If the benefits of our technology do not match the price premium charged by our licensees, the resulting decline in sales of products incorporating our technology could harm our operating results.
Future revenues are difficult to predict for several reasons, including our lengthy and costly license negotiation cycle, and our failure to predict revenues accurately may cause us to miss analysts’ estimates and result in our stock price declining.
The process of persuading system companies to adopt and license our chip interface technologies can be lengthy and, even if successful, there can be no assurance that our chip interfaces will be used in a product that is ultimately brought to market, achieves commercial acceptance, or results in significant royalties to us. In addition, a portion of our revenue comes from development and support services provided to our licensees. Depending upon the nature of the services, a portion of the related revenue may be recognized ratably over the support period, or may be recognized according to contract accounting. Contract revenue accounting may result in deferral of the service fees to the completion of the contract, or may be recognized over the period in which services are performed on a percentage-of-completion basis. There can be no assurance that the product development schedule for these projects will not be changed or delayed. All of these factors make it difficult to predict future licensing revenue and may result in our missing analysts’ estimates which would likely cause our stock price to decline.
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The price of our Common Stock may fluctuate significantly, which may make it difficult for holders to resell their shares when desired or at attractive prices.
Our Common Stock currently is listed on The Nasdaq Global Select Market under the symbol “RMBS.” The trading price of our Common Stock has been subject to wide fluctuations which may continue in the future in response to, among other things, the following:
| • | any progress, or lack of progress, in the development of products that incorporate our chip interfaces; |
| • | our signing or not signing new licensees; |
| • | new litigation or developments in current litigation as discussed above; |
| • | announcements of our technological innovations or new products by us, our licensees or our competitors; |
| • | developments related to the stock option investigation; |
| • | positive or negative reports by securities analysts as to our expected financial results; |
| • | developments with respect to patents or proprietary rights and other events or factors; and |
| • | any delisting of our Common Stock from The Nasdaq Global Select Market |
In addition, the equity markets have experienced volatility that has particularly affected the market prices of equity securities of many high technology companies and that often has been unrelated or disproportionate to the operating performance of such companies.
Our quarterly and annual operating results are unpredictable and fluctuate, which may cause our stock price to be volatile and decline.
Since many of our revenue components fluctuate and are difficult to predict, and our expenses are largely independent of revenues in any particular period, it is difficult for us to accurately forecast revenues and profitability. Factors other than those set forth above, which are beyond our ability to control or assess in advance, that could cause our operating results to fluctuate include:
| • | semiconductor and system companies’ acceptance of our chip interface products; |
| • |
the success of high volume consumer applications, such as the Sony PLAYSTATION®3; |
| • | the dependence of our royalties upon fluctuating sales volumes and prices of licensed chips that include our technology; |
| • | the seasonal shipment patterns of systems incorporating our chip interface products; |
| • | the loss of any strategic relationships with system companies or licensees; |
| • | semiconductor or system companies discontinuing major products incorporating our chip interfaces; |
| • | the unpredictability of the timing and amount of any litigation expenses; |
| • | changes in our chip and system company customers’ development schedules and levels of expenditure on research and development; |
| • | our licensees terminating or failing to make payments under their current contracts or seeking to modify such contracts; and |
| • | changes in our strategies, including changes in our licensing focus and/or possible acquisitions of companies with business models different from our own. |
For the years ended December 31, 2006, 2005 and 2004, royalties accounted for 87%, 83% and 83% of our total revenues, respectively, and we believe that royalties will continue to represent a majority of total revenues for the foreseeable future. Royalties are recognized in the quarter in which we receive a report from a licensee regarding the sale of licensed chips in the prior quarter; however, royalties are only recognized if collectibility is reasonably assured. As a result of these uncertainties and effects being outside of our control, royalty revenues are difficult to predict and make accurate financial forecasts difficult to achieve, which could cause our stock price to become volatile and decline.
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A substantial portion of our revenues is derived from sources outside of the United States and these revenues and our business generally are subject to risks related to international operations that are often beyond our control.
For the years ended December 31, 2006, 2005 and 2004, revenues from our sales to international customers constituted approximately 75%, 71% and 69% of our total revenues, respectively. We currently have international operations in India (design), Japan (business development), Taiwan (business development), Germany (business development) and Korea (business development). As a result of our continued focus on international markets, we expect that future revenues derived from international sources will continue to represent a significant portion of our total revenues.
To date, all of the revenues from international licensees have been denominated in U.S. dollars. However, to the extent that such licensees’ sales to systems companies are not denominated in U.S. dollars, any royalties which are based as a percentage of the customer’s sales, that we receive as a result of such sales could be subject to fluctuations in currency exchange rates. In addition, if the effective price of licensed semiconductors sold by our foreign licensees were to increase as a result of fluctuations in the exchange rate of the relevant currencies, demand for licensed semiconductors could fall, which in turn would reduce our royalties. We do not use financial instruments to hedge foreign exchange rate risk.
Our international operations and revenues are subject to a variety of risks which are beyond our control, including:
| • | export controls, tariffs, import and licensing restrictions and other trade barriers; |
| • | profits, if any, earned abroad being subject to local tax laws and not being repatriated to the United States or, if repatriation is possible, limited in amount; |
| • | changes to tax codes and treatment of revenues from international sources, including being subject to foreign tax laws and potentially being liable for paying taxes in that foreign jurisdiction; |
| • | foreign government regulations and changes in these regulations; |
| • | social, political and economic instability; |
| • | lack of protection of our intellectual property and other contract rights by jurisdictions in which we may do business to the same extent as the laws of the United States; |
| • | changes in diplomatic and trade relationships; |
| • | cultural differences in the conduct of business both with licensees and in conducting business in our international facilities and international sales offices; |
| • | operating centers outside the United States; |
| • | hiring, maintaining and managing a workforce remotely and under various legal systems; and |
| • | geo-political issues. |
We and our licensees are subject to many of the risks described above with respect to companies which are located in different countries, particularly home video game console and PC manufacturers located in Asia and elsewhere. There can be no assurance that one or more of the risks associated with our international operations could not result in a material adverse effect on our business, financial condition or results of operations.
Our results of operations could vary as a result of the methods, estimates, and judgments we use in applying our accounting policies.
The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations, as described elsewhere in this report. Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead us to change
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our methods, estimates, and judgments. Changes in those methods, estimates, and judgments could significantly affect our results of operations. In particular, the calculation of share-based compensation expense under Statement of Financial Accounting Standards No. 123(R) (“SFAS 123(R)”), requires us to use valuation methodologies which were not developed for use in valuing employee stock options and a number of assumptions, estimates, and conclusions regarding matters such as expected forfeitures, expected volatility of our share price, and the exercise behavior of our employees. Furthermore, there are no means, under applicable accounting principles, to compare and adjust our expense if and when we learn about additional information that may affect the estimates that we previously made, with the exception of changes in expected forfeitures of share-based awards. Factors may arise that lead us to change our estimates and assumptions with respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our cost of contract revenues, research and development expenses, marketing, general and administrative expenses and our effective tax rate, which could have an adverse impact on our results of operations.
Our results of operations could vary as a result of the implementation of changes in accounting rules.
Our financial statements are prepared in accordance with U.S. generally accepted accounting principles. These principles are subject to interpretation by various governing bodies, including the FASB and the SEC, who create and interpret appropriate accounting standards. A change from current accounting standards could have a significant effect on our results of operations.
Our business and operating results will be harmed if we are unable to manage growth in our business.
Our business has experienced periods of rapid growth that have placed, and may continue to place, significant demands on our managerial, operational and financial resources. In order to manage this growth, we must continue to improve and expand our management, operational and financial systems and controls. We also need to continue to expand, train and manage our employee base. We cannot assure you that we will be able to timely and effectively meet demand and maintain the quality standards required by our existing and potential customers and licensees. If we ineffectively manage our growth or we are unsuccessful in recruiting and retaining personnel, our business and operating results will be harmed.
We may make future acquisitions or enter into mergers, strategic transactions or other arrangements that could cause our business to suffer.
We may continue to make investments in companies, products or technologies or enter into mergers, strategic transactions or other arrangements. If we buy a company or a division of a company, we may experience difficulty integrating that company’s or division’s personnel and operations, which could negatively affect our operating results. In addition:
| • | the key personnel of the acquired company may decide not to work for us; |
| • | we may experience additional financial and accounting challenges and complexities in areas such as tax planning, cash management and financial reporting; |
| • | our ongoing business may be disrupted or receive insufficient management attention; |
| • | we may not be able to recognize the cost savings or other financial benefits we anticipated; and |
| • | our increasing international presence resulting from acquisitions may increase our exposure to international currency, tax and political risks. |
In connection with future acquisitions or mergers, strategic transactions or other arrangements, we may incur substantial expenses regardless of whether the transaction occurs. In addition, we may be required to assume the liabilities of the companies we acquire. By assuming the liabilities, we may incur liabilities such as those related to intellectual property infringement or indemnification of customers of acquired businesses for similar claims, which could materially and adversely affect our business. We may have to incur debt or issue equity securities to pay for any future acquisition, the issuance of which could involve restrictive covenants or be dilutive to our existing stockholders.
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If we are unable to attract and retain qualified personnel, our business and operations could suffer.
Our success is dependent upon our ability to identify, attract, compensate, motivate and retain qualified personnel who can enhance our existing technologies and introduce new technologies. Competition for qualified personnel, particularly those with significant industry experience, is intense. In addition, the consequences of the stock option investigation and restatements could cause increased attrition of our current personnel and negatively impact our reputation with potential employees. We are also dependent upon our senior management personnel. The loss of the services of any of our senior management personnel, or key sales personnel in critical markets, or critical members of staff, or of a significant number of our engineers could be disruptive to our development efforts or business relationships and could cause our business and operations to suffer.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including new SEC regulations and Nasdaq rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.
If we fail to remediate any material weaknesses in our internal control over financial reporting, we may be unable to accurately report our financial results or reasonably prevent fraud which could result in a loss of investor confidence in our financial reports and have an adverse effect on our business and operating results and our stock price.
Effective internal control over financial reporting is essential for us to produce reliable financial reports and prevent fraud. If we cannot provide reliable financial information or prevent fraud, our business and operating results, as well as our stock price, could be harmed. We have in the past discovered, and may in the future discover, material weaknesses in our internal control over financial reporting. A failure to implement and maintain effective internal control over financial reporting, could harm our operating results, result in a material misstatement of our financial statements, cause us to fail to meet our financial reporting obligations or prevent us from providing reliable and accurate financial reports or avoiding or detecting fraud. This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
Our operations are subject to risks of natural disasters, acts of war, terrorism or widespread illness at our domestic and international locations, any one of which could result in a business stoppage and negatively affect our operating results.
Our business operations depend on our ability to maintain and protect our facility, computer systems and personnel, which are primarily located in the San Francisco Bay Area. The San Francisco Bay Area is in close proximity to known earthquake fault zones. Our facility and transportation for our employees are susceptible to damage from earthquakes and other natural disasters such as fires, floods and similar events. Should an earthquake or other catastrophes, such as fires, floods, power loss, communication failure or similar events disable our facilities, we do not have readily available alternative facilities from which we could conduct our business, which stoppage could have a negative effect on our operating results. Acts of terrorism, widespread illness and war could also have a negative effect at our international and domestic facilities.
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We are leveraged financially, which could adversely affect our ability to adjust our business to respond to competitive pressures and to obtain sufficient funds to satisfy our future research and development needs, and to defend our intellectual property.
We have indebtedness. On February 1, 2005, we issued $300.0 million aggregate principal amount of zero coupon convertible senior notes (“convertible notes”) due February 1, 2010, of which $160.0 million remains outstanding as of the date of this report.
The degree to which we are leveraged could have important consequences, including, but not limited to, the following:
| • | our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate or other purposes may be limited; |
| • | a substantial portion of our cash flows from operations will be dedicated to the payment of the principal of our indebtedness as we are required to pay the principal amount of the convertible notes in cash when due; |
| • | if we elect to pay any premium on the convertible notes with shares of our Common Stock or we are required to pay a “make-whole” premium with our shares of Common Stock, our existing stockholders’ interest in us would be diluted; and |
| • | we may be more vulnerable to economic downturns, less able to withstand competitive pressures and less flexible in responding to changing business and economic conditions. |
A failure to comply with the covenants and other provisions of our debt instruments could result in events of default under such instruments, which could permit acceleration of the convertible notes under such instruments and in some cases acceleration of any future debt under instruments that may contain cross-default or cross-acceleration provisions. For instance, as a result of the stock option investigation, in July 2007, the trustee of the convertible notes accelerated the convertible notes due to an alleged event of default that had occurred under the convertible notes because of our non-compliance with the SEC reporting covenant. We continue to evaluate our options with respect to the convertible notes as a result of the receipt of the notice of acceleration. Although a repayment of the convertible notes pursuant to the acceleration notice would not change our net cash position, a repayment would lower our current cash on hand such that we would not have those funds available for the use in our business.
If we are at any time unable to generate sufficient cash flow from operations to service our indebtedness when payment is due, we may be required to attempt to renegotiate the terms of the instruments relating to the indebtedness, seek to refinance all or a portion of the indebtedness or obtain additional financing. There can be no assurance that we will be able to successfully renegotiate such terms, that any such refinancing would be possible or that any additional financing could be obtained on terms that are favorable or acceptable to us.
Our certificate of incorporation and bylaws, our stockholder rights plan, and Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our Common Stock.
Our certificate of incorporation, our bylaws, our stockholder rights plan and Delaware law contain provisions that might enable our management to discourage, delay or prevent change in control. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our Common Stock. Among these provisions are:
| • | our board of directors is authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as “blank check” preferred stock, with rights senior to those of Common Stock; |
| • | our board of directors is staggered into two classes, only one of which is elected at each annual meeting; |
| • | stockholder action by written consent is prohibited; |
| • | nominations for election to our board of directors and the submission of matters to be acted upon by stockholders at a meeting are subject to advance notice requirements; |
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| • |
certain provisions in our bylaws and certificate of incorporation such as notice to stockholders, the ability to call a stockholder meeting, advanced notice requirements and the stockholders acting by written consent may only be amended with the approval of stockholders holding 662/3% of our outstanding voting stock; |
| • | the ability of our stockholders to call special meetings of stockholders is prohibited; and |
| • | our board of directors is expressly authorized to make, alter or repeal our bylaws. |
In addition, the provisions in our stockholder rights plan could make it more difficult for a potential acquirer to consummate an acquisition of our company. We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject to enumerated exceptions, that if a person acquires 15% or more of our outstanding voting stock, the person is an “interested stockholder” and may not engage in any “business combination” with us for a period of three years from the time the person acquired 15% or more of our outstanding voting stock.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Properties |
As of December 31, 2006, we occupied offices in the leased facilities described below:
| Number of Offices Under Lease |
Location |
Primary Use | ||
| 4 | United States | Executive and administrative offices, research and development, sales and marketing and service functions | ||
| Los Altos, CA (Headquarters) | ||||
| Chapel Hill, NC | ||||
| Mountain View, CA | ||||
| Austin, TX | ||||
| 2 | Bangalore, India | Administrative offices, research and development and service functions | ||
| 1 | Tokyo, Japan | Business development | ||
| 1 | Taipei, Taiwan | Business development | ||
| 1 | Seoul, Korea | Business development | ||
| 1 | Pforzheim, Germany | Business development | ||
In May 2006, we signed an agreement to lease a new office facility in Bangalore, India into which we intend to consolidate all of our Bangalore operations. We are currently awaiting receipt of a certificate of occupancy or confirmation of deemed occupancy under local statutes in order for us to occupy the building.
| Item 3. | Legal Proceedings |
For the information required by this item regarding legal proceedings, see Notes 3, 17 and 18, “Restatement of Consolidated Financial Statements,” “Litigation and Asserted Claims” and “Subsequent Events,” respectively, of Notes to Consolidated Financial Statements of this Form 10-K.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
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| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our Common Stock is listed on The Nasdaq Global Select Market under the symbol “RMBS.” Due to the investigation of our historical stock option practices (see Item 3, “Legal Proceedings”) and the resulting restatements (see Note 3, “Restatement of Consolidated Financial Statements” of Notes to Consolidated Financial Statements), we did not file our periodic reports with the SEC on time and therefore our Common Stock is subject to delisting from The Nasdaq Global Select Market. Although with the filing of this Report on Form 10-K and our Quarterly Reports on Form 10-Q for the quarters ended June 30 and September 30, 2006 we have fulfilled our filing requirements through fiscal 2006, we are still out of compliance on our filings for fiscal 2007. We will continue to be subject to potential delisting until we are current with the SEC on all of our filings and have been notified by Nasdaq that we are in compliance (See Item 1A, “Risk Factors”).
The following table sets forth for the periods indicated the high and low sales price per share of our Common Stock as reported on The Nasdaq Global Select Market.
| Twelve Months Ended December 31, 2006 |
Twelve Months Ended December 31, 2005 | |||||||||||
| High | Low | High | Low | |||||||||
| First Quarter |
$ | 40.22 | $ | 17.50 | $ | 23.79 | $ | 12.95 | ||||
| Second Quarter |
$ | 46.99 | $ | 19.79 | $ | 16.14 | $ | 13.16 | ||||
| Third Quarter |
$ | 25.38 | $ | 10.25 | $ | 14.65 | $ | 10.22 | ||||
| Fourth Quarter |
$ | 23.83 | $ | 15.87 | $ | 18.00 | $ | 10.75 | ||||
Information regarding our securities authorized for issuance under equity compensation plans is included in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” of this report on Form 10-K.
In the first quarter of fiscal year 2007, ended March 31, 2007, the high and low closing prices of our Common Stock on The Nasdaq Global Select Market were $23.95 and $17.31, respectively. In the second quarter of fiscal year 2007, ended June 30, 2007, the high and low closing prices of our Common Stock on The Nasdaq Global Select Market were $22.00 and $17.67, respectively.
As of May 31, 2007, there were 839 holders of record of our Common Stock. Because many of the shares of our Common Stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. We have never paid or declared any cash dividends on our Common Stock or other securities and have no current plans to do so.
Share Repurchase Program
In October 2001, our Board of Directors approved a share repurchase program of our Common Stock principally to reduce the dilutive effect of employee stock options. On January 23, 2006 our Board of Directors approved an authorization to repurchase up to an additional 5.0 million shares of our Common Stock, giving us a total authorization to purchase up to 19.0 million shares of our outstanding Common Stock over an undefined period of time. During the first quarter of fiscal 2006, we repurchased 0.7 million shares at an average price per share of $29.94. As of December 31, 2006, we had repurchased a cumulative total of 13.2 million shares of our Common Stock at an average price per share of $13.95 since the commencement of this program. This amount includes 4.1 million shares repurchased in connection with our $300.0 million zero coupon convertible senior subordinated note offering on February 1, 2005. As
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of December 31, 2006, there remained an outstanding authorization to repurchase 5.8 million shares of our outstanding Common Stock as represented in the table below. In connection with the stock options investigation, repurchases of Common Stock under this program were suspended as of July 19, 2006. We will not repurchase additional shares until after we are current with our SEC filings.
| Period |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Total Paid | Average Price Paid per Share |
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | ||||||
| Beginning Balance 1/01/06 |
12,531,098 | $ | 163,576,320 | $ | 13.05 | 1,520,765 | ||||
| Additional authorization |
5,000,000 | |||||||||
| 6,520,765 | ||||||||||
| 1/01/06 - 1/30/06 |
500,000 | $ | 15,187,375 | $ | 30.37 | 6,020,765 | ||||
| 2/01/06 - 2/28/06 |
200,000 | $ | 5,767,700 | $ | 28.84 | 5,820,765 | ||||
| Total shares repurchased |
13,231,098 | $ | 184,531,395 | $ | 13.95 | |||||
| Item 6. | Selected Financial Data |
The following selected consolidated financial data has been restated to correct for our past accounting for stock options and certain other adjustments. Such data is derived from our consolidated financial statements and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data,” and other financial data included elsewhere in this report. Our historical results of operations are not necessarily indicative of results of operations to be expected for any future period.
On April 10, 2003, the Board of Directors of Rambus voted to change the fiscal year end of Rambus from September 30 to December 31, effective January 1, 2003. As a result, selected financial data is presented for the twelve months ended December 31, 2006, 2005, 2004, 2003, the three months ended December 31, 2002 and the twelve months ended September 30, 2002.
See Note 3, “Restatement of Consolidated Financial Statements,” of Notes to Consolidated Financial Statements, for more detailed information regarding the restatement of our consolidated financial statements as of December 31, 2005 for the years ended December 31, 2005 and 2004 and our selected consolidated financial data as of and for our fiscal years ended December 31, 2005, 2004, 2003, our quarter ended December 31, 2002 and our fiscal year ended September 30, 2002.
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| Twelve Months Ended December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | |||||||||||||||||
| (in thousands, except per share amounts) |
As restated | As restated | As previously reported |
Adjustments | As restated | |||||||||||||||
| Total revenues |
$ | 195,324 | $ | 157,198 | $ | 144,874 | $ | 118,203 | $ | 100 | $ | 118,303 | ||||||||
| Net income (loss) |
$ | (13,816 | ) | $ | 28,940 | $ | 22,361 | $ | 23,221 | $ | (17,238 | ) | $ | 5,983 | ||||||
| Net income (loss) per share: |
||||||||||||||||||||
| Basic |
$ | (0.13 | ) | $ | 0.29 | $ | 0.22 | $ | 0.24 | $ | (0.18 | ) | $ | 0.06 | ||||||
| Diluted |
$ | (0.13 | ) | $ | 0.28 | $ | 0.21 | $ | 0.22 | $ | (0.16 | ) | $ | 0.06 | ||||||
| Consolidated Balance Sheet Data: | ||||||||||||||||||||
| Cash, cash equivalents and marketable securities |
$ | 436,341 | $ | 355,390 | $ | 236,360 | $ | 188,538 | $ | — | $ | 188,538 | ||||||||
| Total assets |
$ | 604,617 | $ | 515,953 | $ | 396,052 | $ | 293,086 | $ | 28,023 | $ | 321,109 | ||||||||
| Deferred revenue |
$ | 7,557 | $ | 9,290 | $ | 23,823 | $ | 42,202 | $ | — | $ | 42,202 | ||||||||
| Convertible notes |
$ | 160,000 | $ | 160,000 | $ | — | $ | — | $ | — | $ | — | ||||||||
| Stockholders’ equity |
$ | 382,288 | $ | 323,467 | $ | 353,576 | $ | 240,080 | $ | 22,277 | $ | 262,357 | ||||||||
| Three Months Ended December 31, | Twelve Months Ended September 30, | |||||||||||||||||||
| 2002 | 2002 | |||||||||||||||||||
| (in thousands, except per share amounts) |
As previously reported |
Adjustments | As restated |
As previously reported |
Adjustments | As restated | ||||||||||||||
| Total revenues |
$ | 25,704 | $ | 74 | $ | 25,778 | $ | 96,565 | $ | 79 | $ | 96,644 | ||||||||
| Net income |
$ | 5,529 | $ | (5,328 | ) | $ | 201 | $ | 24,704 | $ | (24,145 | ) | $ | 559 | ||||||
| Net income per share: |
||||||||||||||||||||
| Basic |
$ | 0.06 | $ | (0.06 | ) | $ | 0.00 | $ | 0.25 | $ | (0.24 | ) | $ | 0.01 | ||||||
| Diluted |
$ | 0.06 | $ | (0.06 | ) | $ | 0.00 | $ | 0.24 | $ | (0.23 | ) | $ | 0.01 | ||||||
| Consolidated Balance Sheet Data: |
||||||||||||||||||||
| Cash, cash equivalents and marketable securities |
$ | 175,832 | $ | — | $ | 175,832 | $ | 156,129 | $ | 1,194 | $ | 157,323 | ||||||||
| Total assets |
$ | 250,523 | $ | 30,085 | $ | 280,608 | $ | 232,959 | $ | 29,421 | $ | 262,380 | ||||||||
| Deferred revenue |
$ | 37,760 | $ | 100 | $ | 37,860 | $ | 26,987 | $ | 174 | $ | 27,161 | ||||||||
| Convertible notes |
$ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||
| Stockholders’ equity |
$ | 202,377 | $ | 23,745 | $ | 226,122 | $ | 195,492 | $ | 21,938 | $ | 217,430 | ||||||||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion contains forward-looking statements, including, without limitation, our expectations regarding revenues, expenses and results of operations, as well as the outcome of our stock option investigation and related litigation. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future actual results to differ materially from our recent results or those projected in the forward-looking statements include, but are not limited to, those discussed in the “Special Note Regarding Forward-Looking Statements” Item 1A. of PART I, “Risk Factors,” and below. We assume no obligation to update the forward-looking statements or such risk factors.
Restatement of Consolidated Financial Statements, Audit Committee, Special Litigation Committee and Company Findings, Remedial Measures and Related Proceedings
This Annual Report on Form 10-K for our fiscal year December 31, 2006 includes restatements of: (1) previously filed consolidated financial statements, financial data and related disclosures as of December 31, 2005 and for our fiscal years ended December 31, 2005 and 2004; (2) our selected consolidated financial data as of and for our
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fiscal years ended December 31, 2005, 2004, 2003, our quarter ended December 31, 2002, and our fiscal year ended September 30, 2002; (3) our management’s discussion and analysis of financial condition and results of operations as of and for our fiscal years ended December 31, 2005 and 2004 contained in Item 7 of this Form 10-K; and (4) our unaudited quarterly financial data for the first quarter of fiscal year ended December 31, 2006 and for all quarters in our fiscal year ended December 31, 2005 located at the end of Item 15 of this Form 10-K. The restatements are the result of errors in the way we accounted for certain historical stock option grants that were discovered through our independent stock option investigation conducted by the Audit Committee of the Board of Directors. See Note 3, “Restatement of Consolidated Financial Statements,” of Notes to Consolidated Financial Statements and Exhibit 99.1 for a detailed discussion of the effect of the restatements.
