UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 10-K

 

 

Commission File Number: 0-20784

 

TRIDENT MICROSYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(408) 962-5000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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 o     No þ

 

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 o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

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 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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

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

 

As of June 30, 2010, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of shares of registrant’s Common Stock held by non-affiliates of registrant was approximately $101,252,215 (based on the closing sale price of the registrant’s common stock on that date). Shares of registrant’s common stock held by the registrant’s executive officers and directors and by each entity that owns 5% or more of registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

At February 28, 2011, the number of shares of the Registrant’s common stock outstanding was 178,192,826.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Definitive Proxy Statement for the Company’s 2011 Annual Meeting of Stockholders — Part III of this Form 10-K.

 

 

TRIDENT MICROSYSTEMS, INC.

 

TABLE OF CONTENTS

 

FORWARD-LOOKING STATEMENTS

 

This Report on Form 10-K contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 which provides a “safe harbor” for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to the management of Trident Microsystems, Inc. (“we,” “our,” “Trident” or “the Company”). The outcome of the events described in these forward-looking statements is subject to risks and uncertainties. Actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements due to factors including those listed under “Risk Factors,” and from time to time in our other filings with the Securities and Exchange Commission, or SEC. For this purpose, statements concerning industry or market segment outlook; market acceptance of or transition to new products; revenues, earnings growth, other financial results and any statements using the terms “believe,” “expect,” “expectation,” “anticipate,” “can,” “should,” “would,” “could,” “estimate,” “appear,” “based on,” “may,” “intended,” “potential,” “are emerging” and “possible” or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those projected or management’s current expectations. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise, except as required by law.

 

 

Change in Fiscal Year End

 

As previously announced, in 2009, we changed our fiscal year end to December 31 from June 30. We made this change to better align our financial reporting period, as well as our annual planning and budgeting process, with our business cycle. The change became effective at the end of the quarter ended December 31, 2009. All references to “years”, unless otherwise noted, refer to the 12-month fiscal year, which prior to July 1, 2009, ended on June 30, and beginning with December 31, 2009, ends on December 31, of each year.

 

Overview

 

Trident Microsystems, Inc. (including our subsidiaries, referred to collectively in this Report as “Trident,” “we,” “our” and “us”) is a provider of high-performance multimedia semiconductor solutions for the digital home entertainment market. We design, develop and market integrated circuits, or ICs, and related software for processing, displaying and transmitting high quality audio, graphics and images in home consumer electronics applications such as digital TVs (DTV), PC and analog TVs, and set-top boxes. Our product line includes system-on-a-chip, or SoC, semiconductors that provide completely integrated solutions for processing and optimizing video, audio and computer graphic signals to produce high-quality and realistic images and sound. Our products also include frame rate converter, or FRC, demodulator or DRX and audio decoder products, interface devices and media processors. Trident’s customers include many of the world’s leading original equipment manufacturers, or OEMs, of consumer electronics, computer display and set-top box products. Our goal is to become a leading provider for the “connected home,” with innovative semiconductor solutions that make it possible for consumers to access their entertainment and content (music, pictures, internet, data) anywhere and at anytime throughout the home.

 

Trident was incorporated in California in 1987 and reincorporated in Delaware in 1992. Our principal executive offices are located at 1170 Kifer Road, Sunnyvale, California 94086-5303, and our telephone number at that location is (408)962-5000. Our internet address is www.tridentmicro.com. The inclusion of our website address in this Report does not include or incorporate by reference into this Report any information on our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other SEC filings are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC.

We operate in one reportable segment: digital media solutions. During the year ended December 31, 2010, six months ended December 31, 2009, and years ended June 30, 2009 and 2008, the digital media solutions segment accounted for all of our revenues, which totaled $557.2 million, $63.0 million, $75.8 million and $257.9 million, respectively.

 

Business Combinations

 

On May 14, 2009, we completed our acquisition of selected assets of the frame rate converter, or FRC, demodulator, or DRX, and audio decoder product lines from Micronas Semiconductor Holding AG, or Micronas, a Swiss corporation. In connection with the acquisition, we issued 7.0 million shares of our common stock and warrants to acquire up to 3.0 million additional shares of our common stock, with a combined fair value of approximately $12.1 million, and incurred approximately $5.2 million of acquisition-related transaction costs and liabilities, for a total purchase price of approximately $17.3 million. In connection with this acquisition, we established three new subsidiaries in Europe, Trident Microsystems (Europe) GmbH, or TMEU, Trident Microsystems Nederland B.V., or TMNM, and Trident Microsystems Holding B.V., or TMH, to primarily provide sales liaison, marketing and engineering services in Europe. TMEU is located in Freiburg, Germany and TMNM and TMH are located in Nijmegen, The Netherlands.