Our previously issued consolidated financial statements for the fiscal years 2005 and prior, which are included in our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q filed with respect to each of the applicable quarters in these fiscal years and the consolidated financial statements included in our Quarterly Report on Form 10-Q for the first quarter of fiscal year 2006, should no longer be relied upon.
Audit Committee Investigation of Historical Stock Option Practices
In early 2006, an academic study and numerous subsequent press reports began to publicize the likely widespread occurrence of accounting and corporate governance irregularities with respect to the granting of stock options and other equity awards at over 100 companies, many in the high-tech sector. One report included Rambus as one of the companies surveyed with a high risk of having backdated stock option grants. As a result, in late May 2006, we conducted an initial review in which we discovered apparent irregularities in past stock option grants and reported our findings to the Audit Committee and the Board of Directors.
On May 30, 2006, the Audit Committee commenced an internal investigation of the timing of past stock option grants and other related accounting issues. Each of the members of the Audit Committee had joined our Board of Directors and Audit Committee after January 1, 2005. The Audit Committee retained independent legal counsel and an independent accounting firm to assist in the investigation.
On July 17, 2006, the Audit Committee concluded that the actual dates of determination for certain past stock option grants differed from the originally stated grant dates for such awards. Because the prices at the originally stated grant dates were lower than the prices on the actual dates of the determination, we concluded that we should have recognized material amounts of stock-based compensation expense which were not accounted for in our previously issued consolidated financial statements. Therefore, the Audit Committee and management concluded that our previously issued consolidated financial statements for the fiscal years 2003, 2004 and 2005 which were included in our 2005 Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q filed with respect to each of the applicable quarters in these fiscal years, and the consolidated financial statements included in our Quarterly Report on Form 10-Q for the first quarter of fiscal year 2006, should no longer be relied upon and would be restated.
Findings and Remedial Actions
By October 18, 2006, the Audit Committee had substantially completed its findings with respect to the timing of our historical stock option grants. The independent investigation over the previous four months included a review of over 200 stock option granting actions from the time of our initial public offering through the commencement of the investigation in late May 2006. The review encompassed over 1.5 million emails and other documents, and over 50 interviews with current and former executive officers, directors, employees and advisors.
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The results of the investigation were consistent with the Audit Committee’s earlier conclusion that our previously filed consolidated financial statements should no longer be relied upon. We are disclosing the restatement of the consolidated financial statements for the affected periods by filing this Annual Report on Form 10-K for the year ended December 31, 2006, which includes the restatement of the consolidated financial statements for the 2005 and 2004 fiscal years, as well as restated supplementary financial data for the first quarter of 2006. In addition, the errors we identified impacted our consolidated financial statements for the periods prior to the year ended December 31, 2004. In the restated consolidated financial statements in this Annual Report on Form 10-K, the cumulative impact of the errors as of December 31, 2003 is represented as a change to the opening balance of accumulated deficit, additional paid in capital and deferred taxes as of January 1, 2004. The impact of these errors will continue to have an effect on our consolidated financial statements for periods through fiscal 2009.
The impact of these errors also extended to the quarter ended March 31, 2006. Restated unaudited consolidated financial statements for the periods ended March 31, 2006 and 2005, related restated management’s discussion and analysis of financial condition and results of operations for these periods and certain restated tables and disclosures related to APB 25, SFAS 123 and SFAS 123(R) are included in Exhibit 99.1. We have filed interim consolidated financial statements on Form 10-Q for the period ended June 30, 2006 and the period ended September 30, 2006. In these quarterly consolidated financial statements, the cumulative impact of the errors as of December 31, 2004 is represented as a change to the opening balance of accumulated deficit, additional paid in capital and deferred taxes as of January 1, 2005.
Other balance sheet items related to prior periods affected by the restatement are reflected in the opening balances of the consolidated balance sheet as of January 1, 2004.
On August 30, 2007, the Audit Committee completed its investigation. The Audit Committee concluded that: (1) there was retroactive pricing of stock options granted to nearly all employees who received options, primarily during the periods from September 30, 1997 to December 31, 2004; (2) the retroactively priced options were not accounted for correctly in the Company’s previously issued consolidated financial statements; (3) the retroactive pricing of options in many instances was intentional, not inadvertent or as a result of administrative error; (4) the retroactive pricing of options involved the selection of low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct; (5) vesting terms on stock options for certain terminating employees were changed without proper authorization; and (6) the retroactive pricing of options in many instances involved the falsification of Stock Option Committee Memoranda, Unanimous Written Consents (UWC) and minutes of the Compensation Committee and offer letters to employees, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as well as in information previously provided to the Company’s independent registered public accounting firm.
Because the retroactive pricing was the result of the actions of only a few individuals, the Board of Directors decided that the Company should continue to honor the retroactively priced options in most instances.
The Audit Committee further concluded that our former Chief Financial Officers and Controllers should have been more involved in understanding whether stock option grants were being properly accounted for, and either knew the proper accounting rules or should have taken steps to become aware of the proper accounting rules for stock option grants. At the time of these practices, it was the reasonable practice of our former Chief Financial Officers and Controllers to rely on senior executives of the Company to create accurate records of the stock option approvals and grants. Our former CEO participated in the approval of misdated stock option grants. He knew or should have been aware of the fact that date selection practices were occurring and that the approval memoranda he signed were not properly reflecting the actual approval dates. However, the Audit Committee also concluded that it was reasonable for the former CEO to believe that the Senior Vice President, Administration was handling the Company’s stock option grants in accordance with the appropriate legal and accounting rules for stock option grants and understood the Company’s actual practices.
Concurrent with the review by the Audit Committee, our management, under the oversight of the Audit Committee, completed an internal review in order to prepare the restated consolidated financial statements which included evaluations of our previous accounting for stock options and led to adjustments for: (a) stock option grants for which the Audit Committee determined that the actual grant date for accounting purposes was different from the stated grant date for new hire grants to employees, annual and other grants to employees, and any grants to officers; (b) grants made to individuals who had extensions of option termination dates and, in some cases, extensions of vesting periods pursuant to separation agreements under which the individuals did not perform any significant duties during the separation period but were still listed as employees; (c) payroll tax withholding liabilities for certain repriced stock grants that no longer qualify for Incentive Stock Option (“ISO”) tax treatment; and (d) other miscellaneous adjustments for modifications and errors, including adjustments for grants to non-employees providing consulting services and adjustments for continued vesting after an individual converted from an employee to a consultant role.
Summary of Accounting Adjustments by Category
These restated consolidated financial statements include adjustments that are primarily related to the stock option matters as well as adjustments that are related to other matters resulting from our internal review and the preparation of these restated consolidated financial statements.
The primary components of the restatement of our historical consolidated financial statements related to stock-based compensation are as follows:
| • | New Hire Grants to Employees We determined that during the period from February 1999 through October 2003, the individuals responsible for stock option grants to newly hired non-executive employees had a regular practice of selecting an exercise price equal to the lowest price of the quarter between the employee’s start date and the end of the quarter for such grants. On certain occasions, individual employees were given a formal employment start date which preceded the date on which they actually began working for us. The result of this practice was that certain employees received a new hire grant at a grant price that was lower than the price of the stock on the employee’s actual start date. |
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There were three new hire grants to non-executive employees between October 2003 and December 2004 for which there were administrative errors made by our human resources department.
There were no material measurement date differences relating to grants to non-executive new hires in fiscal years 2005 and 2006.
| • | Annual and Other Grants to Employees We determined that between September 1998 and October 2003, the Stock Option Committee granted approximately 13.0 million stock options to non-executive employees for which the appropriate measurement dates differed from the recorded grant dates. The Stock Option Committee during this time period consisted of our CEO, Geoff Tate, as its sole member. The majority of the measurement date differences during this time period were caused by the creation of incorrect documentation concerning the date on which the stock options were approved. The human resources department usually created Stock Option Committee memoranda reflecting stock option grants which purported to issue the grants on certain dates which differed from the actual dates on which the approvals were obtained. In October 2003 the Stock Option Committee was dissolved and this practice ceased. |
In late 2003 and 2004 there were grants to non-executive employees for which the price was set on the same date that the Compensation Committee had met and discussed a pool of stock options. However, the individual allocations of the stock option pool had not been completed by management until after the date of those meetings and, consequently, we recorded a retroactively selected measurement date for those grants.
There were no material measurement date differences related to new hires or annual grants to officers in the fiscal year 2005 and 2006.
| • | Grants to Officers We determined that, during each of the years between 1997 and 2001, officers were granted stock options that were not approved by the Compensation Committee of the Board of Directors on the date listed on the approval documentation. Instead, on some occasions, the dates were selected to coincide with a low price for a period. The grants were typically documented using a Unanimous Written Consent (“UWC”) prepared in most instances by the human resources department. The UWCs did not appropriately reflect that the approval date was not the date indicated in the document. With the following exceptions, this practice appears to have ended after 2001. |
Between December 1999 and January 2003 there were instances where officers received a new hire grant that was dated on a date different from the date on which the Compensation Committee approved the grant. Each of these grants was documented using a UWC prepared by the human resources department. The UWCs did not appropriately reflect that the approval date was not the date indicated in the document. This practice, with one exception in January 2003, appears to have ended in July 2002.
In late 2003, there was one granting action for which the exercise price of the options coincided with the date of a Compensation Committee meeting, but for which we were unable to establish that all of the specific allocations and approvals had been completed as of the date of that meeting. Consequently, we have concluded that the grants relating to some of the officers receiving that grant had incorrect measurement dates.
There were no material measurement date differences relating to annual or other grants to non-executive employees in the fiscal years 2005 and 2006.
| • | Extension of Termination Dates We determined that from 1997 to March 2005 we had not maintained accurate documentation, and had not properly accounted for stock-based compensation, for stock options granted to individuals who had extensions of option termination dates and, in some cases, extensions of vesting periods pursuant to separation agreements under which the individuals did not perform any significant duties during the separation period but were still listed as employees. These types of modifications were not always communicated to our finance department, were not identified in our financial reporting processes and were therefore not properly reflected in our consolidated financial statements. |
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| • | Payroll Tax Withholding Liability We determined that certain of our stock grants which had incorrect measurement dates for accounting purposes had been originally issued as incentive stock options but no longer qualified for ISO tax treatment. The disqualification of the ISO classification and the resulting conversion to non-qualified stock option (“NSO”) status exposes us to additional withholding taxes and penalties for failure to properly withhold taxes on the exercise of those options. These expenses reverse in the period in which the related statute of limitations expires. |
| • | Other Stock-based Compensation Adjustments We determined that other miscellaneous modifications and errors had occurred related to employee options that were not identified in our financial reporting processes and therefore not properly reflected in our consolidated financial statements. These miscellaneous items included adjustments for grants to non-employees providing consulting services, adjustments for continued vesting after an individual converted from an employee to a consultant and adjustments in 2006 related to the accounting for our Employee Stock Purchase Plan (“ESPP”) under FAS 123(R). |
In connection with the restatement, we and the Audit Committee conducted certain investigative procedures to determine whether we could continue to rely upon the work performed by the accounting, finance and legal personnel as it relates to fiscal 2006, 2005, 2004 and prior periods, and the extent to which our prior accounting and controls for non-stock option related matters could be relied upon for purposes of the preparation and certification of the restated consolidated financial statements. In this process, and our internal review of other accounting items relating to transactions occurring in fiscal years 1997 through 2006, we identified certain other errors in accounting determinations and judgments which, although immaterial, have been reflected in the restated consolidated financial statements. These primarily include timing differences for revenue and expense recognition and certain balance sheet reclassifications.
We previously applied APB 25 and its related interpretations and provided the required pro forma disclosures under SFAS 123 through our fiscal year ended December 31, 2005. Under the provisions of APB 25, a non-cash, stock-based compensation expense was required to be recognized for any option granted for which the exercise price was below the market price on the actual grant date. Because most of our remeasured options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the options. Starting in fiscal 2006, we adopted SFAS 123(R). As a result, beginning in fiscal year 2006, stock-based compensation expense required to be recorded for each remeasured option is equal to the fair value of the option on the actual grant date, amortized over the remaining expected requisite service period of the option. We did not record these stock-based compensation expenses under APB 25 or SFAS 123(R) in our previously issued consolidated financial statements, and that is why we are restating them in this filing.
Restatement and Impact on Consolidated Financial Statements
As a result of the issues identified, we recorded additional pre-tax, non-cash, stock-based compensation expense of $169.4 million under APB 25 for the period between May 13, 1997 (the date of our initial public offering) and December 31, 2005, comprised of $146.9 million related to remeasured stock options and $22.5 million related to other stock compensation adjustments. The cumulative tax benefit from the recording of these adjustments was $67.0 million. The impact of these adjustments, net of taxes, decreased our previously reported cumulative net income by $102.4 million for the same period. The tax benefit amount differs from the statutory tax benefit principally as a result of limitations on our ability to deduct certain executive stock-based compensation and changes in geographical mix of expenses.
For the year ended December 31, 2006, in accordance with SFAS 123(R), we recorded additional pre-tax, non-cash, stock-based compensation expense of $6.8 million comprised of $6.3 million related to these remeasured stock options and $0.5 million related to other stock compensation adjustments. As of December 31, 2006, we have $6.6 million of unrecognized pre-tax stock-based compensation costs calculated under SFAS 123(R) related to remeasured stock option grants that will be recorded as compensation expense over the remaining expected requisite service period of the options.
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Approximately $132.8 million of the total stock-based compensation expenses, representing adjustments from 1997 through 2003, have been reflected, net of income tax effects of $46.4 million, as an increase of $86.4 million to accumulated deficit in the opening balance sheet for fiscal 2004.
Because certain options formerly classified as ISO grants were determined to have been granted with an exercise price below the fair market value of our stock on the actual grant date, they do not qualify for ISO tax treatment. The disqualification of ISO classification and the resulting conversion to NSO status exposes us to additional withholding taxes and penalties for failing to properly withhold taxes on exercise of those options. Through December 31, 2006, we recorded a tax liability of $1.5 million in connection with this disqualification of such ISO tax treatment for tax years ending December 31, 2003 through December 31, 2006. Of the total liability, $0.3 million was related to fiscal 2006 and was paid in fiscal 2007. These amounts are included in the other stock-based compensation adjustments discussed above. We are currently under IRS remote examination with regard to this issue.
We were unable to record additional deferred tax assets related to stock-based compensation in accordance with limits imposed by Section 162(m) of the Internal Revenue Code on certain executive compensation. Consequently, we were required to reduce our available tax net operating loss carry-forwards arising from certain exercised stock options by $15.6 million for periods through December 31, 2005 because of this Section 162(m) limitation.
For explanatory purposes, we have classified the stock option and other adjustments that were affected by the restatement into the aforementioned categories as presented below. The classified amounts involve certain subjective judgments by us to the extent particular stock option related accounting errors may fall within more than one category As such, the table below should be considered a reasonable representation of the magnitude of expenses in each category. For the fiscal years ended December 31, 2005 and September 30, 2000, we had previously recorded stock-based compensation expense of $2.7 million and $171.1 million, respectively, with a related tax benefit of $0.1 million and $29.8 million, respectively, in our reported consolidated financial statements. For fiscal 2005 and 2000, total stock-based compensation, as restated, was $20.5 million and $204.1 million, respectively, with a related tax benefit of $13.2 million and $40.0 million, respectively.
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The ten year impact of the restatement on stock-based compensation is as follows:
| Cumulative December |
Twelve Months ended December 31, |
Cumulative December |
Twelve December |
Three December |
||||||||||||||||||||
| (in thousands) |
2005 | 2004 | ||||||||||||||||||||||
| Net income, as previously reported (1) |
$ | 33,677 | $ | 33,559 | ||||||||||||||||||||
| Stock-based compensation adjustments: |
||||||||||||||||||||||||
| Additional compensation expense resulting from improper measurement dates for stock option grants: |
||||||||||||||||||||||||
| New hire grants to employees |
$ | (13,766 | ) | (762 | ) | (1,323 | ) | $ | (11,681 | ) | $ | (2,722 | ) | $ | (665 | ) | ||||||||
| Annual and other grants to employees |
(83,893 | ) | (12,655 | ) | (12,230 | ) | (59,008 | ) | (14,413 | ) | (3,891 | ) | ||||||||||||
| All grants to officers |
(49,235 | ) | (4,311 | ) | (8,148 | ) | (36,776 | ) | (8,404 | ) | (2,763 | ) | ||||||||||||
| Subtotal charges for changes to measurement date |
(146,894 | ) | (17,728 | ) | (21,701 | ) | (107,465 | ) | (25,539 | ) | (7,319 | ) | ||||||||||||
| Other stock-based compensation adjustments: |
||||||||||||||||||||||||
| Terminations |
(21,180 | ) | (277 | ) | (1,576 | ) | (19,327 | ) | (1,613 | ) | (21 | ) | ||||||||||||
| Payroll tax (expense) benefit |
(960 | ) | 234 | 4,534 | (5,728 | ) | 344 | — | ||||||||||||||||
| Other matters related to stock-based compensation |
(328 | ) | — | (32 | ) | (296 | ) | — | — | |||||||||||||||
| Subtotal other stock-based compensation adjustments |
(22,468 | ) | (43 | ) | 2,926 | (25,351 | ) | (1,269 | ) | (21 | ) | |||||||||||||
| Total stock-based compensation adjustments |
(169,362 | ) | (17,771 | ) | (18,775 | ) | (132,816 | ) | (26,808 | ) | (7,340 | ) | ||||||||||||
| Tax related effects of stock-based compensation adjustments |
66,989 | 13,070 | 7,558 | 46,361 | 9,421 | 2,057 | ||||||||||||||||||
| Additional compensation expense, net of tax |
(102,373 | ) | (4,701 | ) | (11,217 | ) | (86,455 | ) | (17,387 | ) | (5,283 | ) | ||||||||||||
| Other miscellaneous adjustments |
(60 | ) | (60 | ) | 32 | (32 | ) | |||||||||||||||||
| Tax related effects for other miscellaneous adjustments |
24 | 24 | (13 | ) | 13 | |||||||||||||||||||
| Other adjustments, net of tax |
(36 | ) | (36 | ) | 19 | (19 | ) | |||||||||||||||||
| Total decrease |
$ | (102,409 | ) | (4,737 | ) | (11,198 | ) | $ | (86,474 | ) | ||||||||||||||
| Net income, as restated |
$ | 28,940 | $ | 22,361 | ||||||||||||||||||||
| (1) | The effects of the restatement adjustments on previously reported net income are reconciled only for the years being reported in the Statement of Operations in this Form 10-K. Net income for all other periods is not being reconciled for the effects of the restatement. |
| Twelve Months Ended September 30, | |||||||||||||||||||||||
| 2002 | 2001 | 2000 | 1999 | 1998 | 1997 | ||||||||||||||||||
| Stock-based compensation adjustments: |
|||||||||||||||||||||||
| Additional compensation expense resulting from improper measurement dates for stock option grants: |
|||||||||||||||||||||||
| New hire grants to employees |
$ | (2,767 | ) | $ | (3,194 | ) | $ | (1,902 | ) | $ | (431 | ) | $ | — | $ | — | |||||||
| Annual and other grants to employees |
(21,287 | ) | (11,138 | ) | (6,159 | ) | (2,110 | ) | (10 | ) | — | ||||||||||||
| All grants to officers |
(10,312 | ) | (7,280 | ) | (5,917 | ) | (2,064 | ) | (36 | ) | — | ||||||||||||
| Subtotal charges for changes to measurement date |
(34,366 | ) | (21,612 | ) | (13,978 | ) | (4,605 | ) | (46 | ) | — | ||||||||||||
| Other stock-based compensation adjustments: |
|||||||||||||||||||||||
| Terminations |
(56 | ) | (1,463 | ) | (13,623 | ) | (2,063 | ) | (488 | ) | — | ||||||||||||
| Payroll tax (expense) benefit |
106 | (353 | ) | (5,137 | ) | (581 | ) | (107 | ) | — | |||||||||||||
| Other matters related to stock-based compensation |
— | 63 | (274 | ) | 216 | (301 | ) | — | |||||||||||||||
| Subtotal other stock-based compensation adjustments |
50 | (1,753 | ) | (19,034 | ) | (2,428 | ) | (896 | ) | — | |||||||||||||
| Total stock-based compensation adjustments |
(34,316 | ) | (23,365 | ) | (33,012 | ) | (7,033 | ) | (942 | ) | — | ||||||||||||
| Tax related effects of stock-based compensation adjustments |
10,142 | 12,216 | 10,166 | 2,000 | 359 | — | |||||||||||||||||
| Additional compensation expense, net of tax |
(24,174 | ) | (11,149 | ) | (22,846 | ) | (5,033 | ) | (583 | ) | — | ||||||||||||
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Costs of Restatement and Related Legal Activities
We have incurred substantial expenses for legal, accounting, tax and other professional services in connection with the investigation, our internal review, restatement activities, preparation of the December 31, 2006 consolidated financial statements and restated consolidated financial statements and related legal matters. These expenses were approximately $31.4 million for the year ended December 31, 2006, including an accrual of $18.0 million related to the potential settlement of the class action lawsuit pertaining to the accounting for stock option grants and related disclosures. See Note 17 of Notes to Consolidated Financial Statements, “Litigation and Asserted Claims.”
Through the second quarter of fiscal year 2007, we have incurred additional expenses of approximately $14.4 million for the above noted activities. We expect to continue to incur significant expenses in connection with the derivative and private lawsuits and other stock option investigation related matters.
Regulatory Inquiries Related to Historical Stock Option Practices
We have periodically met and discussed the results of the stock option investigation with the staff of the SEC and the United States Attorney’s Office for the Northern District of California. Such government agencies will likely review such findings and may pursue inquiries of their own, which could lead to further investigations and government action, such as fines or injunctions. At this time, we cannot predict what, if any, government actions may result from the completion of the investigation. There is no assurance that other regulatory inquiries will not be commenced by other U.S. federal, state or foreign regulatory agencies. Any potential regulatory proceeding or action may be time consuming, expensive and distracting from the conduct of our business. An unfavorable outcome or significant judgments, settlements and legal expenses related to resolution of any potential regulatory proceeding or action, or further restatement of our consolidated financial statements, could have a material adverse effect on us. We will continue to cooperate with the appropriate government authorities regarding the investigation.
Late SEC Filings and Nasdaq Delisting Proceedings
We failed to timely file with the SEC our Forms 10-Q for the periods ended June 30, 2006, September 30, 2006, March 31, 2007 and June 30, 2007 and our Form 10-K for the year ended December 31, 2006 as a result of the ongoing Audit Committee investigation. We announced in August and November 2006 and March, May and August 2007 that we had received Nasdaq Staff Determination notices stating that we were not in compliance with Nasdaq Marketplace Rule 4310(c)(14) as a result of failing to file our Forms 10-Q and Form 10-K with the SEC and, therefore, were subject to potential delisting from The Nasdaq Global Select Market. We requested, met with and/or submitted appropriate information to Nasdaq throughout 2006 and 2007 in order to request continued listing, and on August 17, 2007, we were granted a stay of delisting from the Board of Directors of Nasdaq in order to file our delayed SEC reports until October 17, 2007. We remain subject to potential delisting as a result of our failure to timely file our Forms 10-Q for the periods ended March 31, and June 30, 2007 that have yet to be filed with the SEC.
Special Litigation Committee
On October 18, 2006, the Audit Committee recommended, and the Board of Directors approved, the formation of a Special Litigation Committee (the “SLC”) to evaluate potential claims or other actions arising from the findings of the Audit Committee’s investigation. The Board of Directors has appointed Mr. J. Thomas Bentley, Chairman of the Audit Committee, and Mr. Abraham Sofaer, a retired federal judge and Chairman of the Legal Affairs Committee, both of whom joined the Rambus Board of Directors in 2005, to comprise the SLC. We have confirmed that Messrs. Bentley and Sofaer are disinterested directors for the purpose of the SLC and they are not believed to have past or present business dealings with any potential subjects of the investigation that would impair their ability to act independently and in good faith.
The SLC has now concluded its review of claims relating to stock option practices that are asserted in derivative actions against a number of our present and former officers and directors and filed a written report setting out its findings with the U.S. District Court for the Northern District of California. For additional information about the findings of the SLC, please see “Shareholder Litigation Related to Historical Stock Option Practices” below.
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Default and Potential Acceleration of Zero Coupon Convertible Senior Notes
For a complete discussion of the convertible notes and related alleged default and potential acceleration, see Note 16, “Convertible Notes” of Notes to Consolidated Financial Statements.
Shareholder Litigation Related to Historical Stock Option Practices
Derivative Lawsuits
On May 30, 2006, the Audit Committee commenced an internal investigation of the timing of past stock option grants and other related accounting issues.
On May 31, 2006, the first of three shareholder derivative actions was filed in the Northern District of California against us (as a nominal defendant) and certain current and former executives and board members. On August 9, 2006, these actions were consolidated for all purposes under the caption, In re Rambus Inc. Derivative Litigation, Master File No. C-06-3513-JF (N.D. Cal.), and Howard Chu and Gaetano Ruggieri were appointed lead plaintiffs. On October 2, 2006, a consolidated complaint was filed. On November 3, 2006, plaintiffs filed an amended consolidated complaint. The complaint alleges violations of certain federal and state securities laws as well as other state law causes of action. The complaint seeks disgorgement and damages in an unspecified amount, unspecified equitable relief, and attorneys’ fees and costs.
On July 24, 2006, another shareholder derivative action was filed in Santa Clara Superior Court against us (as a nominal defendant) and certain current and former executives and board members (Soffer v. Tate et al., 1-06-cv-067853 (Santa Clara Sup. Court)). We filed a motion to dismiss this suit on August 23, 2006. In an order filed on October 20, 2006, the California court granted our motion and dismissed the complaint.
On August 22, 2006, another shareholder derivative action was filed in Delaware Chancery Court against us (as a nominal defendant) and certain current and former executives and board members (Bell v. Tate et al., 2366-N (Del. Chancery)). Pursuant to agreement of the parties, no deadline for us to respond to the complaint has been set.