 

On February 8, 2010, we completed the acquisition of the television systems and set-top box business lines from NXP B.V., a Dutch besloten vennootschap, or NXP. As a result of the acquisition, we issued 104,204,348 shares of Trident common stock to NXP, or Shares, equal to 60% of the Company’s total outstanding shares of common stock, after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines from NXP and cash proceeds in the amount of $44 million. In accordance with U.S. generally accepted accounting principles, the closing price on February 8, 2010 was used to value our common stock. In addition, we issued to NXP four shares of a newly created Series B Preferred Stock, or the Preferred Shares. The purchase price and fair value of the consideration transferred by us was $140.8 million. In connection with this acquisition, we acquired or established additional subsidiaries in Asia, India and Europe and established a branch office in France of an existing European entity. For details of the acquisition, see Note 13, “Business Combinations,” of Notes to Consolidated Financial Statements.

 

Industry Environment and Our Business Strategy

 

Digital Television:

 

A digital television, or DTV, receives digital content and processes it to display a picture which has far greater resolution and sharper, more clearly defined images than a television based on older analog technology. Standard definition televisions generally contain 480 lines with 720 pixels per line. High definition television, or (HDTV), sets contain 1280 to 1920 pixels per line and up to 1080 lines. The aspect ratio of standard definition sets is 4:3, compared to 16:9 and extending to 21:9 for HDTV. The lines may be displayed using different techniques, often referred to as interlacing or alternatively progressive scan.

 

We have been investing in the DTV market for several years. During that time, the DTV market has continued to grow. We believe that this industry remains in a growth phase. The DTV market has continued to be driven by television picture quality, realism and connectivity in the home although growth in any period or in any particular market segments may be affected by numerous factors, including economic conditions. We believe that consumers not only want a more visually realistic television picture display, but also the ability to integrate their DTV, Internet and entertainment systems into one connected device that works seamlessly throughout the home.

 

To date, we continue to invest in developing strong relationships with top tier OEMs in the TV area such as Samsung, LG, Sony, Sharp, Philips, Vizio and others. The TV original design manufacturers, or ODM, business has become an integrated, important part of the TV OEM business because many TV OEMs use ODMs in Taiwan and China. Accordingly, we believe that it is important to have strong relationships among customers as design and development resources. We have also been investing in integrating key technologies and intellectual property, or IP, into a single system on a chip, or SoC. We believe that the combination of critical DTV technologies and IP, our unique know-how in enhancing digital image quality, and our production experience with top-tier TV manufacturers provides a strategic advantage for Trident in the DTV market.

Notably, we have developed products that include motion estimation and motion compensation technology, or MEMC, which helps to eliminate motion judder, which is most visible when a camera pans across a wide area. In addition, we have continued to focus on enhancing our highly integrated solution that adds Moving Picture Experts Group or MPEG, decoding to image processing in the form of our high definition digital television, or “HiDTV”^®, product lines. We have focused on increasing our capabilities in picture quality by implementing use of halo-free algorithms in our MEMC technology and products and developing internet software called TWIS (Trident Widget Internet Solution) to enable connected TV. TWIS allows a cost-effective Internet TV solution for OEMs and ODMs.

 

Our acquisition of the FRC, DRX and audio decoder product lines from Micronas not only provided us with discrete products and an additional revenue stream, but it also gave us critical intellectual property necessary to further improve Trident’s SoC and discrete product offerings. The acquisition also allowed us to improve the quality of our legacy audio intellectual property, as well as providing new audio products. The DRX product line acquired from Micronas includes DVB-T, ATSC and DTMB. Together with our regionalized software stacks, these products enable customers to implement a worldwide TV solution with a short development cycle.

 

Our acquisition of the televisions systems and set-top box business lines from NXP has also provided us with an additional revenue stream and critical intellectual property necessary to further improve Trident’s product offerings. See Note 13, “Business Combinations,” of Notes to Consolidated Financial Statements.

 

Set-top Box:

 

The capability to receive and process DTV signals can be contained in a set-top box, which then drives a television that is capable of displaying digital content. Digital content is broadcasted via satellite, cable networks or over the air (terrestrial broadcast) in multiple regions throughout the world.