The SLC has concluded its review of claims relating to stock option practices that are asserted in derivative actions against a number of our present and former officers and directors. The SLC has determined that all claims should be terminated and dismissed against the named defendants in the derivative actions with the exception of claims against Ed Larsen, who served as Vice President, Human Resources from September 1996 until December 1999, and then Senior Vice President, Administration until July 2004. The SLC has entered into settlement agreements with certain former officers of the Company. These settlements are conditioned upon the dismissal of the claims asserted against these individuals in the derivative actions. The aggregate value of the settlements to the Company exceeds $6.5 million in cash and equivalent value, as well as substantial additional value to us relating to the relinquishment of claims to over 2.7 million stock options. On August 24, 2007, the written report setting out the findings of the SLC was filed with the U.S. District Court for the Northern District of California. The conclusions of the SLC are subject to review by the court. At a case management conference on September 7, 2007, Rambus informed the California court that it intended to file a motion to terminate in accordance with the SLC’s recommendations. Rambus’ motion is due by October 5, 2007. Plaintiffs stated their intention to oppose Rambus’ motion and to file a motion for leave to amend their complaint. The California court scheduled a hearing on both motions for January 18, 2008.
Class Action Lawsuits
On July 17, 2006, the first of six class action lawsuits was filed in the Northern District of California against us and certain current and former executives and board members. On September 26, 2006, these class action suits were consolidated under the caption, In re Rambus Inc. Securities Litigation, C-06-4346-JF (N.D. Cal.). On November 9, 2006, Ronald L. Schwarcz was appointed lead plaintiff. An amended consolidated complaint was filed on February 14, 2007, naming as defendants us, certain of our current and former executives and board members, and PricewaterhouseCoopers LLP. The complaint alleges violations of various federal securities laws. The complaint seeks damages in an unspecified amount as well as attorneys’ fees and costs. On April 2, 2007, we and certain individual defendants filed a motion to dismiss the lawsuit. PricewaterhouseCoopers LLP filed a motion to dismiss on May 7, 2007. Per agreement of the parties, briefing on the motions to dismiss has been suspended, and a hearing on the motion to dismiss previously scheduled for June 22, 2007, was taken off calendar. No new date for the hearing has been set. Subject to approval by the California court, the parties have agreed in principle to resolve this dispute. The settlement, which is subject to final documentation as well as review by the California court, provides for a payment by Rambus of $18.0 million and would lead to a dismissal with prejudice of all claims against all defendants in the class action litigation.
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Private Lawsuits
On March 1, 2007, a pro se lawsuit was filed in the Northern District of California by two alleged Rambus shareholders against us, certain current and former executives and board members and PricewaterhouseCoopers LLP (Kelley et al. v. Rambus, Inc. et al. C-07-01238-JF (N.D. Cal.)). On April 25, 2007, the plaintiffs filed an amended complaint adding Wilson Sonsini Goodrich & Rosati as a defendant. The plaintiffs filed second and third amended complaints without leave of court on May 8 and 14, 2007, respectively. On May 14, 2007 this case was related to the class action, In re Rambus Inc. Securities Litigation, C-06-4346-JF. We and the other named defendants filed or joined various motions to dismiss the third amended complaint on June 4 and 5, 2007. On May 8, 2007, a substantially identical pro se lawsuit was filed in the Northern District of California by another purported Rambus shareholder against the same parties. These two pro se lawsuits each allege violations of federal and state securities laws, and state law claims for fraud and breach of fiduciary duty. The two lawsuits were consolidated into a single action by court order dated June 25, 2007. Our pending motion to dismiss was taken off calendar, and the plaintiffs filed a consolidated amended complaint on July 25, 2007. We and the other defendants filed motions to dismiss on August 10, 2007. At a hearing on these motions held on September 7, 2007, the California court stated its intention to dismiss the complaint with leave to amend, but no written order has been issued to date.
Business Overview
We design, develop and license chip interface technologies and architectures that are foundational to nearly all digital electronics products. Our chip interface technologies are designed to improve the time-to-market, performance and cost-effectiveness of our customers’ semiconductor and system products for computing, communications and consumer electronics applications.
As of May 31, 2007, our chip interface technologies are covered by more than 600 U.S. and international patents. Additionally, we have approximately 500 patent applications currently pending. These patents and patent applications cover important inventions in memory and logic chip interfaces, in addition to other technologies. We believe that our chip interface technologies provide a higher performance, lower risk, and more cost-effective alternative for our customers than can be achieved through their own internal research and development efforts.
We offer our customers two alternatives for using our chip interface technologies in their products:
First, we license our broad portfolio of patented inventions to semiconductor and system companies who use these inventions in the development and manufacture of their own products. Such licensing agreements may cover the license of part, or all, of our patent portfolio. Patent license agreements are royalty bearing.
Second, we develop “leadership” (which are Rambus-proprietary products widely licensed to our customers) and industry-standard chip interface products that we provide to our customers under license for incorporation into their semiconductor and system products. Because of the often complex nature of implementing state-of-the art chip interface technology, we offer our customers a range of engineering services to help them successfully integrate our chip interface products into their semiconductors and systems. Product license agreements may have both a fixed price (non-recurring) component and ongoing royalties. Engineering services are customarily bundled with our product licenses, and are generally performed on a fixed price basis. Further, under product licenses, our customers may receive licenses to our patents necessary to implement the chip interface in their products with specific rights and restrictions to the applicable patents elaborated in their individual contracts.
We derive the majority of our annual revenues by licensing our broad portfolio of patents for chip interfaces to our customers. Such licenses may cover part or all of our patent portfolio. Leading semiconductor and system companies such as AMD, Elpida, Fujitsu, Qimonda, Intel, Matsushita, NECEL, Renesas, Spansion and Toshiba have licensed our patents for use in their own products.
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We derive additional revenues by licensing our leadership and industry-standard chip interface products to our customers for use in their semiconductor and system products. Our customers include leading companies such as Elpida, Fujitsu, IBM, Intel, Matsushita, Texas Instruments, Sony, ST Micro, Qimonda and Toshiba. Due to the complex nature of implementing our technologies, we provide engineering services under certain of these licenses to help successfully integrate our chip interface products into their semiconductors and systems. Additionally, product licensees may receive, as an adjunct to their chip interface license agreements, patent licenses as necessary to implement the chip interface in their products with specific rights and restrictions to the applicable patents elaborated in their individual contracts.
Royalties represent a substantial portion of our total revenues. The remaining part of our revenue is engineering services revenue which includes license fees and engineering services fees. The timing and amounts invoiced to customers can vary significantly depending on specific contract terms and can therefore have a significant impact on deferred revenues or unbilled receivables in any given period.
We have a high degree of revenue concentration, with our top five licensees representing 63%, 73% and 74% of our revenues for the twelve months ended December 31, 2006, 2005 and 2004, respectively. For the twelve months ended December 31, 2006, revenues from Fujitsu, Elpida, Qimonda and Intel, each accounted for greater than 10% of total revenues. For the twelve months ended December 31, 2005, revenue from Intel, Elpida, Toshiba and Matsushita, each accounted for greater than 10% of our total revenues. For the twelve months ended December 31, 2004, revenue from Intel, Toshiba and Elpida, each accounted for greater than 10% of our total revenues. Our revenues from companies based outside of North America accounted for 75%, 71% and 69% of our revenues for the twelve months ended December 31, 2006, 2005 and 2004, respectively. We expect that we will have significant revenues from companies based outside the United States for the foreseeable future and our revenue concentration will decrease over time as we license new customers.
Historically, we have been involved in significant litigation stemming from the unlicensed use of our inventions. Our litigation expenses have been high and difficult to predict at this time and we anticipate future litigation expenses to continue to be significant, volatile and difficult to predict. If we are successful in the litigation and/or related licensing, our revenue could be substantially higher in the future; if we are unsuccessful, our revenue would likely decline.
Revenue Concentration
As indicated above, we have a high degree of revenue concentration. Many of our licensees have the right to cancel their licenses The particular licensees which account for revenue concentration have varied from period to period as a result of the addition of new contracts, expiration of existing contracts, industry consolidation, the expiration of deferred revenue schedules under existing contracts, and the volumes and prices at which the licensees have recently sold licensed semiconductors to system companies. These variations are expected to continue in the foreseeable future, although we expect that our revenue concentration will decrease over time as we license new customers.
The royalties we receive are partly a function of the adoption of our chip interfaces by system companies. Many system companies purchase semiconductors containing our chip interfaces from our licensees and do not have a direct contractual relationship with us. Our licensees generally do not provide us with details as to the identity or volume of licensed semiconductors purchased by particular system companies. As a result, we face difficulty in analyzing the extent to which our future revenues will be dependent upon particular system companies. System companies face intense competitive pressure in their markets, which are characterized by extreme volatility, frequent new product introductions and rapidly shifting consumer preferences. There can be no assurance as to the unit volumes of licensed semiconductors that will be purchased by these companies in the future or as to the level of royalty-bearing revenues that our licensees will receive from sales to these companies. Additionally, there can be no assurance that a significant number of other system companies will adopt our chip interfaces or that our dependence upon particular system companies will decrease in the future.
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International Revenues
We expect that revenues derived from international licensees will continue to represent a significant portion of our total revenues in the future. To date, all of the revenues from international licensees have been denominated in U.S. dollars. However, to the extent that such licensees’ sales to systems companies are not denominated in U.S. dollars, any royalties that we receive as a result of such sales could be subject to fluctuations in currency exchange rates. In addition, if the effective price of licensed semiconductors sold by our foreign licensees were to increase as a result of fluctuations in the exchange rate of the relevant currencies, demand for licensed semiconductors could fall, which in turn would reduce our royalties. We do not use financial instruments to hedge foreign exchange rate risk.
For additional information concerning international revenues, see Note 13, “Business Segments, Exports and Major Customers” of Notes to Consolidated Financial Statements of this Form 10-K.
Expenses
We intend to continue making significant expenditures associated with engineering, marketing, general and administration including litigation expenses, and expect that these costs and expenses will continue to be a significant percentage of revenues in future periods. Whether such expenses increase or decrease as a percentage of revenues will be substantially dependent upon the rate at which our revenues change.
Engineering. Engineering costs are allocated between cost of contract revenues and research and development expenses. Cost of contract revenues reflects the portion of the total engineering costs which are specifically devoted to individual licensee development and support services. The balance of engineering costs, incurred for the development of generally applicable chip interface technologies, is charged to research and development. In a given period, the allocation of engineering costs between these two components is a function of the timing of the development and implementation schedules of individual licensee contracts.
Marketing, general and administrative. Marketing, general and administrative expenses include expenses and costs associated with trade shows, public relations, advertising, legal, finance, insurance and other marketing and administrative efforts. Litigation expenses are a significant portion of our marketing, general and administrative expenses and they can vary significantly from quarter to quarter. Consistent with our business model, sales and marketing activities are focused on developing relationships with potential licensees and on participating with existing licensees in marketing, sales and technical efforts directed to system companies. In many cases, we must dedicate substantial resources to the marketing and support of system companies. Due to the long business development cycles we face and the semi-fixed nature of marketing, general and administrative expenses in a given period, these expenses generally do not correlate to the level of revenues in that period or in recent or future periods.
Taxes. We report certain items of income and expense for financial reporting purposes in different years than they are reported for tax purposes. We report contract fees and royalties when received for tax purposes, as required by tax law. We recognize revenue for financial reporting purposes as such amounts are earned and this could occur over several reporting periods. As a result of the above and other differences between tax and financial reporting for income and expense recognition, our net operating profit or loss for tax purposes may be more or less than the amount recorded for financial reporting purposes.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of total revenues represented by certain items reflected in our consolidated statements of operations:
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| Twelve Months Ended December 31, | |||||||||
| 2006 | 2005 | 2004 | |||||||
| As restated (1) | As restated (1) | ||||||||
| Revenues: |
|||||||||
| Contract revenues |
13.5 | % | 17.1 | % | 17.1 | % | |||
| Royalties |
86.5 | % | 82.9 | % | 82.9 | % | |||
| Total revenues |
100.0 | % | 100.0 | % | 100.0 | % | |||
| Costs and expenses: |
|||||||||
| Cost of contract revenues * |
15.6 | % | 15.1 | % | 16.2 | % | |||
| Research and development * |
35.3 | % | 31.2 | % | 26.4 | % | |||
| Marketing, general and administrative * |
53.5 | % | 51.2 | % | 43.0 | % | |||
| Costs of restatement and related legal activities |
16.1 | % | 0.0 | % | 0.0 | % | |||
| Total costs and expenses |
120.5 | % | 97.5 | % | 85.6 | % | |||
| Operating income (loss) |
(20.5 | )% | 2.5 | % | 14.4 | % | |||
| Interest and other income, net |
7.3 | % | 22.2 | % | 5.8 | % | |||
| Income (loss) before income taxes |
(13.2 | )% | 24.7 | % | 20.2 | % | |||
| Provision for (benefit from) income taxes |
(6.1 | )% | 6.2 | % | 4.7 | % | |||
| Net income (loss) |
(7.1 | )% | 18.5 | % | 15.5 | % | |||
* Includes stock-based compensation: |
|||||||||
| Cost of contract revenues |
4.2 | % | 2.5 | % | 2.3 | % | |||
| Research and development |
7.6 | % | 5.1 | % | 3.9 | % | |||
| Marketing, general and administrative |
8.9 | % | 5.4 | % | 6.8 | % | |||
| Total stock-based compensation |
20.7 | % | 13.0 | % | 13.0 | % | |||
| (1) | See Note 3, “Restatement of Consolidated Financial Statements,” of the Notes to Consolidated Financial Statements. |
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change |
|||||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | ||||||||||||
| Total Revenues |
|||||||||||||||
| Contract revenues |
$ | 26.4 | $ | 26.9 | $ | 24.8 | (1.9 | )% | 8.5 | % | |||||
| Royalties |
168.9 | 130.3 | 120.1 | 29.6 | % | 8.5 | % | ||||||||
| Total revenues |
$ | 195.3 | $ | 157.2 | $ | 144.9 | 24.2 | % | 8.5 | % | |||||
Contract Revenues
Percentage of Completion Contracts
For the twelve months ended December 31, 2006 as compared to the twelve months ended December 31, 2005, percentage-of-completion contract revenue decreased (approximately $8.2 million) due to completion of leadership chip interface contracts during 2005, including XDR and FlexIO.
For the twelve months ended December 31, 2005 as compared to the twelve months ended December 31, 2004, percentage of completion contract revenue increased (approximately $0.2 million) due to new XDR and FlexIO chip interface contracts offset in part by the decrease in recognition of revenue associated with XDR, FlexIO and serial link chip interface contracts originating prior to 2005.
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We believe that percentage-of-completion contract revenues recognized will continue to fluctuate over time, based on our ongoing contractual requirements, the amount of work performed, and by changes to work required, as well as new contracts booked in the future.
Other Contracts
For the twelve months ended December 31, 2006 as compared to the same period in 2005, revenue which is recognized over the estimated service periods or on a completed contract basis increased (approximately $7.7 million) due to increased revenue from industry standard and leadership chip interface contracts.
For the twelve months ended December 31, 2005 as compared to the same period in 2004, revenue which is recognized over the estimated service periods increased (approximately $1.9 million) primarily due to the increase in recognition of revenue associated with DDR, serial link, XDR and FlexIO contracts.
Royalty Revenues
Patent Licenses
In the twelve months ended December 31, 2006, 2005 and 2004, our largest source of royalties was related to the license of our patents for SDR and DDR-compatible products. Royalties increased (approximately $56.0 million) for SDR and DDR-compatible products in the twelve months ended December 31, 2006 as compared to the same period in 2005. The increase is primarily due to revenue from licensees signed in 2005 and the first quarter of 2006, including Fujitsu, AMD and Qimonda; partially offset by decreased royalties from Samsung and Matsushita. Royalties increased (approximately $12.4 million) for SDR and DDR-compatible products in the twelve months ended December 31, 2005 as compared to the same period in 2004, primarily due to increased shipment volumes of SDR and DDR controllers and the first quarterly royalty payment from Qimonda.
As of December 31, 2006, we had both variable and fixed royalty agreements for our SDR and DDR-compatible licenses. On December 31, 2005, we entered into a five-year patent license agreement with AMD. We expect to recognize royalty revenues under the AMD agreement on a quarterly basis as amounts become due and payable because the contractual terms of the agreement provide for payments on an extended term basis. We recognized royalty revenues of $18.8 million in fiscal year 2006, and we expect to recognize $15.0 million in fiscal years 2007 through 2009 and $11.3 million in the fiscal year 2010 under the AMD agreement. The AMD agreement provides a license to our patents used in the design of DDR2, DDR3, FB-DIMM, PCI Express and XDR controllers as well as other current and future high-speed memory and logic controller interfaces.
On March 16, 2006, we entered into a five-year patent license agreement with Fujitsu. We expect to recognize royalty revenues under the Fujitsu agreement on a quarterly basis as amounts become due and payable as the contractual terms of the agreement provide for payments on an extended term basis. We recognized a total of $34.8 million of royalty revenues in fiscal year 2006. The Fujitsu agreement provides a license that covers semiconductors, components and systems, but does not include a license to Fujitsu for its own manufacturing of commodity SDRAM other than limited amounts of SDR SDRAM annually.
On March 21, 2005, we entered into a settlement and license agreement with Infineon (and its former parent Siemens), which was assigned to Qimonda in October 2006 in connection with Infineon’s spin-off of Qimonda. The settlement and license agreement, among other things, requires Qimonda to pay to us aggregate royalties of $50.0 million in quarterly installments of $5.8 million, which started on November 15, 2005. The settlement and license agreement further provides that if we enter into licenses with certain other DRAM manufacturers, Qimonda will be required to make additional royalty payments to us which may aggregate up to $100.0 million. If we do not succeed in entering into these additional license agreements necessary to trigger Qimonda’s obligations, Qimonda’s quarterly payments will decrease to $3.2 million in the fourth quarter of 2007 and then cease in the first quarter of 2008. If that were to occur, the quarterly payments would not recommence until we enter into these additional license agreements.
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We are in negotiations with new prospective licensees. We expect SDR and DDR-compatible royalties will continue to vary from period to period based on our success adding new licensees, as well as the level of variation in our licensees’ reported shipment volumes, sales price and mix, offset in part by the proportion of licensee payments that are fixed.
On February 2, 2007, the FTC issued its remedy order, which among other things, imposes maximum royalty rates that we can collect for SDR and DDR SDRAM products shipped after April 12, 2007; the FTC subsequently granted a partial stay of this order, which allows us to charge but not collect royalties above the FTC-imposed maximums, pending our anticipated appeal of the FTC’s decision. The FTC has allowed that royalties above these maximums be placed into an escrow account or held by a contingent contractual agreement. We expect that there will be a decrease in SDR and DDR-compatible royalty revenues as a result of the FTC order beginning in the third quarter of 2007.
The Intel patent cross-license agreement represented the second largest source of royalties in the twelve months ended December 31, 2006, 2005 and 2004. Royalties under this agreement decreased from $40.0 million to $20.0 million for the twelve months ended December 31, 2006 compared to the same periods in 2005, and were unchanged in the twelve months ended December 31, 2005 as compared to the same period in 2004. The patent cross-license agreement expired in September 2006 and no further royalty payments are owed to us under it. Intel now has a paid up license for the use of all of our patents which claimed priority prior to September 2006.
Product Licenses
In the twelve months ended December 31, 2006, 2005 and 2004, royalties from RDRAM-compatible products represented the third largest source of royalties. Royalties from RDRAM memory chips and controllers decreased during the twelve months ended December 31, 2006 as compared to the same period in 2005 (approximately $1.4 million). Royalties from RDRAM memory chips and controllers decreased during the twelve months ended December 31, 2005 as compared to the same period in 2004 (approximately $3.4 million). RDRAM is approaching end-of-life and in the future, we expect RDRAM royalties will continue to decline.
Royalties from XDR, FlexIO, DDR and serial link-compatible products represent the fourth largest category of royalties. Royalties from XDR, FlexIO and serial link-compatible products increased during the twelve months ended December 31, 2006 as compared to the same period in 2005 (approximately $4.0 million). The increase of XDR, FlexIO and serial link-compatible products for 2006 over 2005 is primarily due to increased volumes of XDR DRAM associated with shipments of the Sony PLAYSTATION®3 product. Royalties from XDR, FlexIO and serial link-compatible products increased during the twelve months ended December 31, 2005 as compared to the same period in 2004 (approximately $1.2 million). This increase was primarily due to minimum guaranteed royalties from a contract for serial link-compatible products.
In the future, we expect XDR, FlexIO and serial link royalties will continue to vary from period to period based on our licensees’ shipment volumes, sales prices, and product mix. We expect that XDR and FlexIO royalties will increase associated with shipments of the Sony PLAYSTATION®3 product.
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Engineering costs:
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change |
|||||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | ||||||||||||
| As restated (1) | As restated (1) | ||||||||||||||
| Engineering costs |
|||||||||||||||
| Cost of contract revenues |
$ | 22.2 | $ | 19.8 | $ | 20.2 | 12.1 | % | (2.0 | )% | |||||
| Stock-based compensation |
8.2 | 3.9 | 3.3 | 110.3 | % | 18.2 | % | ||||||||
| Total cost of contract revenues |
30.4 | 23.7 | 23.5 | 28.3 | % | 0.9 | % | ||||||||
| Research and development |
54.1 | 41.0 | 32.6 | 32.0 | % | 25.8 | % | ||||||||
| Stock-based compensation |
14.9 | 8.1 | 5.7 | 84.0 | % | 42.1 | % | ||||||||
| Total research and development |
69.0 | 49.1 | 38.3 | 40.5 | % | 28.2 | % | ||||||||
| Total engineering costs: |
$ | 99.4 | $ | 72.8 | $ | 61.8 | 36.5 | % | 17.8 | % | |||||
| Stock-based compensation |
|||||||||||||||
| Cost of contract revenues |
$ | 8.2 | $ | 3.9 | $ | 3.3 | 110.3 | % | 18.2 | % | |||||
| Research and development expenses |
14.9 | 8.1 | 5.7 | 84.0 | % | 42.1 | % | ||||||||
| Total stock-based compensation |
$ | 23.1 | $ | 12.0 | $ | 9.0 | 92.5 | % | 33.3 | % | |||||
| (1) | See Note 3, “Restatement of Consolidated Financial Statements,” of the Notes to Consolidated Financial Statements. |
For the twelve months ended December 31, 2006 as compared to the same period in 2005, the increase in total engineering costs was primarily a result of increased stock-based compensation (approximately $11.1 million) associated with the adoption of SFAS 123(R) in 2006, increased salary and benefit costs (approximately $6.7 million) associated with an average increase of approximately 52 employees (22 in the U.S. and 30 in India), increased bonus expense (approximately $3.3 million) due to higher achievement of bonus targets and an increased number of participants in the corporate bonus plan, increased information technology costs due to spending related to personnel, consulting and depreciation (approximately $2.2 million) increased depreciation and intangible amortization expense (approximately $2.0 million) higher payroll taxes (approximately $0.7 million) associated with higher stock option exercises in the first half of 2006 and increased salary costs.
For the twelve months ended December 31, 2005 as compared to the same period in 2004, the increase in total engineering costs was primarily a result of increased stock-based compensation (approximately $3.0 million), increased salary and benefit costs (approximately $2.3 million) associated with an average increase of approximately 45 employees (10 in the U.S. and 35 in India), increased amortization of intangible asset costs (approximately $1.8 million) associated with the purchase of digital core design assets from GDA during the second quarter of 2005 and the purchase of serial link intellectual property from Cadence during the third quarter of 2004, increased consulting costs (approximately $1.2 million), and increased depreciation and amortization costs (approximately $1.0 million).
In certain periods, the cost of contract revenues may exceed contract revenues. This can be a result of expensing pre-contract costs, expensing completed contract costs where the realizability of an asset is uncertain, and low utilization of project resources.
In the near term, we expect engineering costs will continue to increase as we make investments in the infrastructure and technologies required to maintain our leadership position in chip interface technologies and increase headcount.
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Marketing, general and administrative costs:
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change |
|||||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | ||||||||||||
| As restated (1) | As restated (1) | ||||||||||||||
| Marketing, general and administrative costs |
|||||||||||||||
| Marketing, general and administrative costs |
$ | 48.2 | $ | 33.7 | $ | 29.4 | 43.0 | % | 14.6 | % | |||||
| Litigation expense |
38.9 | 38.2 | 23.1 | 1.8 | % | 65.4 | % | ||||||||
| Stock-based compensation |
17.5 | 8.5 | 9.8 | 105.9 | % | (13.3 | )% | ||||||||
| Total marketing, general and administrative costs |
$ | 104.6 | $ | 80.4 | $ | 62.3 | 30.1 | % | 29.1 | % | |||||
| (1) | See Note 3, “Restatement of Consolidated Financial Statements,” of the Notes to Consolidated Financial Statements. |
For the twelve months ended December 31, 2006 as compared to the same period in 2005, the increase in total marketing, general and administrative costs including litigation expense was primarily a result of increased stock-based compensation costs (approximately $9.0 million) associated with the adoption of SFAS 123(R) in 2006, increased salary costs (approximately $5.6 million) associated with an average increase of approximately 37 employees (29 in the U.S. and 8 internationally), increased bonus expense (approximately $3.2 million) due to higher achievement of bonus targets and an increased number of participants in the corporate bonus plan, increased consulting costs (approximately $1.2 million), higher payroll taxes (approximately $1.1 million) associated with higher stock option exercises in the first half of 2006 and increased salary costs, increased depreciation and intangible amortization expense (approximately $1.0 million) increased litigation expense (approximately $0.7 million) and increased rent expense (approximately $0.7 million). Costs of restatement and related legal activities are discussed in the next section.
For the twelve months ended December 31, 2005 as compared to the same period in 2004, the increase in total marketing, general and administrative costs including litigation expense was primarily due to increased expenses associated with the defense of our intellectual property (approximately $15.1 million), increased salaries (approximately $1.7 million) primarily due to an average increase of approximately 26 employees (22 in the U.S. and 4 internationally), increased information technology costs (approximately $1.8 million) primarily due to increased investment in business applications, and increased professional services costs (approximately $0.6 million); partially offset by decreased stock-based compensation (approximately $1.3 million).
In the future, we expect that marketing, general and administrative expenses will vary from period to period based on the legal, trade shows, advertising, and other marketing and administrative activities undertaken, accounting for stock options and the change in sales, marketing and administrative headcount in any given period. Litigation expenses are expected to vary from period to period due to the variability of litigation activities. Please refer to Notes 17 and 18, “Litigation and Asserted Claims” and “Subsequent Events,” respectively, of Notes to Consolidated Financial Statements for a more detailed explanation of our continuing litigation activities.
Costs of restatement and related legal activities:
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change | |||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | ||||||||||
| Costs of restatement and related legal activities |
$ | 31.4 | $ | — | $ | — | — | — | |||||
For the twelve months ended December 31, 2006 we incurred approximately $31.4 million in costs of restatement and related legal activities. There were no comparable costs incurred for the twelve months ended December 31, 2005 and December 31, 2004. The costs consist primarily of settlement accruals, including the accrual of $18.0 million in the third quarter of 2006 related to the potential settlement of the consolidated class action lawsuit pertaining to the accounting for stock option grants and related disclosures, plus investigation, audit, litigation and other professional fees. Through the second quarter of fiscal 2007 we have incurred additional costs of restatement and related legal activities of approximately $14.4 million. We anticipate that there will be additional costs relating to these matters in the future.
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Interest and other income, net:
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change |
|||||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | ||||||||||||
| Interest and other income, net |
$ | 14.3 | $ | 34.8 | $ | 8.4 | (58.9 | )% | 314.3 | % | |||||
For the twelve months ended December 31, 2006 as compared to the same period in 2005, the decrease in interest and other income, net consists primarily of gains on the repurchases of the outstanding convertible notes in 2005, that were issued in the first quarter of 2005 (approximately $24.0 million), offset in part by higher interest income primarily due to higher cash and marketable securities balances and higher interest rates (approximately $ 5.7 million) in 2006. Fiscal year 2006 interest and other income, net also includes $3.2 million of amortization of note issuance costs, including $2.4 million that was accelerated into the fourth quarter of 2006, in connection with the calling of the $160.0 million in convertible notes (see Note 16 “Convertible Notes” of Notes to Consolidated Financial Statements for more information).
For the twelve months ended December 31, 2005 as compared to the same period in 2004, the increase in interest and other income, net consists primarily of gains on the repurchases of the outstanding convertible notes that were issued in the first quarter of 2005 (approximately $24.0 million) and higher interest income primarily due to higher cash and marketable securities balances and higher interest rates (approximately $8.0 million), offset in part by amortization of note issuance costs (approximately $1.1 million), the 2004 pre-tax gain on the sale of our investment in Tessera (approximately $3.6 million), and the 2004 pre-tax gain in 2004 from a default payment by a sub-lessee of our former headquarters (approximately $0.4 million).
In the future, we expect that interest and other income, net will vary from period to period based upon the amount of cash and marketable securities and interest rates.
Provision for (benefit from) income taxes:
| Twelve Months Ended December 31, | 2005 to 2006 Change |
2004 to 2005 Change |
||||||||||||||
| (dollars in millions) |
2006 | 2005 | 2004 | |||||||||||||
| As restated (1) | As restated (1) | |||||||||||||||
| Provision for (benefit from) income taxes |
$ | (11.9 | ) | $ | 9.8 | $ | 6.8 | (221.4 | )% | 44.1 | % | |||||
| (1) | See Note 3, “Restatement of Consolidated Financial Statements,” of the Notes to Consolidated Financial Statements. |
In the twelve months ended December 31, 2006, our effective tax rate was approximately 46.3%, as compared with an effective rate of approximately 25.3% for the comparable period in 2005. The change in effective tax rate is primarily due to tax benefits from stock related compensation expense related to officers, disqualifying disposition of ESPPs and R&D credit, offset by non-deductible stock related compensation expense. The 2006 tax rate is higher than the statutory rate, primarily due to the R&D credit, partially offset by the lack of deductibility of stock-based compensation expense.
While we do not expect any impact to the effective tax rate for U.S. non-qualified stock option or restricted stock expense due to the adoption of SFAS 123(R), the effective tax rate may be negatively impacted by foreign stock option expense and stock option expense related to executive officers that may not be deductible. Also, SFAS 123(R) requires that the tax benefit of stock option deductions relating to incentive stock options and ESPPs be recorded in the period of disqualifying disposition. This could result in significant fluctuations in our effective tax rate between reporting periods. The effective tax rate for 2005 is lower than the statutory rate primarily due to the tax benefit from stock related compensation expense. The effective tax rate for 2004 is lower than the statutory rate primarily due to the R&D credit and foreign tax credits.
In the twelve months ended December 31, 2005, our effective tax rate was approximately 25.3% as compared with a rate of approximately 23.3% for the twelve months ended December 31, 2004. The effective tax rate increased primarily due to a change in research and development and foreign tax credits, offset by the tax benefit from stock related compensation expense related to officers in 2005.
In the twelve months ended December 31, 2006, our net deferred tax assets increased by $7.7 million, primarily due to the increase in future tax benefits related to litigation expenses, additional tax credits and net operating losses unrelated to stock option windfall benefits, offset by a decrease in future tax benefits related to depreciation and amortization and employee stock related compensation. Pursuant to Footnote 82 of SFAS No. 123(R), tax attributes related to stock option windfall deductions should not be recorded until they result in a reduction of cash taxes payable. On a prospective basis, we no longer include net operating losses attributable to stock option windfall deductions as components of our gross deferred tax assets. Therefore, our unrealized federal and state net operating losses excluded for the year ended December 31, 2006 are $62.9 million and $65.2 million, respectively. The benefit of these net operating losses will be recorded to equity when they reduce cash taxes payable.
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Liquidity and Capital Resources
| Twelve Months Ended December 31, | ||||||||||||
| (in millions) |
2006 | 2005 | 2004 | |||||||||
| As restated (1) | As restated (1) | |||||||||||
| Cash flows |
||||||||||||
| Net cash provided by operating activities |
$ | 63.4 | $ | 33.8 | $ | 43.7 | ||||||
| Net cash used in investing activities |
$ | (68.3 | ) | $ | (139.3 | ) | $ | (60.9 | ) | |||
| Net cash provided by financing activities |
$ | 35.8 | $ | 99.7 | $ | 23.4 | ||||||
| (1) | See Note 3, “Restatement of Consolidated Financial Statements,” of the Notes to Consolidated Financial Statements. |
As of December 31, 2006, we had cash and cash equivalents and marketable securities of $436.3 million, including a long-term component of $12.0 million. As of December 31, 2006, we had total working capital of $224.3 million, including a short-term component of deferred revenue of $6.0 million. Deferred revenue represents the excess of billings to licensees over revenue recognized on license contracts, and the short-term component represents the amount of this deferred revenue expected to be recognized over the next twelve months.
Operating Activities
Cash generated by operating activities in the twelve months ended December 31, 2006 was $63.4 million primarily the result of a net loss of $13.8 million, adjusted for certain non-cash items, including increases resulting from stock-based compensation expense of $40.5 million, depreciation of $11.2 million, amortization of intangible assets of $5.3 million, amortization of $3.2 million of note issuance costs, including an additional $2.4 million in connection with the notice of acceleration relating to the $160.0 million of our convertible notes, and others $0.4 million, offset by a net tax shortfall of $3.9 million driven principally by the forfeiture of stock options of our former CEO. In addition, cash generated by operating activities was positively impacted by an increase in accounts and taxes payable, accrued salaries and benefits and other accrued liabilities of $31.8 million, primarily from $18.0 million to settle litigation, $6.1 million obligation to a strategic partner under a fixed term license agreement, and $4.7 million in employee bonuses. Cash generated by operating activities was partially offset by an increase in accounts receivable and unbilled receivables of $1.6 million, an increase in prepaid expenses and other assets of $7.9 million, principally from deferred taxes, and a net decrease in deferred revenue of $1.7 million.
Cash generated by operating activities was $33.8 million in the twelve months ended December 31, 2005, and was primarily the result of net income of $28.9 million adjusted for certain non-cash items, including depreciation of $9.1 million, amortization of note issuance costs of $1.1 million, amortization of intangible assets of $4.3 million, stock-based compensation of $20.5 million, tax benefit of stock options of $0.7 million, and loss on disposal of assets of $0.2 million, offset by a $24.0 million gain on repurchase of convertible notes. Operating activities were also affected by a decrease in accounts receivable of $0.5 million, a decrease in prepaid expenses, deferred taxes and other assets of $5.7 million primarily due to our election to capitalize certain research and development expenses for tax purposes, and an increase in accounts and taxes payable, accrued salaries and benefits and other accrued liabilities of $1.4 million. This cash generated from operating activities was partially offset by a net decrease in deferred revenue of $14.5 million resulting from contract revenues recognized in excess of contract billings primarily related to increased revenues for XDR and FlexIO chip interface contracts in which billings were made in the prior year.
Cash generated by operating activities was $43.7 million in the twelve months ended December 31, 2004, and was primarily the result of net income of $22.4 million adjusted for certain non-cash items, including depreciation of $5.6 million, amortization of intangible assets of $2.5 million, tax benefit of stock options exercised of $23.2 million, and stock-based compensation of $18.8 million, offset by a gain on sale of investment of $3.6 million. Operating activities were also affected positively by a decrease in accounts receivable of $8.8 million primarily
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related to payments received under XDR and FlexIO chip interface contracts, and an increase in accounts and taxes payable, accrued salaries and benefits and other accrued liabilities of $6.6 million. This cash generated from operating activities was partially offset by an increase in prepaid expenses, deferred taxes and other assets of $22.2 million primarily due to our election to capitalize certain research and development expenses for tax purposes and a net decrease in deferred revenue of $18.4 million resulting from contract revenues recognized in excess of contract billings primarily related to increased revenues for XDR and FlexIO chip interface contracts in which billings were made in the prior year.
Investing Activities
Cash used in investing activities was $68.3 million in the twelve months ended December 31, 2006, and primarily consisted of purchases of marketable securities of $215.2 million, offset by maturities of $166.2 million. In addition, $1.0 million was used to acquire certain proprietary assets from GDA, $0.3 million was used to purchase intangible assets, $14.9 million was used to acquire property and equipment, primarily computer and software and $3.1 million was used to acquire leasehold improvements.
Cash used in investing activities was $139.3 million in the twelve months ended December 31, 2005, and primarily consisted of purchases of marketable securities of $347.7 million resulting from the investment of a portion of the net proceeds from the issuance of convertible notes, offset by maturities of $222.1 million. In addition, $5.4 million was used to acquire certain proprietary digital core designs from GDA, $2.5 million was used to acquire certain serial link intellectual property assets from Cadence and $8.6 million was used for the purchase of property and equipment, including computer and software purchases in the United States and computer equipment, software, leasehold improvements and office equipment and furniture for a new facility in India. The change is partially offset by a reduction in restricted cash of $2.8 million due to the settlement in the Infineon case, which removed the restrictions on these assets.
Cash used in investing activities was $60.9 million for the twelve months ended December 31, 2004, and primarily consisted of purchases of marketable securities of $119.4 million, offset by maturities of $76.8 million, and cash paid for the acquisition and related acquisition costs of certain serial link intellectual property assets from Cadence totaling $11.1 million, $12.3 million for purchases of property and equipment and leasehold improvements (including software tools purchased from Cadence), and a $0.5 million increase in restricted cash. These uses of cash were partially offset by proceeds of $5.6 million from the sale of our investment in Tessera for which we recorded a $3.6 million gain.
Financing Activities
Net cash provided by financing activities was $35.8 million in the twelve months ended December 31, 2006. We received net proceeds of $57.6 million from the issuance of Common Stock associated with exercises of employee stock options and Common Stock issued under our employee stock purchase plan, partially offset by repurchases of our Common Stock of $21.0 million. In addition, we made a $0.8 million installment payment on a $2.8 million agreement related to a fixed asset purchase in 2005.
Net cash provided by financing activities was $99.7 million in the twelve months ended December 31, 2005. We received net proceeds from the issuance of convertible notes of $292.8 million and net proceeds from the issuance of Common Stock associated with exercises of employee stock options and Common Stock issued under our employee stock purchase plan of $8.5 million. This cash provided from the issuance of convertible notes and Common Stock was partially offset by the repurchase of our Common Stock of $88.2 million and the repurchases of outstanding convertible notes of $113.0 million. In addition, we repaid approximately $0.4 million against an installment payment plan used to acquire capitalized software.
Cash generated by financing activities was $23.4 million in the twelve months ended December 31, 2004, and was the result of net proceeds of $45.1 million from the issuance of Common Stock associated with exercises of employee stock options and stock issued under the employee stock purchase plan. This cash provided from the issuance of Common Stock was partially offset by $21.7 million we used to repurchase Common Stock under our stock repurchase program.
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We currently anticipate that existing cash and cash equivalent balances and cash flows from our operating activities will be adequate to meet our cash needs for at least the next 12 months. As described elsewhere in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and this report, we are involved in ongoing litigation related to our intellectual property and our stock option investigation. Any adverse settlements or judgments in this litigation could have a material adverse impact on our results of operations, cash balances and cash flows in the period in which such events occur. In addition, as described elsewhere in this report, the Trustee for our convertible notes has alleged that an event of default with respect to the convertible notes has occurred and has called for the acceleration of payment of those convertible notes. We are evaluating our options with respect to the convertible notes as a result of the receipt of the notice of acceleration. We believe that we have adequate financial resources to pay any unpaid principal and any accrued or default interest due on the notes.
Contingent Warrants, Common Stock Equivalents, and Options
Warrants
In October 1998, our Board of Directors authorized an incentive program in the form of warrants for a total of up to 1,600,000 shares of our Common Stock to be issued to various RDRAM licensees. The warrants, which were issued at the time certain targets were met, have an exercise price of $2.50 per share and a life of five years from the date of issuance. These warrants vest and become exercisable only upon the achievement of certain milestones by Intel relating to shipment volumes of RDRAM chipsets. Warrants exercisable for a total of 1,520,000 shares of our Common Stock had been issued under the program. As of December 31, 2006, no warrants were exercised as the defined milestones were not achieved, and all warrants have expired.
Contingent Common Stock Equivalents and Options
As of December 31, 2005, there were 1,000,000 contingent unvested Common Stock Equivalents, or CSEs, and 799,346 contingent unvested options, which vest upon the achievement of certain milestones by Intel relating to shipment volumes of RDRAM 850E chipsets. These CSEs were granted to our previous Chief Executive Officer and President in 1999 and the options were granted to certain of our employees in 1999 and 2001. The CSEs were granted with a term of 10 years and the options were granted with an exercise price of $2.50 and a term of 10 years. It was previously expected that there would be a non-cash charge to our statement of operations, based on fair value of the CSEs and options, when the achievement of certain Intel milestones became probable. Intel has since phased out the 850E chipset and as a result, the unvested CSEs and options will never vest.
During the year ended December 31, 2006, 77,500 contingent unvested options were forfeited and all of the contingent unvested CSEs were forfeited unvested when the officers terminated their services. As of December 31, 2006, there were no contingent unvested CSEs and 721,846 contingent unvested options. As noted above, none are expected to vest.
Share Repurchase Program
In October 2001, our Board of Directors approved a share repurchase program of our Common Stock principally to reduce the dilutive effect of employee stock options. On January 23, 2006 our Board of Directors approved an authorization to repurchase up to an additional 5.0 million shares of our Common Stock, giving us a total authorization to purchase up to 19.0 million shares of our outstanding Common Stock over an undefined period of time. During the first quarter of fiscal 2006, we repurchased 0.7 million shares at an average price per share of $29.94. As of December 31, 2006, we had repurchased a cumulative total of 13.2 million shares of our Common Stock at an average price per share of $13.95 since the commencement of this program. This amount includes 4.1 million shares repurchased in connection with our $300.0 million zero coupon convertible senior subordinated note offering on February 1, 2005. As
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of December 31, 2006, there remained an outstanding authorization to repurchase 5.8 million shares of our outstanding Common Stock. In connection with the stock options investigation, repurchases of Common Stock under this program were suspended as of July 19, 2006. We will not repurchase additional shares until after we are current with our SEC filings.
Contractual Obligations
We lease our present office facilities in Los Altos, California, under an operating lease agreement through December 31, 2010. As part of this lease transaction, we provided a letter of credit restricting $600,000 of our cash as collateral for certain of our obligations under the lease. The cash is restricted as to withdrawal and is managed by a third party subject to certain limitations under our investment policy. We also lease a facility in Mountain View, California, through November 11, 2009, Chapel Hill, North Carolina through November 15, 2009 and lease a facility for our design center in Bangalore, India through November 30, 2009. In addition, as a result of our acquisition of GDA in 2005, we entered into a lease for an additional facility in Bangalore, India through March 31, 2007, which was recently extended through mid-November 2007. The Company also leases office facilities in Austin, Texas and various international locations under non-cancelable leases that range in terms from month-to-month to one year.
In May 2006, we signed an agreement to lease a new office facility in Bangalore, India into which we intend to consolidate all of our Bangalore operations. We are currently awaiting receipt of a certificate of occupancy or confirmation of deemed occupancy under local statutes in order for us to occupy the building.
On February 1, 2005, we issued $300.0 million aggregate principal amount of convertible notes due February 1, 2010 to Credit Suisse First Boston LLC and Deutsche Bank Securities, as initial purchasers who then sold the convertible notes to institutional investors. We elected to pay the principal amount of the convertible notes in cash when they are due and the initial conversion price of the convertible notes is $26.84 per share. Subsequently, we repurchased a total of $140.0 million face value of the outstanding convertible notes. As a result, the convertible notes outstanding and payable as of December 31, 2005 were reduced to $160.0 million.
On August 17, 2006, we received a notice of default from U.S. Bank National Association, as trustee (the “Trustee”) for the convertible notes. The notice asserted that our failure to file our Form 10-Q for the quarter ended June 30, 2006 constituted a default under Sections 7.2 and 14.1 of the Indenture, dated as of February 1, 2005 between us and the Trustee (the “Indenture”). The notice stated that per Section 9.1 of the Indenture, if we did not cure the default within sixty days of August 17, 2006, an event of default would occur. On October 25, 2006, we received a notice from the Trustee stating that since we had not cured the default that had been asserted by the Trustee within the sixty day cure period, an event of default had in fact occurred as of October 16, 2006. On January 22, 2007, we received an additional notice of default from the Trustee relating to our failure to file our Form 10-Q for the quarter ended September 30, 2006. On July 31, 2007, we received a notice of acceleration from the Trustee stating that under direction received from holders of more than 25% in aggregate principal amount of the outstanding convertible notes, the Trustee was declaring the unpaid principal plus accrued interest and unpaid liquidated damages immediately due and payable. Default interest on the notes accrues at a rate of 2% per annum from the date on which full payment of the notes is due to the date that full payment is made.
As of December 31, 2006, we have reclassified the aggregate principal amount of the convertible notes of $160.0 million from non-current liabilities to current liabilities and reflected them as due in less than one year in the following table. We are evaluating our options with respect to the notes as a result of the receipt of the notice of acceleration and believe that we have adequate financial resources to pay any unpaid principal and any accrued or default interest due on the convertible notes. See Note 16 “Convertible Notes” of Notes to Consolidated Financial Statements for a detailed discussion of this matter.
In connection with certain German litigation, the German courts have requested that we set aside adequate funds to cover potential court cost claims. Accordingly, approximately $1.7 million is restricted as to withdrawal, managed by a third party subject to certain limitations under our investment policy and included in restricted cash to cover the German court requirements.
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As of December 31, 2006, our material contractual obligations are:
| Payment due by period | |||||||||||||||
| (in thousands) | Total | Less than 1 year |
1-3 years | 3-5 years | More than 5 years | ||||||||||
| Contractual obligations |
|||||||||||||||
| Operating leases |
$ | 23,239 | $ | 6,446 | $ | 11,728 | $ | 5,065 | $ | — | |||||
| Convertible notes |
160,000 | 160,000 | — | — | — | ||||||||||
| Purchased software license agreements (1) |
8,212 | 7,394 | 818 | — | — | ||||||||||
| Total |
$ | 191,451 | $ | 173,840 | $ | 12,546 | $ | 5,065 | $ | — | |||||
| (1) | We have commitments with various software vendors for non-cancellable license agreements that generally have terms longer than one year. The above table summarizes those contractual obligations as of December 31, 2006, which are also listed on our balance sheet under current and other long-term liabilities. |
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, investments, income taxes, litigation and other contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Overview
Our revenue recognition policy is based on the American Institute of Certified Public Accountants Statement of Position 97-2, “Software Revenue Recognition” (“SOP 97-2”) as amended by Statement of Position 98-4 (“SOP 98-4”) and Statement of Position 98-9 (“SOP 98-9”). For certain of our revenue contracts, revenue is recognized according to Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”).
In application of the specific authoritative literature cited above, we comply with Financial Accounting Standards Board Statement of Financial Accounting Concepts No. 5 and 6. We recognize revenue when persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is reasonably assured. If any of these criteria are not met, we defer recognizing the revenue until such time as all criteria are met. Determination of whether or not these criteria have been met may require us to make judgments, assumptions and estimates based upon current information and historical experience.
Our revenue consists of royalty revenues and contract revenues generated from agreements with semiconductor companies, system companies and certain reseller arrangements. Royalty revenues consist of patent license royalties and product license royalties. Contract revenues consist of fixed license fees, fixed engineering fees and service fees associated with integration of our chip interface products into our customers’ products. Contract revenues may also
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include support or maintenance. Reseller arrangements generally provide for the pass-through of a percentage of the fees paid to the reseller by its customer for use of our patent and product licenses. We do not recognize revenue for these arrangements until we have received notice of revenue earned by and paid to the reseller, accompanied by the pass-through payment from the reseller. We do not pay commissions to the reseller for these arrangements.
Many of our licensees have the right to cancel their licenses. In such arrangements revenue is only recognized to the extent that is consistent with the cancellation provisions. Cancellation provisions within such contracts generally provide for a prospective cancellation with no refund of fees already remitted by customers for products provided and payments for services rendered prior to the date of cancellation. Unbilled receivables represent enforceable claims and are deemed collectible in connection with our revenue recognition policy.
Royalty Revenues
We recognize royalty revenues upon notification by the licensees and if collectibility is reasonably assured. The terms of the royalty agreements generally either require licensees to give us notification and to pay the royalties within 60 days of the end of the quarter during which the sales occur or are based on a fixed royalty that is due within 45 days of the end of the quarter. From time to time, we engage accounting firms other than our independent registered public accounting firm to perform, on our behalf, periodic audits of some of the licensee’s reports of royalties to us and any adjustment resulting from such royalty audits is recorded in the period such adjustment is determined. We have two types of royalty revenues: (1) patent license royalties and (2) product license royalties.
Patent licenses. We license our broad portfolio of patented inventions to semiconductor and systems companies to use these inventions in the development and manufacture of their own products. Such licensing agreements may cover the license of part, or all, of our patent portfolio. We generally recognize revenue from these arrangements as amounts become due and payable. The contractual terms of the agreements generally provide for payments over an extended period of time.
Product licenses. We develop proprietary and industry-standard chip interface products, such as RDRAM and XDR that we provide to our customers under product license agreements. These arrangements include royalties, which can be based on either a percentage of sales or number of units sold. We recognize revenue from these arrangements upon notification from the licensee and if collectibility is reasonably assured.
Contract Revenues
We generally recognize revenue in accordance the provisions of SOP 81-1 for development contracts related to licenses of our chip interface products, such as XDR and FlexIO that involve significant engineering and integration services. Revenues derived from such license and engineering services may be recognized using the completed contract or percentage-of-completion method. For all license and service agreements accounted for using the percentage-of-completion method, we determine progress to completion using input measures based upon labor-hours incurred. We have evaluated use of output measures versus input measures and have determined that our output is not sufficiently uniform with respect to cost, time and effort per unit of output to use output measures as a measure of progress to completion. Part of these contract fees may be due upon the achievement of certain milestones, such as provision of certain deliverables by us or production of chips by the licensee. The remaining fees may be due on pre-determined dates and include significant up-front fees.
A provision for estimated losses on fixed price contracts is made, if necessary, in the period in which the loss becomes probable and can be reasonably estimated. If we determine that it is necessary to revise the estimates of the work required to complete a contract, the total amount of revenue recognized over the life of the contract would not be affected. However, to the extent the new assumptions regarding the total amount of work necessary to complete a project were less than the original assumptions, the contract fees would be recognized sooner than originally expected.
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Conversely, if the newly estimated total amount of work necessary to complete a project was longer than the original assumptions, the contract fees will be recognized over a longer period. If there is significant uncertainty about the time to complete or the deliverables by either party, we evaluate the appropriateness of applying the completed contract method of accounting under SOP 81-1. Such evaluation is completed by us on a contract-by-contract basis. For all contracts where revenue recognition must be delayed until the contract deliverables are substantially complete, we evaluate the realizability of the assets which the accumulated costs would represent and defer or expense as incurred based upon the conclusions of our realization analysis.
If application of the percentage-of-completion method results in recognizable revenue prior to an invoicing event under a customer contract, we will recognize the revenue and record an unbilled receivable. Amounts invoiced to our customers in excess of recognizable revenues are recorded as deferred revenues. The timing and amounts invoiced to customers can vary significantly depending on specific contract terms and can therefore have a significant impact on deferred revenues or unbilled receivables in any given period.