 

Today’s set-top box market is characterized by advanced video services that drive new capabilities such as 3DTV, 3D graphics user interfaces, personalized multi-screen services, rich navigation and improved multimedia and Internet TV experiences. Service providers are competing to deliver these solutions at the highest quality level, the lowest cost and with the highest security protection in order to win new and retain existing subscribers for pay-TV services today. At the same time, this market is also experiencing a rapid transition towards a connected home where semiconductor solutions are making it possible for consumers to access their entertainment and content anywhere and at any time throughout the home.

 

Through our acquisition of NXP’s television and set-top box lines, we are actively participating in this market. Our set-top box products include SoCs and discrete components for worldwide satellite, terrestrial, cable and IPTV networks. We have in our line of set-top box products, a fully integrated 45nm set-top box SoC platform, providing an optimized system that reduces the manufacturer bill-of-materials costs and power consumption, enabling an improved home entertainment experience. Complete reference designs that help manufacturers reduce cost and speed time-to-market are available, and can be bundled with a range of operating systems, middleware, drivers and development tools.

 

By integrating NXP’s set-top box and digital television business lines with our legacy products, we have enhanced our ability to deliver the size and economies of scale necessary to be successful in the digital home entertainment market, with the broad product portfolio, IP expertise and operational infrastructure to support growth. Both the digital TV and set-top box markets share a significant amount of intellectual property. Through this acquisition, we believe that we can further accelerate innovation by leveraging an expanded IP portfolio, SoC design expertise, competitive cost structure and deep relationships throughout the TV and set-top box OEM customer base and ecosystem.

 

Markets and Applications

 

In the year ended December 31, 2010, six months ended December 31, 2009 and years ended June 30, 2009 and 2008, we principally focused our efforts on continuing development of leading edge video, audio and demodulator processing capabilities, which are marketed as discrete components, and the design, development and marketing of our SoC products, which integrate our IP as well as licensed IP from other providers. Our digital media solutions products accounted for all of our total revenues for the year ended December 31, 2010, six months

ended December 31, 2009 and for the years ended June 30, 2009 and 2008. We plan to continue developing our next generation SoC and discrete products for the worldwide DTV and set-top box markets.

 

The extension of our product portfolio through the acquisition of the FRC, DRX and audio decoder product lines from Micronas allows us to address new markets and develop new technologies for existing markets. There is synergy between the SoC and discrete component business. It is possible that new technology, such as improved picture quality, higher frame rates and higher resolution will first be introduced in discrete products and later migrate as proven solutions into the main SoC for TV applications. A new discrete component is required when a new standard emerges. For example, in certain parts of the European Union market, (United Kingdom and Finland), the reception (demodulation) technology standard changed from DVB-T to DVB-T2, starting in 2010. The DRX products address the TV market either as part of a NIM (Network Interface Module) or on the main processor board. These DRX products are also used in PC TV and STB applications.

 

Our audio intellectual property acquired from Micronas supports the high quality requirements of TV manufacturers through integration of audio features into our SoC products. In addition, our new discrete audio products are suitable for home-audio markets. We are currently offering our discrete audio products for use in sound-projectors, surround sound, sound bars and home theater audio systems.

 

The high level of functional integration and video quality of our TV SoCs and FRCs enables our customers to have flexibility and cost advantages in their advanced TV designs. Our video processor converts both standard and high-definition analog TV signals into a high-quality progressive-scan video signal suitable for today’s advanced digital televisions. The HiDTV^® family applies the same concept of functional integration and video quality excellence to standard-definition and high-definition digital broadcast signals, as well as internet content. We expect that the transition to digital broadcasting will continue, and we believe our future success in large part depends on our ability to integrate new technologies and have products that support market volume opportunity on an ongoing basis.

 

We currently are shipping SoCs that have been designed using the 45 nanometer process. It provides significant benefits over the older geometries by enabling lower power consumption, smaller size, higher yields and higher levels of integration.

 

Digital Television Products:

 

We have been developing products for digital media applications since 1999 and have focused our strategy around providing our customers with advanced picture quality independent of signal input, supporting advanced video technologies such as 3D and providing superior connectivity technologies. The DTV market in particular has emerged as a high volume market for our products. Our DTV products are designed to optimize and enhance video quality for various display devices, including LCD, plasma and 3D televisions.

 

System-on-Chip (SoC) Products for TV

 

Our SoC family of products provides high levels of functional integration and video quality, enabling our customers both flexibility and cost advantages in their advanced TV designs. Our rich portfolio of IP enables the integration of all required functions for a given market segment including demodulators, video decoding and picture quality processing as well as frame-rate conversion and audio. Our newest SoC products offer connected TV features that enable TV sets to accept digital media through a storage device, home network, cable and satellite, or the Internet. These products also feature support for a variety of widget engines and applications that enable consumers to easily use a wide range of content from the Internet, including data and streaming video, through their TV.