We recognize revenue in accordance with SOP 97-2, SOP 98-4 and SOP 98-9 for development contracts related to licenses of our chip interface products that involve non-essential engineering services and post contract support (“PCS”). These SOPs apply to all entities that earn revenue on products containing software, where software is not incidental to the product as a whole. Contract fees for the products and services provided under these arrangements are comprised of license fees and engineering service fees which are not essential to the functionality of the product. Our rates for PCS and for engineering services are specific to each development contract and not standardized in terms of rates or length. Because of these characteristics, we do not have a sufficient population of contracts from which to derive vendor-specific objective evidence.
Therefore, as required by SOP 97-2, after we deliver the product, if the only undelivered element is PCS, we will recognize revenue ratably over either the contractual PCS period or the period during which PCS is expected to be provided. We review assumptions regarding the PCS periods on a regular basis. If we determine that it is necessary to revise the estimates of the support periods, the total amount of revenue to be recognized over the life of the contract would not be affected. However, if the new estimated periods were shorter than the original assumptions, the contract fees would be recognized ratably over a shorter period. Conversely, if the new estimated periods were longer than the original assumptions, the contract fees would be recognized ratably over a longer period.
Litigation
We are involved in certain legal proceedings, as discussed in Note 17, “Litigation and Asserted Claims” of Notes to Consolidated Financial Statements of this Form 10-K. Based upon consultation with outside counsel handling our defense in these matters and an analysis of potential results, we accrue for losses related to litigation if we determine that a loss is probable and can be reasonably estimated. If a specific loss amount cannot be estimated, we review the range of possible outcomes and accrue the low end of the range of estimates. Any such accrual would be charged to expense in the appropriate period. We recognize litigation expenses in the period in which the litigation services were provided.
Income Taxes
As part of preparing our consolidated financial statements, we are required to calculate the income tax expense or benefit which relates to the pretax income or loss for the period. In addition, we are required to assess the realization of the tax asset or liability to be included on the consolidated balance sheet as of the reporting dates.
This process requires us to calculate various items including permanent and temporary differences between the financial accounting and tax treatment of certain income and expense items, differences between federal and state tax treatment of these items, the amount of taxable income reported to various states, foreign taxes and tax credits. The differing treatment of certain items for tax and accounting purposes results in deferred tax assets and liabilities, which are included on our consolidated balance sheet.
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At December 31, 2006, our balance sheet included net deferred tax assets of approximately $109.6 million, relating primarily to the difference between tax and book treatment of depreciation and amortization, employee stock related compensation expenses, net operating loss and tax credit carryovers.
We periodically evaluate the realizability of the deferred tax assets based on all available evidence, both positive and negative. Future taxable income and other factors determine how much benefit we ultimately realize from deferred tax assets. If our estimate of future taxable income or the overall expected realizability of the deferred tax assets changes, a valuation allowance may have to be recorded, which could materially impact our financial position and results of operation.
Stock-Based Compensation
Prior to January 1, 2006, we accounted for stock-based awards and our Employee Stock Purchase Plan using the intrinsic method in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees,” FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock-Based Compensation, an Interpretation of APB Opinion No. 25,” FASB Technical Bulletin No. 97-1 (“FTB 97-1”) “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option,” and related interpretations and provided the required pro forma disclosures of SFAS 123 “Accounting for Stock-Based Compensation.” In accordance with APB 25, a non-cash, stock-based compensation expense was recognized for any options for which the exercise price was below the market price on the actual grant date and for any grants that were modified from their original terms. The charge for the options with an exercise price below the market price on the actual grant date was equal to the number of options multiplied by the difference between the exercise price and the market price of the option shares on the actual grant date. That expense was amortized over the vesting period of the options. The charge for modifications of options in general was equal to the number of options modified multiplied by the difference between the market price of the options on the modification date and the grant price. The charge for modified options was taken over the remaining service period, if any. See Note 3, “Restatement of Consolidated Financial Statements” of Notes to Consolidated Financial Statements for more information on the restatement of our financial statements for periods prior to January 1, 2006.
Effective January 1, 2006, we adopted SFAS 123(R), which requires the measurement at fair value and recognition of compensation expense for all stock-based payment awards. We selected the modified prospective method of adoption which recognizes compensation expense for the fair value of all stock-based payments granted after January 1, 2006 and for the fair value of all awards granted to employees prior to January 1, 2006 that remain unvested on the date of adoption. We use the Black-Scholes-Merton (“BSM”) option pricing model to estimate the fair value of our stock option and Employee Stock Purchase Plan (“ESPP”) awards consistent with the provisions of SFAS 123(R). The BSM option-pricing model requires the estimation of highly complex and subjective variables. These variables include expected volatility, expected life of the award, expected dividend rate and expected risk-free rate of return. The assumptions for expected volatility and expected life are the two assumptions that most significantly affect the grant date fair value. The expected stock price volatility assumption was determined using the implied volatility of the Company’s
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Common Stock. We use implied volatility for both our stock options and ESPP shares based on freely traded options in the open market, as we believe implied volatility is more reflective of market conditions and a better indicator of expected volatility than historical or blended volatility. If there is not sufficient volume in our market traded options for any period, we will use an equally weighted blend of historical and implied volatility. The expected term assumption for our stock option grants was determined using a Monte Carlo simulation model which projects future option holder behavior patterns based upon actual historical option exercises. SFAS 123(R) also requires the application of a forfeiture rate to the calculated fair value of stock options on a prospective basis. Our assumption of forfeiture rate represents the historical rate at which our stock-based awards were surrendered prior to vesting over the trailing four years. If our assumption of forfeiture rate changes, we would have to make a cumulative adjustment in the current period. We monitor the assumptions used to compute the fair value of our stock options and ESPP awards on a regular basis and we will revise our assumptions as appropriate. In the event that assumptions used to compute the fair value of these awards are later determined to be inaccurate or if we change our assumptions significantly in future periods, stock-based compensation expense and our results of operations could be materially impacted. See Note 2 “Summary of Significant Accounting Policies” section “Stock-based compensation” of Notes to Consolidated Financial Statements for more information regarding the valuation of stock-based compensation.
Recent Accounting Pronouncements
See Note 2, “Summary of Significant Accounting Policies” of Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
We are exposed to financial market risks, primarily arising from the effect of interest rate fluctuations on our investment portfolio. Interest rate fluctuation may arise from changes in the market’s view of the quality of the security issuer, the overall economic outlook, and the time to maturity of our portfolio. We mitigate this risk by investing only in high quality, highly liquid instruments. Securities with original maturities of one year or less must be rated by two of the three industry standard rating agencies as follows: A1 by Standard & Poor’s, P1 by Moody’s and/or F-1 by Fitch. Securities with original maturities of greater than one year must be rated by two of the following industry standard rating agencies as follows: AA- by Standard & Poor’s, Aa3 by Moody’s and/or AA- by Fitch. By corporate policy, we limit the amount of our credit exposure to $10.0 million for any one commercial issuer. Our policy requires that at least 10% of the portfolio be in securities with a maturity of 90 days or less. In addition, we may make investments in securities with maturities up to 36 months. However, the bias of our investment policy is toward shorter maturities.
We invest our cash equivalents and short-term investments in a variety of U.S. dollar financial instruments such as Treasuries, Government Agencies, Repurchase Agreements, Commercial Paper and Bankers’ Acceptance. Our policy specifically prohibits trading securities for the sole purposes of realizing trading profits. However, we may liquidate a portion of our portfolio if we experience unforeseen liquidity requirements. In such a case if the environment has been one of rising interest rates we may experience a realized loss, similarly, if the environment has been one of declining interest rates we may experience a realized gain. As of December 31, 2006, we had an investment portfolio of fixed income marketable securities of $363.0 million excluding cash and cash equivalents. If market interest rates were to increase immediately and uniformly by 10% from the levels as of December 31, 2006, the fair value of the portfolio would decline by approximately $0.8 million. Actual results may differ materially from this sensitivity analysis.
We bill our customers in U.S. dollars. Although the fluctuation of currency exchange rates may impact our customers, and thus indirectly impact us, we do not attempt to hedge this indirect and speculative risk. Our overseas operations consist primarily of business development offices of from 3 to 11 people in any one country and one design center in India. We monitor our foreign currency exposure; however, as of December 31, 2006, our foreign currency exposure is not material enough to warrant foreign currency hedging.
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The table below summarizes the book value, fair value, unrealized losses and related weighted average interest rates for our marketable securities portfolio as of December 31, 2006 and 2005:
| Twelve months ended December 31, 2006 | |||||||||||||
| (dollars in thousands) |
Fair Value | Book Value |
Unrealized Gain/ (Loss) |
Average Rate of Return (annualized) |
|||||||||
| Marketable securities: |
|||||||||||||
| United States government debt securities |
$ | 226,813 | $ | 227,576 | $ | (763 | ) | 4.2 | % | ||||
| Corporate notes and bonds |
136,224 | 136,417 | (193 | ) | 5.2 | % | |||||||
| Total marketable securities |
$ | 363,037 | $ | 363,993 | $ | (956 | ) | ||||||
| Twelve months ended December 31, 2005 | |||||||||||||
| (dollars in thousands) |
Fair Value | Book Value |
Unrealized Gain/ (Loss) |
Average Rate of Return (annualized) |
|||||||||
| Marketable securities: |
|||||||||||||
| United States government debt securities |
$ | 280,659 | $ | 283,018 | $ | (2,359 | ) | 3.8 | % | ||||
| Corporate notes and bonds |
32,340 | 32,705 | (365 | ) | 2.4 | % | |||||||
| Total marketable securities |
$ | 312,999 | $ | 315,723 | (2,724 | ) | |||||||
| Item 8. | Financial Statements and Supplementary Data |
See Item 15 “Exhibits and Financial Statement Schedules” of this Form 10-K for required financial statements and supplementary data.
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
Background to the Restatement
Audit Committee Investigation of Historical Stock Option Practices
In early 2006, an academic study and numerous subsequent press reports began to publicize the likely widespread occurrence of accounting and corporate governance irregularities with respect to the granting of stock options and other equity awards at over 100 companies, many in the high-tech sector. One report included Rambus as one of the companies surveyed with a high risk of having backdated stock option grants. As a result, in late May 2006, we conducted an initial review in which we discovered apparent irregularities in past stock option grants and reported our findings to the Audit Committee and the Board of Directors.
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On May 30, 2006, the Audit Committee commenced an internal investigation of the timing of past stock option grants and other related accounting issues. Each of the members of the Audit Committee had joined our Board of Directors and Audit Committee after January 1, 2005. The Audit Committee retained independent legal counsel and an independent accounting firm to assist in the investigation.
On July 17, 2006, the Audit Committee concluded that the actual dates of determination for certain past stock option grants differed from the originally stated grant dates for such awards. Because the prices at the originally stated grant dates were lower than the prices on the actual dates of determination, we concluded that we should have recognized material amounts of stock-based compensation expense which were not accounted for in our previously issued consolidated financial statements. Therefore, the Audit Committee and management, concluded that our previously issued consolidated financial statements for the fiscal years 2003, 2004 and 2005, which were included in our 2005 Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q filed with respect to each of the applicable quarters in these fiscal years, and the consolidated financial statements included in our Quarterly Report on Form 10-Q for the first quarter of fiscal year 2006, should no longer be relied upon and would be restated.
By October 18, 2006, the Audit Committee had substantially completed its findings with respect to the timing of the Company’s historical stock option grants. The independent investigation over the previous four months included a review of over 200 stock option granting actions from the time of our initial public offering through the commencement of the investigation in late May 2006. The review encompassed over 1.5 million emails and other documents, and over 50 interviews with current and former executive officers, directors, employees and advisors.
The results of the investigation were consistent with the Audit Committee’s earlier conclusion that our previously filed consolidated financial statements should no longer be relied upon. We are disclosing the restatement of the consolidated financial statements for the affected periods by filing this Form 10-K for the fiscal year ended December 31, 2006, which includes the restatement of the consolidated financial statements for the 2005 and 2004 fiscal years, as well as restated consolidated financial data for the first quarter of 2006. In addition, the errors we identified impacted our consolidated financial statements for the periods prior to the year ended December 31, 2004. In the 2006 Form 10-K, the cumulative impact of the errors as of December 31, 2003 is represented as a change to the opening balance of accumulated deficit, additional paid in capital and deferred tax assets as of January 1, 2004. The impact of these errors will continue to have an effect on our consolidated financial statements through fiscal 2009.
The impact of these errors also extended to the quarter ended March 31, 2006. Our previously filed consolidated financial statements for the quarter ended March 31, 2006, related management’s discussion and analysis of financial condition and results of operations and certain tables and disclosures related to APB 25, SFAS 123 and SFAS 123(R) are restated in Exhibit 99.1. We have filed interim consolidated financial statements on Form 10-Q for the period ended June 30, 2006 and the period ended September 30, 2006. In these quarterly consolidated financial statements, the cumulative impact of the errors as of December 31, 2004 is represented as a change to the opening balance of accumulated deficit, additional paid in capital and deferred taxes as of January 1, 2005.
Other balance sheet items related to prior periods affected by the restatement are reflected in the opening balances of the consolidated balance sheet as of January 1, 2004.
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Findings Concerning Stock Option Grant Controls and Procedures
On August 30, 2007, the Audit Committee completed its investigation. The Audit Committee concluded that: (1) there was retroactive pricing of stock options granted to nearly all employees who received options, primarily during the periods from September 30, 1997 to December 31, 2004; (2) the retroactively priced options were not accounted for correctly in the Company’s previously issued consolidated financial statements; (3) the retroactive pricing of options in many instances was intentional, not inadvertent or as a result of administrative error; (4) the retroactive pricing of options involved the selection of low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct; (5) vesting terms on stock options for certain terminating employees were changed without proper authorization; and (6) the retroactive pricing of options in many instances involved the falsification of Stock Option Committee Memoranda, Unanimous Written Consents (UWC) and minutes of the Compensation Committee and offer letters to employees, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as well as in information previously provided to the Company’s independent registered public accounting firm.
Because the retroactive pricing was the result of the actions of only a few individuals, the Board of Directors decided that the Company should continue to honor the retroactively priced options in most instances.
The Audit Committee further concluded that our former Chief Financial Officers and Controllers should have been more involved in understanding whether stock option grants were being properly accounted for, and either knew the proper accounting rules or should have taken steps to become aware of the proper accounting rules for stock option grants. At the time of these practices, it was the reasonable practice of our former Chief Financial Officers and Controllers to rely on senior executives of the Company to create accurate records of the stock option approvals and grants. Our former CEO participated in the approval of misdated stock option grants. He knew or should have been aware of the fact that date selection practices were occurring and that the approval memoranda he signed were not properly reflecting the actual approval dates. However, the Audit Committee also concluded that it was reasonable for the former CEO to believe that the Senior Vice President, Administration was handling the Company’s stock option grants in accordance with the appropriate legal and accounting rules for stock option grants and understood the Company’s actual practices.
Concurrent with the review by the Audit Committee, our management, under the oversight of the Audit Committee, completed an internal review of our previously recorded accounting for stock option based compensation expenses and subsequently made adjustments for: (a) stock option grants for which the Audit Committee determined that the actual grant date for accounting purposes was different from the stated grant date for new hire grants to employees, annual and other grants to employees, and any grants to officers; (b) grants made to individuals who had extensions of option termination dates and, in some cases, extensions of vesting periods pursuant to separation agreements under which the individuals did not perform any significant duties during the separation period and were employees in name only; (c) payroll tax withholding liabilities for certain repriced stock grants that no longer qualify for ISO tax treatment; and (d) other miscellaneous adjustments for modifications and errors, including adjustments for grants to non-employees providing consulting services, and adjustments for continued vesting after an individual converted from an employee to a consultant role and tax effect for each of the adjustments noted above.
During the course of the review, we also identified certain other errors in accounting determinations and judgments related to transactions occurring in prior fiscal years that, although not significant, current management has included in the restated consolidated financial statements. Restatement adjustments are further described in Note 3 “Restatement of Consolidated Financial Statements” of Notes to the Consolidated Financial Statements.
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our current CEO and current CFO, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such terms are defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange
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Act”), as of December 31, 2006, the end of the period covered by this Annual Report on Form 10-K. Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported on a timely basis and that such information is accumulated and communicated to management, including our CEO and CFO. To the extent that components of our internal control over financial reporting are included within our disclosure controls and procedures, they are included in the scope of management’s annual assessment of our internal control over financial reporting.
Based on this evaluation, our management, including our current CEO and current CFO, has concluded that our disclosure controls and procedures were not effective as of December 31, 2006 because of the material weakness in our internal control over financial reporting discussed below. Notwithstanding the material weakness described below, our current management has concluded that the Company’s consolidated financial statements for the periods covered by and included in this Annual Report on Form 10-K are fairly stated in all material respects in accordance with generally accepted accounting principles in the U. S. for each of the periods presented herein.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our management, including the CEO and CFO conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework.
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on its financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements would not be prevented or detected. Management has determined that we have the following material weakness in our internal control over financial reporting as of December 31, 2006.
Insufficient personnel with appropriate accounting knowledge and training: We lacked a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting requirements. Specifically, this control deficiency resulted in audit adjustments that corrected an understatement of revenue and audit adjustments to deferred revenue, deferred
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rent, property and equipment, depreciation, consulting expenses and certain accrual accounts and disclosures in the consolidated financial statements for the year ended December 31, 2006, primarily arising from an insufficient review by us as to relevant information obtained through communications with personnel in operations and through review of certain key contracts and agreements of unique transactions for such accounts. Additionally, this control deficiency could result in misstatements of the aforementioned accounts and disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined this control deficiency constitutes a material weakness.
Based on the above described material weakness, our CEO and CFO have concluded that we did not maintain effective internal control over financial reporting as of December 31, 2006, based on the criteria in Internal Control-Integrated Framework issued by the COSO.
Our assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included in this Annual Report on Form 10-K.
Remediation of Material weakness in Internal Control Over Financial Reporting
Management, with oversight from the Company’s Audit Committee, is committed to remediating the material weakness identified above by implementing changes to our internal control over financial reporting. Management is in the process of implementing, the following changes to the Company’s internal control over financial reporting:
| • | We are actively recruiting for the newly created position of Vice President of Accounting/Finance, who will have oversight over all of the accounting functions in the Company; |
| • | We will be actively recruiting accountants with experience and expertise to fill key positions , specifically in the areas of general accounting, revenue and external reporting to replace the contractors who are currently fulfilling such roles; |
| • | We will expand our training to our accounting and finance employees in the various areas of generally accepted accounting principles, particularly in the areas of revenue recognition and stock-based compensation. This will include initial and continuous training, specifically focused on new and developing topics; |
| • | Secondary review controls executed by accounting personnel will be subject to targeted internal audit reviews, specifically with the focus of ensuring such monitoring controls include an in-depth review of the related transactions’ source documents and communications with personnel in operations responsible for such transactions; |
| • | We will continue our efforts to review our internal controls over financial reporting with the intent to automate previously manual processes specifically in the areas of contract administration, revenue recognition and stock administration; |
| • | We will continue to improve communications between Finance personnel responsible for completing reviews of the Company’s revenue agreements and operations personnel responsible for the execution of work on those transactions; |
| • | We will continue to improve documentation and review standards for SOP 97-2 and 81-1 transactions—inclusive of matters raised by operations personnel during our quarterly revenue recognition review meetings. |
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Additionally, management is investing in ongoing efforts to continuously improve the control environment and has committed considerable resources to the continuous improvement of the design, implementation, documentation, testing and monitoring of our internal controls.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| Item 9B. | Other Information |
None.
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| Item 10. | Directors, Executive Officers and Corporate Governance |
Directors
Our Board of Directors is currently comprised of ten members who are divided into two classes with overlapping two-year terms. We currently have five Class I directors and five Class II directors. At each annual meeting of stockholders, a class of directors is elected for a term of two years to succeed those directors whose terms expire on the annual meeting date. A director serves in office until his or her respective successor is duly elected and qualified or until his or her death or resignation. Any additional directorships resulting from an increase in the number of directors will be distributed among the two classes so that, as nearly as possible, each class will consist of an equal number of directors. Any vacancy occurring mid-term will be filled by a person selected by a majority of the other current members of the Board of Directors. There is no family relationship between any of our directors.
Directors are elected by a plurality of the shares present in person or represented by proxy at our annual meeting and entitled to vote on the election of directors. There are no cumulative voting rights in the election of directors.
Pursuant to the Charter for the Chairperson of the Board of Rambus Inc. (which was adopted in October 2006 and is available on our website at http://investor.rambus.com/governance/chairperson.cfm), a Chairperson, who may not be our Chief Executive Officer, is elected annually by the Board of Directors after our annual meeting. The Chairperson acts as the presiding director at Board meetings and manages the agenda of such meetings, and manages the affairs of the Board, including ensuring that the Board is organized properly, functions effectively, and meets its obligations and responsibilities. The Chairperson also acts as the principal contact for the Chief Executive Officer and other members of the Board and management, as appropriate, for matters requiring the attention of the full Board.
The following table contains information regarding our directors as of May 31, 2007.
Class I Directors Whose Terms are Scheduled to Expire at the Annual Meeting in 2008
| Name |
Age |
Principal Occupation and Business Experience | ||
| Sunlin Chou, Ph.D. |
60 | Dr. Chou was appointed to the Board of Directors in March 2006. Dr. Chou served for 34 years at Intel Corporation, a leader in the semiconductor industry, before retiring in 2005 as a senior vice president. He was co-general manager of the Technology and Manufacturing Group from 1998 to 2005. Dr. Chou holds a B.S., M.S and E.E. in Electrical Engineering from the Massachusetts Institute of Technology and received a Ph.D. in Electrical Engineering from Stanford University. | ||
| Bruce Dunlevie |
50 | Mr. Dunlevie has served as a director since our founding in March 1990. He has been a general partner of the venture capital firm Benchmark Capital since May 1995, and was a general partner of the venture capital firm Merrill, Pickard, Anderson & Eyre between 1989 and 2000. He holds a B.A. in History from Rice University and an M.B.A. from Stanford University. Mr. Dunlevie also serves on the board of Palm, Inc., and several private companies. | ||
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| Name |
Age |
Principal Occupation and Business Experience | ||
| Mark Horowitz, Ph.D. |
50 | Dr. Horowitz has served as a director since our co-founding in March 1990 and has served as chief scientist since May 2005. Dr. Horowitz also served as a vice president from March 1990 to May 1994. Dr. Horowitz has taught at Stanford University since 1984 where he is currently a professor of Electrical Engineering and Computer Science. He holds B.S. and M.S. degrees in Electrical Engineering from the Massachusetts Institute of Technology and received his Ph.D. in Electrical Engineering from Stanford University. | ||
| Harold Hughes |
61 | Mr. Hughes has served as our chief executive officer and president since January 2005 and as a director since June 2003. He served as a United States Army Officer from 1969 to 1972 before starting his private sector career with Intel Corporation. Mr. Hughes held a variety of positions within Intel Corporation from 1974 to 1997, including treasurer, vice president of Intel Capital, chief financial officer, and vice president of Planning and Logistics. Following his tenure at Intel, Mr. Hughes was the chairman and chief executive officer of Pandesic, LLC. He holds a B.A. from the University of Wisconsin and an M.B.A. from the University of Michigan. He also serves as a director of Berkeley Technology, Ltd. | ||
| Abraham D. Sofaer |
69 | Mr. Sofaer has served as a director since May 2005. He has been the George P. Shultz Distinguished Scholar and Senior Fellow at the Hoover Institution at Stanford University since 1994. Mr. Sofaer has a long and distinguished career in the legal profession. Prior to assuming his current roles, he served in private practice as a partner at Hughes, Hubbard & Reed in Washington, DC and as the chief legal adviser to the U.S. Department of State. From 1979 to 1985, Mr. Sofaer served as a U.S. District Judge for the Southern District of New York. He was a professor at the Columbia University School of Law from 1969 to 1979, and from 1967 to 1969 was an Assistant U.S. Attorney in the Southern District of New York. Mr. Sofaer graduated magna cum laude with a B.A. in History from Yeshiva College and received his law degree from the New York University School of Law where he was editor-in-chief of the NYU Law Review. He clerked for Hon. J. Skelly Wright on the U.S. Court of Appeals for the District of Columbia Circuit, and for Justice William J. Brennan, Jr. on the U.S. Supreme Court. Mr. Sofaer currently serves as a director of NTI, Inc. and Gen-Probe, Inc. | ||
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Class II Directors Whose Terms are Scheduled to Expire at the Annual Meeting in 2007
| Name |
Age |
Principal Occupation and Business Experience | ||
| J. Thomas Bentley |
57 | Mr. Bentley has served as a director since March 2005. He served as a managing director at SVB Alliant (formerly Alliant Partners), a mergers and acquisitions firm, since he co-founded the firm in 1990 until October 2005. Mr. Bentley holds a B.A. in Economics from Vanderbilt University and an M.S. in Management from the Massachusetts Institute of Technology. Mr. Bentley currently serves on the board of Nanometrics, Inc. | ||
| P. Michael Farmwald, Ph.D. |
53 | Dr. Farmwald has served as a director since our founding in March 1990 and has served as senior technical advisor since October 2006. In addition, he served as vice president and chief scientist from March 1990 to November 1993. Dr. Farmwald founded Skymoon Ventures, a venture capital firm, in 2000. In addition, Dr. Farmwald has co-founded other semiconductor companies, including Matrix Semiconductor, Inc. in 1997. Dr. Farmwald holds a B.S. in Mathematics from Purdue University and a Ph.D. in Computer Science from Stanford University. | ||
| Penelope A. Herscher |
46 | Ms. Herscher has served as a director since July 2006. She currently holds the position of president and chief executive officer of firstRain, Inc., a custom-configured, on-demand intelligence services firm. Prior to joining firstRain, Ms. Herscher held the position of executive vice president and chief marketing officer at Cadence Design Systems. From 1996 to 2002, Ms. Herscher was president and chief executive officer of Simplex Solutions, which was acquired by Cadence in 2002. Before Simplex, she was an executive at Synopsys for eight years and started her career as an R&D engineer with Texas Instruments. She holds a B.A. with honors in Mathematics from Cambridge University in England. Ms. Herscher serves on the boards of firstRain and several non-profit institutions. | ||
| Kevin Kennedy, Ph.D. |
51 | Dr. Kennedy has served as the non-employee chairman of the Board of Directors since August 2006 and has served as a director since April 2003. He is currently chief executive officer, president and director at JDS Uniphase Corporation, a communications equipment corporation. From August 2001 to September 2003, Dr. Kennedy was the chief operating officer of Openwave Systems, Inc., a software corporation. Prior to joining Openwave Systems Inc., Dr. Kennedy served seven years at Cisco Systems, Inc., a networking corporation, most recently as senior vice president of the Service Provider Line of Business and Software Technologies Division, and 17 years at Bell Laboratories. He holds a B.S. from Lehigh University and an M.S. and Ph.D. from Rutgers University, each in Engineering. Dr. Kennedy is also a director of KLA-Tencor Corp. | ||
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| Name |
Age |
Principal Occupation and Business Experience | ||
| David Shrigley |
59 | Mr. Shrigley has served as a director since October 2006. Mr. Shrigley joined the Board of Directors of Wolfson Microelectronics plc, a supplier of mixed-signal chips for the digital market in November 2006 and became its chief executive officer in March 2007. He served as a general partner at Sevin Rosen Funds, a venture capital firm, from 1999 to 2005. Prior to that, Mr. Shrigley held the position of executive vice president, Marketing, Sales and Service at Bay Networks. Mr. Shrigley served in various executive positions during the prior 18 years at Intel, including vice president and general manager of Asia Pacific Sales and Marketing Operations based in Hong Kong, and vice president and general manager, Corporate Marketing. Mr. Shrigley holds a B.A. from Franklin University. |
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Executive Officers
Information regarding our executive officers and their ages and positions as of May 31, 2007, is contained in the table below. Our executive officers are appointed by, and serve at the discretion of, our Board of Directors. There is no family relationship between any of our executive officers.
| Name |
Age |
Position and Business Experience | ||
| Kevin S. Donnelly |
45 | Senior Vice President, Engineering. Mr. Donnelly joined us in 1993. Mr. Donnelly has served in his current position since March 2006. From February 2005 to March 2006, Mr. Donnelly served as co-vice president of Engineering. From October 2002 to February 2005 he served as vice president, Logic Interface Division. Mr. Donnelly held various engineering and management positions before becoming vice president, Logic Interface Division in October 2002. Before joining us, Mr. Donnelly held engineering positions at National Semiconductor, Sipex, and Memorex, over an eight year period. He holds a B.S. in Electrical Engineering and Computer Sciences from the University of California, Berkeley, and an M.S. in Electrical Engineering from San Jose State University. | ||
| Sharon E. Holt |
42 | Senior Vice President, Worldwide Sales, Licensing and Marketing. Ms. Holt has served as our senior vice president, Worldwide Sales, Licensing and Marketing (formerly titled Worldwide Sales and Marketing) since joining us in August 2004. From November 1999 to July 2004, Ms. Holt held various positions at Agilent Technologies, Inc., an electronics instruments and controls company, most recently as vice president and general manager, Americas Field Operations, Semiconductor Products Group. Prior to Agilent Technologies, Inc., Ms. Holt held various engineering, marketing, and sales management positions at Hewlett-Packard Company, a hardware manufacturer. Ms. Holt holds a B.S. in Electrical Engineering, with a minor in Mathematics, from the Virginia Polytechnic Institute and State University. | ||
| Harold Hughes |
61 | Chief Executive Officer and President. Mr. Hughes has served as our chief executive officer and president since January 2005 and as a director since June 2003. He served as a United States Army Officer from 1969 to 1972 before starting his private sector career with Intel Corporation. Mr. Hughes held a variety of positions within Intel Corporation from 1974 to 1997, including treasurer, vice president of Intel Capital, chief financial officer, and vice president of Planning and Logistics. Following his tenure at Intel, Mr. Hughes was the chairman and chief executive officer of Pandesic, LLC. He holds a B.A. from the University of Wisconsin and an M.B.A. from the University of Michigan. He also serves as a director of Berkeley Technology, Ltd. | ||
| Thomas Lavelle |
57 | Senior Vice President and General Counsel. Mr. Lavelle has served in his current position since December 2006. Previous to that, Mr. Lavelle served as vice president and general counsel at Xilinx, one of the world’s leading suppliers of programmable chips. Mr. Lavelle joined Xilinx in 1999 after spending more than 15 years at Intel Corporation where he held various positions in the legal department. Mr. Lavelle earned a J.D. from Santa Clara University School of Law and a B.A. from the University of California at Los Angeles. | ||
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| Name |
Age |
Position and Business Experience | ||
| Satish Rishi |
47 | Senior Vice President, Finance and Chief Financial Officer. Mr. Rishi joined us in his current position in April 2006. Prior to joining us, Mr. Rishi held the position of executive vice president of Finance and chief financial officer of Toppan Photomasks, Inc., (formerly DuPont Photomasks, Inc.) one of the world’s leading photomask providers, from November 2001 to April 2006. During his 20-year career, Mr. Rishi has held senior financial management positions at semiconductor and electronic manufacturing companies. He served as vice president and assistant treasurer at Dell Inc. Prior to Dell, Mr. Rishi spent 13 years at Intel Corporation, where he held financial management positions both in the United States and overseas, including assistant treasurer. Mr. Rishi holds a B.S. with honors in Mechanical Engineering from Delhi University in Delhi, India and an M.B.A. from the University of California at Berkeley’s Haas School of Business. He also serves as a director of Measurement Specialties, Inc. | ||
| Michael Schroeder |
47 | Vice President, Human Resources. Mr. Schroeder has served as our vice president, Human Resources since joining us in June 2004. From April 2003 to May 2004, Mr. Schroeder was vice president, Human Resources at DigitalThink, Inc., an online service company. From August 2000 to August 2002, Mr. Schroeder served as vice president, Human Resources at Alphablox Corporation, a software company. From August 1992 to August 2000, Mr. Schroeder held various positions at Synopsys, Inc., a software and programming company, including vice president, California Site Human Resources, group director Human Resources, director Human Resources and employment manager. Mr. Schroeder attended the University of Wisconsin, Milwaukee and studied Russian. | ||
| Martin Scott, Ph.D. |
52 | Senior Vice President, Engineering. Dr. Scott has served in his current position since December 2006. Dr. Scott joined us from PMC-Sierra, Inc., a provider of broadband communications and storage integrated circuits, where he was most recently vice president and general manager of its Microprocessor Products Division from March 2006. Dr. Scott was the vice president and general manager for the I/O Solutions Division (which was purchased by PMC-Sierra) of Avago Technologies Limited, an analog and mixed signal semiconductor components and subsystem company, from October 2005 to March 2006. Dr. Scott held various positions at Agilent Technologies, including as vice president and general manager for the I/O Solutions division from October 2004 to October 2005, when the division was purchased by Avago Technologies, vice president and general manager of the ASSP Division from March 2002 until October 2004, and, before that, Network Products operation manager. Dr. Scott started his career in 1981 as a member of the technical staff at Hewlett Packard Laboratories and held various management positions at Hewlett Packard and was appointed ASIC business unit manager in 1998. He earned a B.S. from Rice University and holds both an M.S. and Ph.D. from Stanford University. | ||
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| Name |
Age |
Position and Business Experience | ||
| Laura S. Stark |
38 | Senior Vice President, Platform Solutions. Ms. Stark joined us in 1996 as strategic accounts manager, and held the positions of strategic accounts director and vice president, Alliances and Infrastructure, before assuming the position of vice president, Memory Interface Division in October 2002. She held this position until February 2005 when she was appointed to her current position. Prior to that, Ms. Stark held various positions in the semiconductor products division of Motorola, a communications equipment company, during a six year tenure, including technical sales engineer for the Apple sales team and field application engineer for the Sun and SGI sales teams. Ms. Stark holds a B.S. in Electrical Engineering from the Massachusetts Institute of Technology. |
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act requires our executive officers, directors and ten percent stockholders to file reports of ownership and changes in ownership with the SEC. The same persons are required to furnish us with copies of all Section 16(a) forms they file. Based solely on our review of these forms, we believe that during fiscal 2006 all of our executive officers, directors and ten percent stockholders complied with the applicable filing requirements except for late Forms 4 filed on behalf of Mr. Bentley, Mr. Chou, Mr. Dunlevie, Dr. Farmwald, Mr. Kennedy and Mr. Sofaer. The late filings for Mr. Bentley, Mr. Chou, Mr. Dunlevie, Dr. Farmwald, Dr. Kennedy and Mr. Sofaer were related to automatic grants of stock options to these directors made on October 2, 2006 that was inadvertently reported late by us on their behalf on October 11, 2006.
Code of Business Conduct and Ethics
We have a Code of Business Conduct and Ethics for all of our directors, officers and employees. Our Code of Business Conduct and Ethics is available on our website at http://investor.rambus.com/governance/ethics.cfm /. In addition, stockholders may request a free copy of our Code of Business Conduct and Ethics from:
Rambus Inc.
Attention: Investor Relations
4440 El Camino Real
Los Altos, CA 94022
Tel: 650-947-5050
To date, there have been no waivers under our Code of Business Conduct and Ethics. We will post any waivers, if and when granted, of our Code of Business Conduct and Ethics on our website at http://investor.rambus.com/governance/ethics.cfm.
Audit Committee
Currently, the Audit Committee is comprised of Mr. Bentley, Mr. Sofaer and Mr. Chou, with Mr. Bentley serving as Chairman. The Audit Committee oversees our corporate accounting and financial reporting processes and controls, as well as our internal and external audits. Its duties include:
| • | Reviewing our accounting and financial reporting processes and internal controls, |
| • | Providing oversight and review at least annually of our risk management policies, including our investment policies, |
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| • | Retaining the independent auditors, approving their fees, and providing oversight and communication with them, |
| • | Reviewing the plans, findings and performance of our internal auditors, |
| • | Reviewing our annual, quarterly and other financial statements and related disclosure documents, and |
| • | Overseeing special investigations into financial and other matters, as necessary, such as the independent investigation into historical stock option grants. |
Our Board of Directors has determined that Mr. Bentley is the “Audit Committee financial expert” and that Mr. Bentley, together with each of Mr. Sofaer and Mr. Chou, has no material relationship with us (either directly as a partner, stockholder or officer of an organization that has a relationship with us) and is “independent” as defined under NASD Rule 4200 and the applicable rules promulgated by the SEC.
The Audit Committee’s role is detailed in the Audit Committee Charter, which was amended and restated by our Board of Directors on April 4, 2007, and is available on our website at http://investor.rambus.com/governance/governance.cfm
| Item 11. | Executive Compensation |
Compensation Discussion and Analysis
Overview of Compensation Program
We develop leading-edge chip interface technology years ahead of the market’s needs. We provide this technology to our customers through both patent licenses and through licenses for our leadership (Rambus-proprietary) architectures and designs. As our innovations are often adopted into industry-standard solutions, we license industry-standard designs as a further service for our customers.
Our business model requires that we attract and retain the best scientific and engineering personnel in our field of focus in order to realize our fundamental competitive advantage and deliver the greatest value for our stockholders. Because our technology is foundational in the large and growing market for digital electronics, competition for qualified individuals is fierce. Thus, our compensation program is designed to attract and retain the best talent, especially leading scientists and engineers, in the industry.
Our guiding philosophy for all of our employees is that total compensation (i.e., base salary, annual incentive bonus, long-term equity grants and other employee benefits and arrangements) should correlate highly to achievement of our financial and non-financial objectives. We also grant long-term, equity-based and cash incentive compensation in order to more closely align the long-term interests of management with those of our stockholders. Total compensation is tied both to company and individual performance. We strive to reward our employees, regardless of level, commensurate with their contributions, sustained performance and value created. This philosophy reflects our key strategic compensation design priorities: pay for performance, employee retention, cost management, and continued focus on corporate governance. Our total compensation philosophy is posted on our website at http://investor.rambus.com/governance/total_comp.cfm
This Compensation Discussion and Analysis presents our compensation policies, programs, and practices for the named executive officers presented on the Summary Compensation Table appearing later in this report.
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Role and Responsibilities of the Compensation Committee
The Compensation Committee’s roles and responsibilities include the following activities which are among the duties reflected in our Compensation Committee Charter, which is posted on our website at http://investor.rambus.com/governance/compensation.cfm:
| • | Annually review and approve the CEO and other executive officers’ compensation in the context of their performance, which includes reviewing and approving their annual base salary, annual incentive bonus, including the specific goals, targets, and amounts, equity compensation, employment agreements, severance arrangements, and change in control agreements/provisions, and any other benefits, compensation or arrangements. |
| • | Administer our stock option and equity incentive plans pursuant to the terms of such plans and the authority delegated by the Board. In its administration of the plans, the Compensation Committee may grant stock options, stock appreciation rights, restricted stock, restricted stock units or other equity compensation to individuals eligible for such grants and amend such awards following their grant. |
| • | Adopt, amend and oversee the administration of our significant employee benefits programs. |
| • | Review external surveys to establish appropriate ranges of compensation. |
| • | Retain and terminate any compensation consultant to assist in the evaluation of CEO or executive officer or director compensation, and approve the consultant’s fees and other terms of service, as well as obtain advice and assistance from internal or external legal, accounting or other advisors. |
Setting Executive Compensation
Based on the foregoing objectives, the Compensation Committee has structured annual and long-term incentive-based cash and non-cash executive compensation to attract and retain the named executive officers, and align their focus and actions to achieve our Company’s business goals.
To determine the appropriate levels of compensation for our executive officers, the Compensation Committee reviews in-depth analysis conducted by management and external consultants. The analysis is based, in part, on information reported in proxy statements and independent, third-party published survey data. Each year the Vice President of Human Resources works to provide analysis and recommendations in support of executive compensation. This analysis includes specific market pricing for each named executive officer position within the Company. To support the detailed analysis and recommendations, the Vice President of Human Resources works with both the Director of Compensation and independent consultants. The Vice President of Human Resources and the CEO then provide recommendations for executive officers other than the CEO to the Compensation Committee for their consideration and approval. The Vice President of Human Resources then presents analysis for determination of the CEO’s compensation to the Compensation Committee, and the Compensation Committee then deliberates in closed session.
In 2006, Compensia, a third party, independent consultant, assisted the Compensation Committee in evaluating the compensation program for our executive officers and directors. Compensia, working with management, has assisted the Compensation Committee each year since 2004. Compensia utilized peer group comparison and benchmarking surveys to assess the competitiveness and appropriateness of our compensation programs against our Compensation Peer Group described below and other industry comparisons. Compensia’s analysis included last fiscal year data and three-year average data evaluated against a variety of compensation utilization metrics including total equity compensation expense, equity expense as a percent of net income, and equity expense as a percent of revenue. Base and total cash compensation were also compared against the Compensation Peer Group and industry financial performance metrics, including revenue growth, net income growth, and total shareholder return.
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In making compensation decisions, the Compensation Committee compares analysis of each element as well as the aggregation of all elements of total compensation against our peer group of publicly-traded companies, which we refer to as the Compensation Peer Group. The Compensation Peer Group consists of companies against which the Compensation Committee believes we compete for talent and represents similar benchmark attributes including revenue size, complexity, like industry, market capitalization, and number of employees. For fiscal year 2006, the Compensation Peer Group included: Actel Corp., Magma Design Auto Inc., Ceva Inc., MIPS Technologies Inc., Cymer Inc., Omnivision Tech Inc., DSP Group Inc., Pixelworks Inc., Formfactor Inc., Virage Logic Corp., Interdigital Communication Corp., Altera Corp., LSI Logic Corp., Atmel Corp., Nvidia Corp., Benchmark Electronics Inc., PMC Sierra Inc., Cypress Semiconductor Corp., Semtech Corp., Fairchild Semiconductor Intl Inc., Sigmatel Inc., Silicon Lab Inc., Integrated Circuit Systems Inc., Integrated Device Tech Inc., and Vishay Intertechnology Inc. The Compensation Committee reviews the Compensation Peer Group annually to ensure the appropriateness of the group for compensation comparisons.
Consistent with our “Pay for Performance” philosophy, the Compensation Committee targets our executive officers’ total cash compensation at or near the 75th percentile of the Compensation Peer Group. Base salary targets for executive officers are designed so that salary opportunities for a given office are positioned at approximately the 50th percentile of the Compensation Peer Group. The Compensation Committee believes that this percentile will allow us to maintain control over fixed compensation expense while affording competitive upside to the executives as a result of our financial performance. Variable or incentive cash compensation is realized based on the achievement of our annual operating plan as approved by the Board and achievement of individual objectives as described in more detail below.
In 2006, the Compensation Committee collaborated with management in the continuing effort to enhance corporate governance and align our compensation and benefit practices with the long term interests of our stockholders. In 2006, we implemented and obtained the approval of our stockholders of a new equity incentive plan that replaced our expiring 1997 Stock Option Plan, referred to as the 1997 Plan. Our new 2006 Equity Incentive Plan, referred to as the 2006 Plan, eliminated a historic evergreen replenishment provision and requires shareholder approval for share replenishment which we will propose as needed based on market comparisons and our performance. We have worked to reduce the issuance of equity as a percentage of overall compensation in-line with peer market trends. We have also worked to reduce the “burn rate,” or number of equity awards issued annually as a percentage of our total outstanding shares, to less than 3% of total outstanding shares in 2006, and we are projecting a burn rate of between 2.5% and 3% for 2007. When compared to our Compensation Peer Group, we fell below the 50th percentile for the last fiscal year and the three-year average overall gross burn rate and net burn rate (which factors in cancellations of equity awards under our plans). Our stock option issuance per employee has declined over 70 percent from 2003 to 2006. Also, in October 2006, the Compensation Committee considered and adopted stock ownership guidelines effective 2007 for our executive officers and directors as described below.
The Compensation Committee’s policy with respect to the adjustment or recovery of compensation as a result of material changes in our financial statements requiring an accounting restatement is to retain discretion over all pay elements and reserve the right to reduce or forego future compensation based on any required restatement or adjustment. The Compensation Committee intends to review these matters in light of the restatements that occurred as a result of the stock option investigation and consider the evolution of the policy as part of its annual policy review this year.
The Compensation Committee considers the potential future effects of Section 162(m) of the Internal Revenue Code of 1986, as amended. Section 162(m) limits the deductibility by public companies of certain executive compensation in excess of $1,000,000 per executive per year, but excludes from the calculation of such $1,000,000 limit certain elements of compensation, including performance-based compensation, provided that certain requirements are met. Both our 1997 Plan and 2006 Plan permit the Compensation Committee grant equity awards that are “performance-based” and thus fully tax-deductible by us. The Compensation Committee currently intends to continue evaluating all of our executive compensation and will qualify such compensation as performance based compensation under Section 162(m) to the extent it determines doing so is in our best interests. All of the stock options granted to our executive officers are intended to qualify under Section 162(m) as performance-based compensation. However, during our stock option investigation we discovered that certain stock options granted to Mr. Donnelly, Mr. Patel and Ms. Stark were granted with an exercise price below the fair market value of the underlying shares on the date of grant and will not qualify as performance based compensation under Section 162(m). In addition, the restricted stock unit and restricted stock awards granted to our executive officers do not qualify as performance-based compensation.
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The Compensation Committee also considers the effects of Section 409A of the Internal Revenue Code when granting or providing compensation. Section 409A imposes additional significant taxes in the event that an executive officer, director or service provider receives “deferred compensation” that does not meet the requirements of Section 409A. To assist in the avoidance of additional tax under Section 409A, we generally structure equity awards in a manner intended to comply with the applicable Section 409A requirements. However, in connection with the stock option investigation, certain stock options that were determined to have been granted at a discount to fair market value do not meet the requirements of Section 409A. Rambus has not paid or otherwise grossed up current or former executives for any additional taxes imposed by Section 409A with respect to these stock options. The Compensation Committee will continue to consider the appropriateness of any such action in the future based on applicable company and industry-wide developments.
As discussed elsewhere in this report, we have concluded an investigation into historical stock option grants. The Compensation Committee has taken into consideration the results of the investigation with respect to the internal control and other compensation policies of Rambus. A summary of the investigation and our findings are set forth under Note 3 of the Notes to Consolidated Financial Statements, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 9A, “Controls and Procedures.”
Both in response to the findings of the stock option investigation and as a result of our continuing efforts to enhance corporate governance, we have made many improvements to our policies and procedures for equity award grants. In November 2006, we changed the new hire grant procedures for named executive officers and other executives to be made on the first trading day of the month following their date of hire. The Compensation Committee also approved moving the annual performance equity grant date for all employees to the first trading day in February of each year. This date in February was chosen in order to allow these granting actions to take place as soon after our annual financial earnings release as was practical. We feel that this schedule coupled with prospective grant policies will afford more transparency and improve the governance of our equity program. In addition, we added improved internal controls to verify key elements of our policy and process compliance. These improvements included additional review and back-up audit requirements for both pre- and post-grant administration.
In designing our compensation programs, we take into consideration the accounting effect that each element will or may have on us. For example, in evaluating the 2006 Employee Stock Purchase Plan, referred to as the 2006 Stock Purchase Plan, the Compensation Committee considered both the appropriateness and competitiveness of our compensation strategy and the effect of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (revised 2004), referred to as SFAS 123(R), with respect to the compensation expense recorded in the financial statements. As a result, the Compensation Committee adopted modifications in early 2007 to the 2006 Stock Purchase Plan. These changes eliminated a 24 month look-back and substituted it with a standard 6 month look-back while retaining a purchase price equal to 85% of the fair market value on the first day of the offering period or the last day of the offering period, whichever is lower.
2006 Executive Compensation Components
For the fiscal year ended December 31, 2006, the principal components of compensation for named executive officers were:
| • | Annual Base Salary |
| • | Annual Variable Compensation |
| • | Equity Based Compensation |
| • | All Other Compensation which includes 401(k) match, health/welfare and other standard benefits |
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Base Salary
We provide our named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. The annual base salary for executive officers is determined relative to job scope, past and present contributions for performance and compensation for similar positions within our Compensation Peer Group. Base salary ranges for named executive officers are determined for each executive based on his or her position and responsibility by using the Compensation Peer Group and other industry market data.
We emphasize pay for performance in all components of compensation, and make salary adjustments based on individual employee performance relative to published compensation levels for incumbents of similar positions in the Compensation Peer Group. In 2006, annual salary represented 50% of our CEO’s annual total target cash and between 55% and 60% of the annual total target for the other named executive officers with the remainder of other total target in the form of bonus.
In 2007, the Compensation Committee approved a 15.4% increase in the CEO’s base salary and total cash compensation. As a result, his total target cash compensation level for fiscal year 2007 remains slightly below our target of 75th percentile of the Compensation Peer Group. Historically, we have paid the CEO below-market total cash compensation but we have issued more equity awards as compensation in comparison to the Compensation Peer Group and other industry companies. Starting in 2005 and continuing in 2006 and 2007, we have aligned the CEO’s total compensation package to be consistent with our other named executive officers and in-line with our compensation philosophy as applied against our Compensation Peer Group.
Performance-based Incentive Plan
The Compensation Committee rewards achievement at specified levels of financial and individual performance. Each officer has a target bonus level that is competitive with target bonuses for similar positions reported in our independent, third-party surveys and information from proxy statements. The Compensation Committee also reviews and ensures that the target bonus levels are competitive in comparison to the Compensation Peer Group. We have historically and continue to target the 75th percentile for total target cash within these defined talent markets. The Compensation Committee believes that financial performance is a key measurement in determining variable compensation.
The 2006 incentive plan included our named executive officers as well as employees through senior individual contributor levels, and all employees will be eligible to participate in 2007. The incentive plan is funded based on achievement of an adjusted pre-tax income target, which excludes stock-based compensation expense and other one time charges deemed by the Compensation Committee to be extraordinary and outside of management control. Pre-tax income was chosen as our financial performance metric because it is a function of both the top-line revenue performance and expense management efficiency. The Compensation Committee retains the discretion to exclude the one-time charges from the pre-tax income calculation. For fiscal year 2006, the pre-tax achievement excluded stock-based compensation expenses, a one-time bonus paid to outside litigation counsel, and expenses incurred as a result of the stock option investigation. The incentive plan is designed to be funded linearly beginning at a threshold of 70% of the pre-approved plan and rises to a potential 200% of target funding based on the achievement exceeding the pre-tax income target. Named executive officers participating in the plan are also measured against objectives that tie directly to our overall operating plan objectives. For fiscal year 2006, these objectives included specific customer goals, licensing objectives, specific technology development milestones, internal control and process improvements, and productivity initiatives. Final payout of these cash incentive awards, if any, is determined by the funding level achieved and each individual’s performance against their key objectives or management by objectives.
For fiscal year 2006, our adjusted pretax results generated a funding level of 1.75 times the total target bonus. All of our named executive officers received between 125% and 180% of their incentive targets. Our CEO earned a bonus of 175% of his incentive target based on the adjusted pretax results.
Long-term Equity Incentive Compensation—Stock Awards and Option Grants
Ownership of our Common Stock is a key element of executive compensation. Our named executive officers are eligible to participate in the 2006 Plan and our 2006 Stock Purchase Plan. The 2006 Plan permits the Board or the Compensation
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Committee to grant restricted stock, stock options, stock appreciation rights, restricted stock units and other stock-based equity awards to employees, including named executive officers, on such terms as the Board or the Compensation Committee may determine. On several occasions in 2006, we opted to grant restricted stock or restricted stock units, referred to as RSUs, instead of stock options generally because we wished to reduce overall equity issuances and compensation expenses, while also focusing on the effectiveness of the use of a restricted stock or RSU element for specific purposes. We determined that granting such awards in lieu of stock options provided us with an additional recruitment incentive in the hiring of Mr. Rishi and part of a special litigation incentive for Mr. Danforth. The Compensation Committee continues to evaluate the proper mix for the issuance of stock options, restricted stock or RSUs, and other equity awards.
Currently, equity grants are the only element of our long-term compensation. We are using long-term compensation as a retention tool and as a primary compensation element to align our named executive officers with the long-term interest of our stockholders. The Compensation Committee compared the number of shares and the value of the equity grants with the Compensation Peer Group and third party industry survey data. Our targeted value for these awards is at or above the 75th percentile for each named executive officer. As a further retention tool, we generally apply a 5-year vesting schedule on these equity grants in comparison to the more standard 3-year or 4-year vesting period used by most of the Compensation Peer Group.
In determining the size of a stock option grant to a named executive officer, the Compensation Committee takes into account equity participation by comparable employees, external competitive circumstances and other relevant factors. Because these options typically vest ratably over 60 months, they require the named executive officer’s continued service. In addition, the Compensation Committee considers each named executive officer’s performance and contribution during the fiscal year, analyses reflecting the value delivered by the executive and competitive practices.
Our stock purchase plans permit employees to acquire our Common Stock through payroll deductions and promote broad-based equity participation throughout our company.
The Compensation Committee believes that these stock plans align the interests of the named executive officers as well as our other employees with the long-term interests of the stockholders.
Stock Ownership Guidelines.
In October 2006, our Board approved stock ownership and retention guidelines for executives and directors. Under these guidelines, our executive officers will be expected to accumulate and hold an equivalent value of our Common Stock that is equal or greater than 2 times to 5 times of their annual base salary, and to maintain this minimum amount throughout their tenure as an executive officer. The CEO will be expected to accumulate and hold an equivalent value of 5 times his/her annual base salary, all other Section 16 executive officers will be expected to accumulate and hold an equivalent value of 3 times their annual base salaries, and all other executives will be expected to accumulate and hold an equivalent value of 2 times their annual base salaries. All executive officers have five years to achieve this accumulated value requirement from January 1, 2007, or the date that the executive officer assumes his or her position, whichever is later. These targets were determined and set as the result of benchmark surveys conducted against industry survey data. Elements that will qualify towards ownership goals will include: vested and unvested restricted stock and restricted stock units, vested and unexercised stock options, stock purchase plan holdings and any other shares of Common Stock owned outright.
401(k) Plan and Other Health and Life Insurance Premium
Our named executive officers, like other employees, are eligible to participate in our 401(k) plan. In any plan year, we will contribute to each participant a matching contribution equal to 50% of the first 6% of the participant’s eligible compensation that has been contributed to the plan. In addition, all named executive officers and other employees are eligible to participate in all health and welfare benefits offered by us in accordance with the terms and conditions of such plans or arrangements.
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We do not provide pension arrangements or post-retirement health coverage for our named executive officers or other employees.
Other Compensation
At the end of fiscal 2006, we gave to each employee a Sony PLAYSTATION®3 (“PS3™”) computer entertainment system which features our XDR™ memory and FlexIO™ processor bus interface technologies. We also paid a tax gross-up to each employee with respect to the value of the PS3™ received.
From time to time, primarily as a recruitment tool, the Compensation Committee has approved certain other compensation in the form of reimbursement or payment of relocation costs. For instance, in 2006, Rambus paid such expenses for Mr. Rishi in connection with his initial employment. We also have a policy of paying for or reimbursing various living expenses in connection with our executive officers whose job duties require them to work for us abroad, such as with Mr. Patel in 2006. Rambus will also make tax gross-up payments on these relocation, expatriate and related other compensation.
Rambus does not provide any other perquisites or other compensation to its named executive officers.
Employment and Retention Agreements
All of our employees, including our named executive officers, are employees-at-will and as such typically do not have employment contracts with us, except in the case of some employees of our foreign subsidiaries and as discussed below. We also do not provide post-employment health coverage or other benefits, except in connection with the retention agreements, details of which are included below.
The Compensation Committee periodically evaluates the need for such agreements with respect to market practices in order to remain competitive and attract and retain executive officers. For instance, individual circumstances may arise which lead to entering into such agreements to attract executive officers to join our company.
In addition, in 2006, as part of the arrangement for Mr. Danforth to assume a role focused on certain litigation matters, the Compensation Committee approved the entry into an employment agreement with Mr. Danforth. Mr. Danforth, who was our Senior Vice President and General Counsel, entered into the amended and restated employment agreement with us effective February 1, 2006. Pursuant to the terms of the agreement, Mr. Danforth is employed as a full-time employee during a period in which we and Mr. Danforth mutually agree and afterwards as a part-time employee through a subsequent twelve-month period. The agreement will terminate once all payments due and all other obligations of the parties have been made or satisfied. Mr. Danforth’s base salary and annual target bonus will be set by us in our sole discretion and he will also be paid certain additional bonuses if and when certain triggering events relating to outcomes in certain litigation matters occur during the term of the agreement. For fiscal year 2006, Mr. Danforth was issued 63,383 RSUs as a result of the achievement of certain of these triggering events. If Mr. Danforth’s employment is involuntarily terminated prior to October 22, 2007 by us other than for “Cause” (as defined in the agreement) or other than due to Mr. Danforth’s death or “Disability” (as defined in the agreement), then subject to Mr. Danforth entering into a release of claims in favor of us, Mr. Danforth shall receive severance from us which shall include certain salary and bonus payments and immediate accelerated vesting of stock options to acquire shares of our Common Stock to the same extent as if Mr. Danforth had remained employed by us through October 22, 2007. Had this provision in Mr. Danforth’s agreement been triggered on December 31, 2006, the value of the accelerated equity grants would have amounted to approximately $1.5 million. Effective July 27, 2006, Mr. Danforth left the position of Senior Vice President, General Counsel and assumed the role of senior legal advisor in which he focuses on the management of certain of our litigation matters.
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Compensation Committee Report
Our Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management and, based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this report.
| THE COMPENSATION COMMITTEE |
| Penelope A. Herscher (Chair) |
| Kevin Kennedy |
| David Shrigley |
Summary Compensation Table
The following table shows compensation information for 2006 for the named executive officers.
Summary Compensation
For Fiscal Year 2006
| Name and Title |
Year | Salary ($) |
Bonus ($) |
Stock Awards(1) ($) |
Option Awards(2) ($) |
Non-Equity ($) |
Change in ($) |
All Other Compensation(4) ($) |
Total ($) | |||||||||||
| Harold E. Hughes(5) |
2006 | 375,000 | — | — | 1,857,443 | 662,282 | — | 9,388 | 2,904,113 | |||||||||||
| Satish Rishi(6) |
2006 | 208,077 | — | 305,995 | 868,169 | 256,445 | — | 451,886 | (7) | 2,090,572 | ||||||||||
| Robert K. Eulau(8) |
2006 | 50,305 | — | — | 248,260 | (9) | — | — | 2,554 | 301,119 | ||||||||||
| John D. Danforth(10) |
2006 | 255,000 | — | 968,171 | 2,141,852 | (11) | 296,201 | — | 11,274 | 3,672,498 | ||||||||||
| Laura Sue Stark |
2006 | 255,000 | — | — | 2,312,180 | 343,217 | — | 11,455 | 2,921,852 | |||||||||||
| Kevin S. Donnelly |
2006 | 246,000 | — | — | 2,273,933 | 317,895 | 11,625 | 2,849,453 | ||||||||||||
| Samir A. Patel(12) |
2006 | 240,000 | — | — | 1,609,941 | 307,095 | — | 37,205 | (13) | 2,194,241 | ||||||||||
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| (1) | Stock awards consist of restricted stock granted in connection with the hiring of Mr. Rishi and RSUs as part of a special litigation incentive for Mr. Danforth. Amounts shown do not reflect compensation actually received by the named executive officer. Instead, the amounts shown are the dollar amounts recognized for financial statement reporting purposes by Rambus in fiscal year 2006 for stock awards in accordance with the provisions of SFAS 123(R). The assumptions used to calculate the value of stock awards are set forth under Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. |
| (2) | Amounts shown do not reflect compensation actually received by the named executive officers. Instead, the amounts shown are the dollar amounts, disregarding the estimate of forfeitures related to service-based vesting conditions, recognized for financial statement reporting purposes by Rambus in fiscal year 2006 for stock option awards in accordance with the provisions of SFAS 123(R). Stock compensation expense calculations for financial statement purposes spread the grant date cost of those awards over the service period. Therefore, amounts in this column include the expense for awards granted in fiscal year 2006 and previous years. The assumptions used to calculate the value of stock option awards are set forth under Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. |
| (3) |
Amounts consist of bonuses earned for services rendered in fiscal year 2006 under our 2006 incentive plan. |
| (4) | In addition to any amounts disclosed with respect to individual named executive officers, amounts reported in the “All Other Compensation” column consist of (1) matching contributions to the named executive officers’ 401(k) accounts, (2) premiums paid for health and welfare insurance policies, and (3) tax “gross-ups” of $312 per employee for PS3™ entertainment systems provided to all of our employees. |
| (5) | Mr. Hughes assumed the additional responsibility as our Chief Financial Officer from March 2, 2006 to April 10, 2006. |
| (6) | Mr. Rishi joined Rambus as Senior Vice President, Finance and Chief Financial Officer on April 11, 2006. |
| (7) | We provided Mr. Rishi with taxable and non-taxable relocation benefits valued at $165,740 and $31,835, respectively, and paid Mr. Rishi an additional $127,839 to cover tax expenses related to these relocation benefits. Mr. Rishi also received a $120,000 sign-on bonus. |
| (8) | Mr. Eulau served as our Senior Vice President, Finance and Chief Financial Officer until March 1, 2006. |
| (9) | As a result of his separation and pursuant to their terms, Mr. Eulau forfeited options representing 309,154 shares of Common Stock that were unvested at the time he ended his employment with us. |
| (10) | Mr. Danforth served as our Senior Vice President, General Counsel and Secretary until July 27, 2006, at which time he assumed the non-executive position of senior legal advisor. |
| (11) | On December 31, 2006, we amended two stock option agreements, each dated October 8, 2001, with Mr. Danforth to increase the exercise price per share from $8.00 to $11.72 for outstanding, unexercised stock options to purchase 59,445 shares of our Common Stock held by Mr. Danforth. The value of Mr. Danforth’s stock option awards includes the deemed exchanged value of these options. |
| (12) | Mr. Patel served as Senior Vice President, Product Development & Production until January 2, 2007. |
| (13) | In connection with Mr. Patel’s service in India through July 2006, we provided Mr. Patel with housing, education, and estimated tax related payments of $25,331. |
Page 78 of 170
Grants of Plan Based Awards
The following table shows all plan-based awards granted to the named executive officers during fiscal year 2006. The option awards and the unvested portion of the stock awards identified in the table below are also reported in the Outstanding Equity Awards at Fiscal 2006 Year-End Table that follows.
Grants of Plan-Based Awards
For Fiscal Year 2006
| Estimated Future Payouts Under Incentive Plan Awards (1) |
Estimated Future Payouts Under Equity Incentive Plan Awards |
All Other Awards Stock Units (2) (#) |
All Other Awards: Options (3) (#) |
Exercise or Base Awards ($/Sh) |
Grant Date & Options Awards (4) (($) | |||||||||||||||||
| Name |
Grant Date |
Threshold ($) |
Target ($) |
Maximum ($) |
Threshold (#) |
Target (#) |
Maximum (#) |
|||||||||||||||
| Harold E. Hughes |
1/6/2006 | — | — | — | — | — | — | — | 270,000 | 22.94 | 3,866,643 | |||||||||||
| — | 213,750 | 375,000 | 795,000 | — | — | — | — | — | — | — | ||||||||||||
| Satish Rishi |
4/11/2006 | — | — | — | — | — | — | 40,000 | — | 0.001 | 1,632,000 | |||||||||||
| 4/11/2006 | — | — | — | — | — | — | — | 220,000 | 40.80 | 6,004,834 | ||||||||||||
| — | 114,000 | 200,000 | 424,000 | — | — | — | — | — | — | — | ||||||||||||
| Robert K. Eulau |
1/6/2006 | — | — | — | — | — | — | — | 75,000 | 22.94 | 1,074,068 | |||||||||||
| — | 105,450 | 185,000 | 392,200 | — | — | — | — | — | — | — | ||||||||||||
| John D. Danforth(5) |
12/31/06 | — | — | — | — | — | — | — | 59,445 | 11.72 | — | |||||||||||
| 5/2/2006 | — | — | — | — | — | — | 26,780 | — | — | 999,965 | ||||||||||||
| 2/1/2006 | — | — | — | — | — | — | 36,603 | — | — | 999,994 | ||||||||||||
| 1/6/2006 | — | — | — | — | — | — | — | 100,000 | 22.94 | 1,432,090 | ||||||||||||
| — | 105,450 | 185,000 | 392,200 | — | — | — | — | — | — | — | ||||||||||||
| Laura Sue Stark |
1/6/2006 | — | — | — | — | — | — | — | 70,000 | 22.94 | 1,002,463 | |||||||||||
| — | 111,150 | 195,000 | 413,400 | — | — | — | — | — | — | — | ||||||||||||
| Kevin S. Donnelly |
1/6/2006 | — | — | — | — | — | — | — | 70,000 | 22.94 | 1,002,463 | |||||||||||
| — | 102,600 | 180,000 | 381,600 | — | — | — | — | — | — | — | ||||||||||||
| Samir A. Patel |
1/6/2006 | — | — | — | — | — | — | — | 70,000 | 22.94 | 1,002,463 | |||||||||||
| — | 102,600 | 180,000 | 381,600 | — | — | — | — | — | — | — | ||||||||||||
| (1) |
Amounts shown are estimated payouts for fiscal year 2006 to the named executive officers based on the 2006 bonus targets under the plan discussed under “Compensation Discussion and Analysis—2006 Executive Compensation Components—Performance-based Incentive Plan.” Actual bonuses received by these named executive officers for fiscal 2006 are reported in the Summary Compensation for Fiscal Year 2006 table under the column entitled “Non-Equity Incentive Plan Compensation.” |
| (2) | Stock awards consist of restricted stock granted in connection with the hiring of Mr. Rishi and RSUs granted as part of a special litigation incentive for Mr. Danforth. |
| (3) | All options granted to the named executive officers in fiscal 2006 vest 10% after six months and the remaining options vest monthly in 1/60 increments. |
| (4) | The value of a stock award or option award is based on the fair market value as of the grant date of such award determined pursuant to SFAS 123(R). Stock awards consist of restricted stock and RSU awards. The exercise price for all options granted to the named executive officers is 100% of the fair market value of the shares on the grant |
Page 79 of 170
| date. The option exercise price has not been deducted from the amounts indicated above. Regardless of the value placed on a stock option on the grant date, the actual value of the option will depend on the market value of our Common Stock at such date in the future when the option is exercised. The proceeds to be paid to the individual following this exercise do not include the option exercise price. |
| (5) | In addition, as described under “Compensation Discussion and Analysis—2006 Executive Compensation Components—Employment and Retention Agreements,” Mr. Danforth was entitled to certain additional bonuses if and when certain triggering events relating to outcomes in certain litigation matters occur during the term of his agreement. On December 31, 2006, we amended two Stock Option Agreements, each dated October 8, 2001, with Mr. Danforth to increase the exercise price per share from $8.00 to $11.72 for outstanding, unexercised stock options to purchase 59,445 shares of our Common Stock held by Mr. Danforth. The value of Mr. Danforth’s stock option awards includes the deemed exchanged value of these options. |
Page 80 of 170
Outstanding Equity Awards at Fiscal Year-End
The following table shows all outstanding equity awards held by the named executive officers as of December 31, 2006. Unvested stock awards reported in the Grants of Plan-Based Awards Table on the previous page are also included in the table below.
Outstanding Equity Awards
at Fiscal 2006 Year-End
| Option Awards | Stock Awards | ||||||||||||||||||||||
| # of Securities (#) |
# of Securities (#) |
Equity Plan Awards: # Options |
Option Exercise |
Option Expiration |
# of Shares or Units of Stock That Have Not Vested |
Mkt Value of Shares or Units of Stock That Have Not Vested |
Equity Awards: # of or Other Rights That Have Not |
Equity Incentive Shares,
Units Other Rights That Have | |||||||||||||||
| Name |
Exercisable | Unexercisable | (#) | ($) | Date | (#) | ($)(6) | (#) | ($) | ||||||||||||||
| Harold E. Hughes | 119,791 | 130,209 | (1) | — | $ | 21.5100 | 1/10/2015 | — | — | — | — | ||||||||||||
| 35,000 | 5,000 | (2) | — | $ | 17.5100 | 6/2/2013 | — | — | — | — | |||||||||||||
| 5,376 | 9,167 | (3) | — | $ | 16.0700 | 10/1/2014 | — | — | — | — | |||||||||||||
| 49,500 | 220,500 | (4) | — | $ | 22.9400 | 1/6/2016 | — | — | — | — | |||||||||||||
| Satish Rishi |
29,333 | 190,667 | (5) | — | $ | 40.8000 | 4/11/2016 | 35,000 | (23) | $ | 662,550 | — | — | ||||||||||
| Robert K. Eulau | — | — | — | — | — | — | — | — | — | ||||||||||||||
| John D. Danforth | 30,555 | (21) | 0 | — | $ | 8.0000 | 10/8/2011 | 20,916 | (24) | $ | 395,940 | — | — | ||||||||||
| 34,445 | (22) | 0 | — | $ | 11.7200 | 10/8/2011 | 17,854 | (25) | $ | 337,976 | — | — | |||||||||||
| 25,000 | (22) | 0 | — | $ | 11.7200 | 10/8/2011 | — | — | — | — | |||||||||||||
| 75,000 | 75,000 | (7) | — | $ | 7.5000 | 4/10/2012 | — | — | — | — | |||||||||||||
| 68,000 | 12,000 | (8) | — | $ | 8.6370 | 11/21/2012 | — | — | — | — | |||||||||||||
| 0 | 70,000 | (9) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 100,000 | 0 | (10) | — | $ | 31.1600 | 1/30/2014 | — | — | — | — | |||||||||||||
| 0 | 20,000 | (11) | — | $ | 31.1600 | 1/30/2014 | — | — | — | — | |||||||||||||
| 0 | 40,000 | (12) | — | $ | 31.1600 | 1/30/2014 | — | — | — | — | |||||||||||||
| 0 | 70,000 | (13) | — | $ | 24.0400 | 12/3/2014 | — | — | — | — | |||||||||||||
| 18,333 | 81,667 | (4) | — | $ | 22.9400 | 1/6/2016 | — | — | — | — | |||||||||||||
| Laura Sue Stark | 140,000 | 0 | (14) | — | $ | 15.6719 | 10/20/2009 | — | — | — | — | ||||||||||||
| 60,000 | 0 | (19) | — | $ | 54.6250 | 12/12/2010 | — | — | — | — | |||||||||||||
| 20,000 | 0 | (16) | — | $ | 4.8600 | 8/23/2011 | — | — | — | — | |||||||||||||
| 15,000 | 15,000 | (8) | — | $ | 8.6370 | 11/21/2012 | — | — | — | — | |||||||||||||
| 50,000 | 0 | (18) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 65,000 | (20) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 85,000 | (9) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 85,000 | (13) | — | $ | 24.0400 | 12/3/2014 | — | — | — | — | |||||||||||||
| 12,833 | 57,167 | (4) | — | $ | 22.9400 | 1/6/2016 | — | — | — | — | |||||||||||||
| 0 | 80,000 | (15) | — | $ | 2.5000 | 12/1/2009 | — | — | — | — | |||||||||||||
| Kevin S. Donnelly | 9,628 | 0 | (17) | — | $ | 15.3125 | 2/18/2009 | — | — | — | — | ||||||||||||
| 50,000 | 0 | (18) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 60,000 | 0 | (19) | — | $ | 54.6250 | 12/12/2010 | — | — | — | — | |||||||||||||
| 60,000 | 0 | (16) | — | $ | 4.8600 | 8/23/2011 | — | — | — | — | |||||||||||||
| 0 | 65,000 | (20) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 68,372 | 0 | (17) | — | $ | 15.3125 | 2/18/2009 | — | — | — | — | |||||||||||||
| 12,833 | 57,167 | (4) | — | $ | 22.9400 | 1/6/2016 | — | — | — | — | |||||||||||||
| 60,000 | 15,000 | (8) | — | $ | 8.6370 | 11/21/2012 | — | — | — | — | |||||||||||||
| 0 | 75,000 | (13) | — | $ | 24.0400 | 12/3/2014 | — | — | — | — | |||||||||||||
| 0 | 80,000 | (15) | — | $ | 2.5000 | 12/1/2009 | — | — | — | — | |||||||||||||
| 0 | 85,000 | (9) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 160,000 | 0 | (14) | — | $ | 15.6719 | 10/20/2009 | — | — | — | — | |||||||||||||
| Samir A. Patel | 40,000 | 0 | (19) | — | $ | 54.6250 | 12/12/2010 | — | — | — | — | ||||||||||||
| 60,000 | 0 | (14) | — | $ | 15.6719 | 10/20/2009 | — | — | — | — | |||||||||||||
| 0 | 60,000 | (15) | — | $ | 2.5000 | 12/1/2009 | — | — | — | — | |||||||||||||
| 47,223 | 0 | (16) | — | $ | 4.8600 | 8/23/2011 | — | — | — | — | |||||||||||||
| 51,000 | 9,000 | (8) | — | $ | 8.6370 | 11/21/2012 | — | — | — | — | |||||||||||||
| 30,000 | 0 | (18) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 40,000 | (20) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 50,000 | (9) | — | $ | 25.1600 | 11/25/2013 | — | — | — | — | |||||||||||||
| 0 | 80,000 | (13) | — | $ | 24.0400 | 12/3/2014 | — | — | — | — | |||||||||||||
| 12,833 | 57,167 | (4) | — | $ | 22.9400 | 1/6/2016 | — | — | — | — | |||||||||||||
Page 81 of 170
| (1) | The option was granted on January 10, 2005. Options representing 1/48th of the shares vest monthly during the four year period following the grant date. |
| (2) | The option was granted on June 2, 2003. Options representing 5,000 shares vested on December 2, 2003 and the remaining options vested in equal monthly installments until it was fully vested on June 2, 2007. |
| (3) | The option was granted on October 1, 2004. Options representing 1/48th of the shares vest per month over the four year period following the grant date. |
| (4) | The option was granted on January 6, 2006. Options representing 10% of the shares vested six months from the grant date and the remaining shares vest in equal monthly installments until it is fully vested on January 6, 2011. |
| (5) | The option was granted on April 11, 2006. Options representing 10% of the shares vested six months from the grant date and the remaining shares vest in equal monthly installments until it is fully vested on April 11, 2011. |
| (6) | The market value is calculated using the closing price of our Common Stock of $18.93 on December 29, 2006 (the last trading day of 2006), as reported on the Nasdaq Global Select Market, multiplied by the unvested stock amount. |
| (7) |
The option was granted on April 10, 2002. Options representing 1/24 th of the total grant began vesting in monthly installments on January 1, 2006. |
| (8) |
The option was granted on November 21, 2002. Options representing 1/60 th of the total grant began vesting in monthly installments on September 30, 2002. |
| (9) |
The option was granted on November 25, 2003. Options representing 1/12 th of the total grant will begin vesting in monthly installments on January 1, 2008. |
| (10) |
The option was granted on January 30, 2004. Options representing 1/24 th of the total grant vested in monthly installments over 24 months beginning on January 1, 2004. The option is now fully vested. |
| (11) |
The option was granted on January 30, 2004. Options representing 1/12 th of the total grant began vesting in monthly installments on January 1, 2007. |
| (12) |
The option was granted on January 30, 2004. Options representing 1/12 th of the total grant will begin vesting in monthly installments on January 1, 2008. |
| (13) |
The option was granted on December 3, 2004. Options representing 1/12 th of the total grant will begin vesting in monthly installments on January 1, 2009. |
| (14) |
The option was granted on October 20, 1999. Options representing 1/24th of the total grant vested in monthly installments beginning January 1, 2003. The option is now fully vested. |
| (15) | The option was granted on December 1, 1999. The option is no longer eligible to vest due to vesting milestones that were never achieved. |
| (16) | The option was granted on August 23, 2001. Options representing 50% of the total grant vested monthly over two years beginning September 30, 2001. The remaining 50% of the total grant vested monthly over three years beginning September 30, 2003. The option is now fully vested. |
| (17) |
The option was granted on February 18, 1999. Options representing 1/48th of the total grant vested in monthly installments beginning February 18, 1999. The option is now fully vested. |
| (18) | The option was granted on November 25, 2003. Options representing 1/24th of the total grant vested in monthly installments beginning on January 1, 2005. The option is now fully vested. |
| (19) |
The option was granted on December 12, 2000. Options representing 1/12th of the total grant vested in monthly installments beginning on January 1, 2005. The option is now fully vested. |
| (20) |
The option was granted on November 25, 2003. Options representing 1/12th of the total grant began vesting on January 1, 2007 in monthly installments. |
Page 82 of 170
| (21) | The option was granted on October 8, 2001. Due to the mispricing of this option grant, this grant was split into two grants. One of the two grants has already been fully exercised. Options representing 10% of the total grant vested six months from the grant date and the remaining shares vested in monthly installments. The options are now fully vested. |
| (22) | The option was granted on October 8, 2001. Due to the mispricing of this option grant, this grant was split into two grants. Options representing 10% of the total grant vested six months from the grant date and the remaining shares vested in monthly installments. The options are now fully vested. |
| (23) | The restricted stock award was granted on April 11, 2006. A portion of the restricted stock award representing 5,000 shares vested on April 24, 2007 and restricted stock representing 10,000 shares will vest on the first available trading day under our insider trading policy in April 2008, 2009 and 2010. |
| (24) | The RSUs were granted on February 1, 2006. A portion of the RSUs representing 5,229 shares vested on January 22, 2007 and April 23, 2007. The remaining RSUs representing 5,229 shares will vest on July 23, 2007 and October 22, 2007. |
| (25) | The restricted stock units were granted on May 2, 2006. A portion of the restricted stock units representing 4,463 shares vested on January 22, 2007 and April 23, 2007. The remaining restricted stock units representing 4,464 shares will vest on July 23, 2007 and October 22, 2007. |
Each of the options and other equity awards reflected on the table above were issued under the 1997 Plan, the 1999 Plan or the 2006 Plan, which are plans that were or are available to all of our employees.
In the case of the 1997 Plan and the 1999 Plan, if a “merger” of the Company occurs, as defined in the relevant plan, each outstanding option or equity award will be assumed or an equivalent option or right substituted by the successor company. Following such assumption or substitution, if the participant’s status as a service provider is terminated by the successor corporation as a result of an “involuntary termination” other than for “cause,” each as defined in the relevant plan, within twelve months following the merger, then the participant will fully vest and have the right to exercise all of his or her options and will convert any other equity awards into shares of Common Stock. In the event that the successor company refuses to assume or substitute for the equity award the participant will fully vest in and have the right to exercise all of his or her options or stock appreciation rights, including shares as to which such awards would not otherwise be vested or exercisable, all restrictions on restricted stock will lapse, and, with respect to restricted stock units, performance shares and performance units, all performance goals or other vesting criteria will be deemed achieved at target levels and all other terms and conditions met immediately prior to the merger. In addition, if an option or stock appreciation right becomes fully vested and exercisable in lieu of assumption or substitution in the event of a merger, the administrator of the relevant plan will notify the participant that the option or stock appreciation right will be fully vested and exercisable for 15 days from such notice, and the option or stock appreciation right will terminate upon the expiration of such 15-day period.
In the case of the 2006 Plan, in the event of a “change of control” of the Company, as defined in the plan, each outstanding option or equity award will be assumed or an equivalent option or right substituted by the successor company. In the event that the successor company refuses to assume or substitute for the option or equity award, the participant will fully vest in and have the right to exercise all of his or her options or stock appreciation rights, including shares as to which such awards would not otherwise be vested or exercisable, all restrictions on restricted stock will lapse, and, with respect to restricted stock units, performance shares and performance units, all performance goals or other vesting criteria will be deemed achieved at target levels and all other terms and conditions met. In addition, if an option or stock appreciation right becomes fully vested and exercisable in lieu of assumption or substitution in the event of a change of control, the administrator of the 2006 Plan will notify the participant that the option or stock appreciation right will be fully vested and exercisable for a period of time determined by the administrator, and the option or stock appreciation right will terminate upon the expiration of such period.
Page 83 of 170
Option Exercises and Stock Vested
The following table shows all stock options exercised and value realized upon exercise, and all stock awards vested and value realized upon vesting, by the named executive officers during fiscal year 2006.
Option Exercises and Stock Vested Table
For Fiscal Year 2006
| Option Awards | Stock Awards | ||||||||
| Name |
Number of (#) |
Value Realized on Exercise(1) ($) |
Number of Shares Acquired on Vesting (#) |
Value Realized on Vesting(2) ($) | |||||
| Harold E. Hughes |
5,457 | 60,627 | — | — | |||||
| Satish Rishi |
— | — | 5,000 | 83,795 | |||||
| Robert K. Eulau |
463,846 | 10,343,583 | — | — | |||||
| John D. Danforth |
170,000 | 4,736,610 | 9,692 | (3) | 144,120 | ||||
| — | — | 9,692 | (4) | 162,438 | |||||
| — | — | 5,229 | 232,691 | ||||||
| Laura Sue Stark |
210,265 | 5,233,735 | — | — | |||||
| Kevin S. Donnelly |
154,000 | 3,982,973 | — | — | |||||
| Samir A. Patel |
148,431 | 3,235,394 | — | — | |||||
| (1) |
The value realized equals the difference between the option exercise price and the sale price on the date of exercise, multiplied by the number of shares of Common Stock for which the option was exercised. |
| (2) | The value realized equals the market value of our Common Stock on the vesting date, multiplied by the number of shares that vested. |
| (3) |
Of this amount, 140 shares of Common Stock were withheld by us to cover tax withholding obligations. |
| (4) |
Of this amount, 140 shares of Common Stock were withheld by us to cover tax withholding obligations. |
Potential Payments Upon Termination or Change-in-Control
Mr. Danforth has entered into an employment agreement with the Company which provides for payment upon certain termination events and is described in detail under “Compensation Discussion and Analysis—2006 Executive Compensation Components—Employment and Retention Agreements” above.
Page 84 of 170
Compensation of Directors
The following table shows compensation information for our current and former non-employee directors for 2006.
Director Compensation
For Fiscal Year 2006
| Fees Earned or Paid in Cash |
Stock Awards(1) |
Option Awards(2) |
Non-Equity Incentive Plan |
Change in Pension Non-Qualified Deferred |
All Other Compensation |
Total | ||||||||||
| Name |
($) | ($) | ($) | ($) | ($) | ($) | ($) | |||||||||
| J. Thomas Bentley |
30,000 | — | 142,519 | (3) | — | — | 648 | 173,167 | ||||||||
| Sunlin Chou |
19,097 | — | 199,190 | (4) | — | — | 648 | 218,935 | ||||||||
| Bruce Dunlevie |
25,000 | — | 190,043 | (5) | — | — | 648 | 215,691 | ||||||||
| P. Michael Farmwald |
25,000 | — | 177,123 | (6) | — | — | 648 | 202,771 | ||||||||
| Penelope A. Herscher |
11,753 | — | 73,127 | (7) | — | — | 648 | 85,528 | ||||||||
| Kevin Kennedy |
25,000 | — | 268,749 | (8) | — | — | 648 | 294,397 | ||||||||
| David J. Mooring (9) |
— | — | 680,638 | (10) | — | — | — | 680,638 | ||||||||
| Mark Pinto |
— | — | — | (11) | — | — | — | — | ||||||||
| David Shrigley |
5,571 | — | 30,333 | (12) | — | — | 648 | 36,552 | ||||||||
| Abraham Sofaer |
22,500 | — | 103,621 | (13) | — | — | 8,123 | (14) | 134,244 | |||||||
| Geoff Tate (15) |
15,208 | — | 159,997 | (16) | — | — | 2,998 | 178,203 |
| (1) | None of the directors held any restricted stock units or restricted stock awards at the end of 2006. |
| (2) | Amounts shown do not reflect compensation actually received by the non-employee directors. Instead, the amounts shown are the dollar amounts, disregarding the estimate of forfeitures related to service-based vesting conditions, recognized for financial statement reporting purposes by Rambus in fiscal year 2006 for stock option awards in accordance with the provisions of SFAS 123(R). Stock compensation expense calculations for financial statement purposes spread the grant date cost of those awards over the vesting period. Therefore, amounts in this column include the expense for awards granted in fiscal year 2006 and previous years. The assumptions used to calculate the value of stock option awards are set forth under Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. |
| (3) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on March 11, 2005 at an exercise price of $14.00 per share, with a fair value as of the grant date of $9.20 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 3, 2005 at an exercise price of $12.11 per share, with a fair value as of the grant date of $7.09 disregarding forfeiture assumptions and (c) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Bentley had options to purchase an aggregate of 72,917 shares outstanding as of December 31, 2006. |
| (4) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on March 27, 2006 at an exercise price of $38.59 per share, with a fair value as of the grant date of $24.09 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Chou had options to purchase an aggregate of 60,000 shares outstanding as of December 31, 2006. |
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| (5) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 20,000 shares of Common Stock made on October 1, 2002 at an exercise price of $4.72 per share, with a fair value as of the grant date of $3.44 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 1, 2003 at an exercise price of $17.04 per share, with a fair value as of the grant date of $13.04 disregarding forfeiture assumptions and (c) an option award of 20,000 shares of Common Stock made on October 1, 2004 at an exercise price of $16.07 per share, with a fair value as of the grant date of $12.28 disregarding forfeiture assumptions and (d) an option award of 20,000 shares of Common Stock made on October 3, 2005 at an exercise price of $12.11 per share, with a fair value as of the grant date of $7.09 disregarding forfeiture assumptions and (e) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Dunlevie had options to purchase an aggregate of 340,000 shares outstanding as of December 31, 2006. |
| (6) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 20,000 shares of Common Stock made on October 1, 2003 at an exercise price of $17.04 per share, with a fair value as of the grant date of $13.04 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 1, 2004 at an exercise price of $16.07 per share, with a fair value as of the grant date of $12.28 disregarding forfeiture assumptions and (c) an option award of 20,000 shares of Common Stock made on October 3, 2005 at an exercise price of $12.11 per share, with a fair value as of the grant date of $7.09 disregarding forfeiture assumptions and (d) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Farmwald had options to purchase an aggregate of 80,000 shares outstanding as of December 31, 2006. |
| (7) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on July 12, 2006 at an exercise price of $22.36 per share, with a fair value as of the grant date of $15.53 disregarding forfeiture assumptions. Ms. Herscher had options to purchase an aggregate of 40,000 shares outstanding as of December 31, 2006. |
| (8) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on March 31, 2003 at an exercise price of $13.21 per share, with a fair value as of the grant date of $9.17 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 1, 2003 at an exercise price of $17.04 per share, with a fair value as of the grant date of $13.04 disregarding forfeiture assumptions and (c) an option award of 20,000 shares of Common Stock made on October 1, 2004 at an exercise price of $16.07 per share, with a fair value as of the grant date of $12.28 disregarding forfeiture assumptions and (d) an option award of 20,000 shares of Common Stock made on October 3, 2005 at an exercise price of $12.11 per share, with a fair value as of the grant date of $7.09 disregarding forfeiture assumptions and (e) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Kennedy had options to purchase an aggregate of 120,000 shares outstanding as of December 31, 2006. |
| (9) | Mr. Mooring’s employment with us ended in February 2006, but he remained as a director until May 10, 2006. Mr. Mooring did not receive any compensation as a director in fiscal year 2006. Except as specifically disclosed, the amount reflected above do not include any amounts that Mr. Mooring received as an employee. |
| (10) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 600,000 shares of Common Stock made on August 23, 2001 at an exercise price of $4.86 per share, with a fair value as of the grant date of $10.52 disregarding forfeiture assumptions and (b) an option award of 400,000 shares of Common Stock made on November 21, 2002 at an exercise price of $8.64 per share, with a fair value as of the grant date of $6.38 disregarding forfeiture assumptions and (c) an option award of 200,000 shares of Common Stock made on November 25, 2003 at an exercise price of $25.16 per share, with a fair value as of the grant date of $24.76 disregarding forfeiture assumptions and (d) an option award of 85,000 shares of Common Stock made on December 3, 2004 at an exercise price of $24.04 per share, with a fair value as of the grant date of $19.43 disregarding forfeiture assumptions. The amount reflected as stock compensation expense recognized by us in 2006 is related to stock options granted to Mr. Mooring between 2001 and 2004 while he was an executive officer. When Mr. Mooring resigned from the board he forfeited all of his 680,001 unvested options to purchase Common Stock. |
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| (11) | Due to corporate conflicts, Mr. Pinto resigned from Rambus Board on March 17, 2006. Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on March 10, 2006 at an exercise price of $31.36 per share, with a fair value as of the grant date of $19.58. Upon resignation, all of Mr. Pinto’s stock options terminated. Mr. Pinto had no outstanding shares as of December 31, 2006. |
| (12) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on October 11, 2006 at an exercise price of $19.13 per share, with a fair value as of the grant date of $13.68 disregarding forfeiture assumptions. Mr. Shrigley had options to purchase an aggregate of 40,000 shares outstanding as of December 31, 2006. |
| (13) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 40,000 shares of Common Stock made on May 4, 2005 at an exercise price of $14.24 per share, with a fair value as of the grant date of $8.85 disregarding forfeiture assumptions and (b) an option award of 20,000 shares of Common Stock made on October 2, 2006 at an exercise price of $17.14 per share, with a fair value as of the grant date of $12.31 disregarding forfeiture assumptions. Mr. Sofaer had options to purchase an aggregate of 60,000 shares outstanding as of December 31, 2006. |
| (14) | All other compensation for Mr. Sofaer includes quarterly retainer paid in Common Stock with a value of $7,475. |
| (15) | Mr. Tate was an employee of Rambus until January 13, 2006, and he remained as a director and Chairman of the Board until August 13, 2006. Except as specifically disclosed, the amounts reflected above do not include any amounts that Mr. Tate received as an employee. |
| (16) | Reflects the compensation costs recognized by Rambus in 2006 associated with (a) an option award of 600,000 shares of Common Stock made on August 23, 2001 at an exercise price of $4.86 per share, with a fair value as of the grant date of $10.52 disregarding forfeiture assumptions and (b) an option award of 400,000 shares of Common Stock made on November 21, 2002 at an exercise price of $8.64 per share, with a fair value as of the grant date of $6.38 disregarding forfeiture assumptions and (c) an option award of 200,000 shares of Common Stock made on November 25, 2003 at an exercise price of $25.16 per share, with a fair value as of the grant date of $20.34 disregarding forfeiture assumptions and (d) an option award of 150,000 shares of Common Stock made on November 25, 2003 and an exercise price of $25.16 per share, with a fair value as of the grant date of $19.27 disregarding forfeiture assumptions and (e) an option award of 100,000 shares of Common Stock made on December 3, 2004 at an exercise price of $24.04 per share, with a fair value as of the grant date of $19.43 disregarding forfeiture assumptions. The amount reflected as stock compensation expense recognized by us in 2006 is related to stock options granted to Mr. Tate between 2001 and 2004 while he was an executive officer. Effective January 13, 2006, at his request, Mr. Tate entered into an agreement with us pursuant to which Mr. Tate agreed to cancel an aggregate of 665,000 unvested options to purchase Common Stock and 500,000 unvested Common Stock equivalents held by him. This action was taken by Mr. Tate unilaterally in connection with his wishing to conform his compensation going forward as a non-employee Board member to our then current policies with respect to Board and executive compensation. Mr. Tate resigned from the Board of Directors on August 13, 2006, and thus his remaining 2,736,800 options expired by their terms on November 13, 2006. |
Overview of Compensation and Procedures
We review the level of compensation of our independent directors on an annual basis. To determine the appropriate level of compensation for independent directors we have historically obtained data from a number of different sources including:
| • | publicly available data describing director compensation in Compensation Peer Group companies and |
| • | survey data collected by our human resources department. |
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As part of the ongoing strategy to modify the composition of our Board through the addition of independent directors, in 2006 we evaluated and recommended several changes to director cash compensation. Since 2005, we have added the following independent Directors; Thomas Bentley, Abraham Sofaer, Sunlin Chou, Penelope Herscher, and David Shrigley. We compensate non-employee members of the board through a mixture of cash and equity-based compensation. In 2006, each independent director received an annual retainer of $25,000 paid in quarterly installments for their services as a director. The Chairpersons of the Audit Committee and Legal Affairs Committee each received an annual retainer of $30,000 paid in quarterly installments. After reviewing market data against our Compensation Peer Group, multiple surveys and public sources, and considering the time commitment that frequent meetings required of our directors, the Compensation Committee recommended and the Board considered and approved a proposal to raise our cash compensation for non-employee independent directors. In 2007, we will pay each of our independent directors an annual retainer of $40,000, our Chairperson and the Audit Committee Chairperson will each receive an annual retainer of $65,000, our Compensation Committee and all other committee chairs will receive an annual retainer of $50,000. In addition, as a result of the effort and time expended by our independent directors on the investigation of historical stock option grants and related matters, in 2007, once we are current with our SEC filing obligations, we will pay each member of the Special Litigation Committee a one-time payment of $75,000 and each of our other independent directors serving on the Audit Committee and the Compensation Committee a one-time payment of $35,000.
Each independent director is granted an initial option to purchase 40,000 shares of Common Stock when he or she is first appointed a member of our Board of Directors. On the first trading day of October each year, each independent director receives an annual stock option grant to purchase 20,000 shares of our Common Stock at a price equal to the fair market value of our Common Stock on the date of grant, so long as that director have been serving on the Board for at least six months on such date. The expiration date of such options may not exceed ten years. The automatic option grants generally vest over a four-year period, with one-eighth of shares subject to the option vesting six months after the date of grant and the remaining shares vesting ratably each month thereafter, subject to the independent director continuing to provide services to us through each applicable vesting date. The automatic grants do not limit the ability of the administrator of the 2006 Plan to grant other discretionary awards to independent directors under the plan, and the administrator has the discretion to change the terms of the automatic grants prospectively.
Awards granted to the independent directors under the 2006 Plan are generally not transferable, and all rights with respect to an award granted to a participant generally will be available during a participant’s lifetime only to the participant.
Each of the options granted to our independent directors was issued under the 1997 Plan or the 2006 Plan, which are plans that are available to all of our employees. As described under Item 11, “Executive Compensation, Outstanding Equity Awards at Fiscal Year-End,” the 1997 Plan provides for certain acceleration upon a “merger” of the Company, as defined under the 1997 Plan, and the 2006 Plan provides for certain acceleration upon a “change of control” of the Company, as defined under the 2006 Plan. In addition, with respect to options and any other equity awards granted to non-employee directors that are assumed or substituted for upon a change of control under the 2006 Plan, if the non-employee director is terminated other than upon a voluntary resignation, the options and other equity awards granted to such non-employee director will fully vest and be exercisable with respect to 100% of the shares subject to such options and other equity awards.
Pursuant to stock ownership guidelines adopted by the Board, each independent director will be expected to accumulate and hold an equivalent value of our Common Stock of 2 times their annual total cash compensation and to achieve this within five years from January 1, 2007 or the date that the director joined the Board, whichever is later. Directors are expected to maintain this minimum amount of stock ownership throughout their tenure on the Board.
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Compensation Committee Interlocks and Insider Participation
During fiscal year 2006, no interlocking relationship existed between any member of our Compensation Committee and any member of any other company’s board of directors or compensation committee, nor has any such interlocking relationship existed in the past. With the exception of Dr. Farmwald while he was on the Compensation Committee, during fiscal year 2006, no member of the Compensation Committee was, or was formerly, an officer or an employee of us. As of October 2006, Dr. Farmwald was no longer a member of the Compensation Committee.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Equity Compensation Plan Information
The following table provides information as of December 31, 2006 with respect to the shares of our Common Stock that may be issued under our existing equity compensation plans.
| A | B | C | |||||
| Plan Category |
Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights |
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights |
Number of Securities (Excluding Securities | ||||
| Equity Compensation Plans Approved by Security Holders (1) |
13,236,039 | $ | 18.10 | 10,772,138 | |||
| Equity Compensation Plans Not Approved by Security Holders (2) |
5,585,463 | $ | 18.53 | — | |||
| Total |
18,821,502 | 10,772,138 | |||||
| (1) | Data reflects our 1990 Stock Plan (the “1990 Plan”), 1997 Stock Plan (the “1997 Plan”), 2006 Equity Incentive Plan (the “2006 Plan”), 1997 Employee Stock Purchase Plan (the “1997 Purchase Plan”) and 2006 Employee Stock Purchase Plan (the “2006 Purchase Plan”). |
Our 2006 Plan was approved by our stockholders at our 2006 annual meeting. Under the 2006 Plan as approved, a total of 8,400,000 shares of our Common Stock were reserved for issuance. The 2006 Purchase Plan was approved by our stockholders at our 2006 annual meeting. Under the 2006 Purchase Plan as approved, a total of 1,600,000 shares of our Common Stock were reserved for purchase. No offerings have been made under this plan.
Our 1990 Stock Plan was terminated in May 1997 with the adoption of the 1997 Stock Plan. Although no further awards may be made thereunder, the plan continues to govern outstanding awards granted under that plan.
As a result of the stockholder approval of our 2006 Plan, we terminated the 1997 Plan so that, as of the date of termination, no further awards have been or will be made thereunder, but the plan will continue to govern outstanding awards granted under that plan.
The 1997 Purchase Plan will expire at the conclusion of the last offering period on October 31, 2007, with no further offerings to purchase shares of our Common Stock under this plan occurring after expiration. The shares of
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Common Stock reflected in Column A include shares that would be issued in exchange for cash received from employees as of December 31, 2006. The majority of the shares of Common Stock remaining under the 1997 Purchase Plan are not expected to be issued as any remaining shares that are not sold in the October 31, 2007 purchase will not be available for sale pursuant to the expiration of the plan.
| (2) | Data reflects our 1999 Nonstatutory Stock Option Plan described below. |
1999 Nonstatutory Stock Option Plan
The 1999 Nonstatutory Stock Option Plan is our only equity compensation plan that was not approved by our stockholders. As a result of the stockholder approval of our 2006 Equity Incentive Plan, we terminated the 1999 Nonstatutory Stock Option Plan so that, as of the date of termination, no further awards have been or will be made thereunder, but the plan will continue to govern outstanding awards granted under that plan.
Security Ownership of Certain Beneficial Owners and Management
Under the proxy rules of the SEC, a person who directly or indirectly has or shares voting power or investment power with respect to a security is considered a beneficial owner of the security. Voting power is the power to vote or direct the voting of shares, and investment power is the power to dispose of or direct the disposition of shares. Shares as to which voting power or investment power may be acquired within 60 days are also considered as beneficially owned under the proxy rules.
The following table sets forth certain information as of May 31, 2007, regarding beneficial ownership of our Common Stock by: (i) each person who is known to us to own beneficially more than five percent (5%) of our Common Stock; (ii) each of our current directors; (iii) each of the named executive officers in the Summary Compensation Table of this annual report; and (iv) the total for our current directors and current executive officers as a group. The information on beneficial ownership in the table and the footnotes is based upon our records and the most recent Schedule 13D or 13G filed by each such person or entity and information supplied to us by such person or entity. For our named executive officers who are no longer employed by us, the information on beneficial ownership reflects the most recent records we have for such person as of their separation date. Unless otherwise indicated, each person has sole voting power and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. Shares subject to options which are exercisable within 60 days of May 31, 2007 are deemed to be outstanding and to be beneficially owned by the person holding such options for the purpose of computing the percentage ownership of such person, but are not deemed to be outstanding and to be beneficially owned for the purpose of computing the percentage ownership of any other person.
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| Name or Group of Beneficial Owners |
Number of Shares Beneficially Owned |
Options Exercisable in 60 Days |
Percentage of Shares Beneficially Owned (1) |
||||
| PRIMECAP Management Company (2) 225 South Lake Ave. #400 Pasadena, CA 91101 |
11,016,227 | — | 10.61 | % | |||
| Vanguard Horizon Funds – Vanguard Capital (3) Opportunity Fund 100 Vanguard Blvd. Malvern, PA 19355 |
5,205,000 | — | 5.01 | % | |||
| FMR Corp. and affiliates (4) 82 Devonshire Street Boston, MA 02109 |
5,140,000 | — | 4.95 | % | |||
| Harold Hughes, Director, Chief Executive Officer and President |
365,543 | 285,543 | * | ||||
| Satish Rishi, Senior Vice President, Finance and (5) Chief Financial Officer |
95,000 | 55,000 | * | ||||
| Robert K. Eulau, Senior Vice President and (6) Chief Financial Officer |
71,906 | — | * | ||||
| John Danforth, Senior Legal Advisor (7) |
525,708 | 418,500 | * | ||||
| Laura Sue Stark, Senior Vice President, Platform Solutions |
408,916 | 348,500 | * | ||||
| Kevin S. Donnelly, Senior Vice President, Technology Development |
559,542 | 531,500 | * | ||||
| Samir A. Patel, Former Senior Vice President, (8) Product Development and Production |
92,006 | — | * | ||||
| J. Thomas Bentley, Director |
35,833 | 28,750 | * | ||||
| Sunlin Chou, Director (9) |
17,083 | 17,083 | * | ||||
| Bruce Dunlevie, Director (10) |
670,492 | 305,000 | * | ||||
| P. Michael Farmwald, Director |
2,823,236 | 45,000 | 2.72 | % | |||
| Penelope A. Herscher, Director (11) |
10,000 | 10,000 | * | ||||
| Mark Horowitz, Director |
1,433,476 | 58,500 | 1.38 | % | |||
| Kevin Kennedy, Chairman of the Board |
85,000 | 85,000 | * | ||||
| David Shrigley, Director (12) |
7,500 | 7,500 | * | ||||
| Abraham D. Sofaer, Director |
27,047 | 25,416 | * | ||||
| All current directors and executive officers as a group (17 persons) |
6,808,230 | 2,071,958 | 6.56 | % |
| * | (Less than 1%) |
| (1) | Percentage of shares beneficially owned is based on 103,820,383 shares outstanding as of May 31, 2007. |
| (2) | As reported on Schedule 13G/A filed on March 8, 2007. |
| (3) | As reported on Schedule 13G/A filed on February 14, 2007. |
| (4) | As reported on Schedule 13G filed on February 14, 2007. The Schedule 13G was filed jointly by FMR Corp. and Edward C. Johnson 3d with respect to a subsidiary and fund of FMR Corp. that own the shares. |
| (5) | Mr. Rishi was appointed to his position effective April 11, 2006. |
| (6) | Mr. Eulau resigned from his position effective March 2, 2006. |
| (7) | Effective July 27, 2006, Mr. Danforth left the position of Senior Vice President, General Counsel and assumed the non-executive officer position of senior legal advisor. Mr. Danforth’s Number of Shares Beneficially Owned includes 29,076 shares of Common Stock that will be issued to Mr. Danforth upon conversion of outstanding RSUs once we are current with our SEC filings. |
| (8) | Mr. Patel resigned from his position effective January 2, 2007. |
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| (9) | Dr. Chou was appointed to our Board of Directors on March 27, 2006. |
| (10) | Includes 16,000 shares held by Mr. Dunlevie as a trustee for his children and 129,332 shares held jointly with his spouse, Elizabeth W. Dunlevie. |
| (11) | Ms. Herscher was appointed to our Board of Directors on July 14, 2006. |
| (12) | Mr. Shrigley was appointed to our B |