 

FRC

 

Our family of frame rate converter products provides superior solutions for digital display picture quality, removing disturbing film judder and eliminating motion blur as well as enhancing color and sharpness. It removes motion blur for standard and high-definition content by up-converting the picture frame rate up to 240Hz. It calculates and inserts additional picture frames based on motion vector estimation and compensation. This

eliminates the unpleasant film judder which appears with film material displayed on a conventional 50Hz or 60Hz Flat Panel TV and provides a lively and vibrant viewing experience. Our FRCs also support LED backlight dimming, a leading panel technology that is important for increasing contrast as well as reducing overall power consumption of the TV.

 

DRX

 

Our DTV demodulator family accommodates most worldwide DTV transmission standards. It covers DVB-C (Europe and China), ATSC (North America and Korea) and DVB-T (Europe). The DRX-J (for North America) and DRX-K (for Europe) devices are a family of pin-to-pin compatible demodulators supporting the broadcast standards in Europe and North America. DRX are unique hybrid demodulators for analog and digital broadcast, both terrestrial and via cable. We continue to develop products for new standards like DVB-T2, ISDB and China Terrestrial.

 

Audio Decoder

 

The MAP-M / MSP-M IC families represent solutions comprised of all required building blocks to address high-quality home-audio and TV-audio applications. The MAP-M combines a powerful digital signal processing, or DSP, for decoding and post processing with digital interfaces such as S/PDIF, asynchronous I²S and Hi-resolution PWM. On-chip analog I/Os include line, phono, and microphone inputs as well as D/A converters for line and amplifier outputs. An integrated HP-amplifier completes the system. The MSP-M has the same building blocks as the MAP-M, but is additionally equipped with a demodulator/stereo decoder for all analog TV-audio standards including NIC AM and FM stereo radio. In addition to the available licensed technologies from BBE, Dolby or SRS and our own sophisticated meloD Audio Processing, MAP-M / MSP-M can be easily extended with customer specific algorithms avoiding the cost for an additional DSP.

 

Set-top Box (STB) Products:

 

Our set-top box line-up now features the world’s first fully integrated 45nm STB SoC platform, providing a family of solutions that deliver advanced performance, industry leading power management and support for on-line VOD services. We offer products targeted for the major markets within set-top box: Satellite, Cable & IPTV and Terrestrial STB as follows:

 

Satellite STB

 

We offer a full range of chip-set solutions for pay-TV operator and Free-to-air STBs including DVB-S/DVB-S2/8-PSK demodulators, highly integrated SoCs and PSTN modem interface ICs. The STB SoC portfolio covers a broad spectrum of customer needs from very low cost SD MPEG-2 SoCs to high performance HD H.264 DVR SoCs. Multiple generations of Trident SoCs have been deployed in leading operator networks worldwide and support the industry leading conditional access security systems and middleware platforms.

 

Cable & IPTV STB

 

We offer a full range of chip-set solutions for cable operator & IPTV STBs’ including highly integrated SoCs. The STB SoC portfolio covers a broad spectrum of customer needs from very low cost SD MPEG-2 SoCs to high performance HD H.264 DVR SoCs. We also offer products for DOCSIS^R modems. Multiple generations of Trident SoCs have been deployed in leading operator networks worldwide and support the industry leading conditional access security systems and middleware platforms.

 

Terrestrial STB

 

We offer a full range of chip-set solutions for Free-to-air & pay-TV STBs including DVB-T demodulators and highly integrated SoCs. The STB SoC portfolio covers a broad spectrum of customer needs from very low cost SD MPEG-2 SoCs to high performance HD H.264 DVR SoCs. Multiple generations of Trident SoCs have been deployed in terrestrial broadcast networks worldwide and support leading industry middleware platforms.

Our STB chip-set solutions are supported with complete system hardware reference designs and embedded system software.

 

Manufacturing

 

Wafer Fabrication

 

We have adopted a “fabless” manufacturing strategy whereby we contract-out our wafer fabricating needs to qualified contractors that we believe provide cost, technology or capacity advantages for specific products. As a result, we have generally been able to avoid the significant capital investment required for wafer fabrication facilities and to focus our resources on product design, quality assurance, marketing and customer support. During the year ended December 31, 2010, our manufacturing requirements were principally served by Taiwan Semiconductor Manufacturing Corporation, or TSMC; United Microelectronics Corporation, or UMC, NXP and Micronas. During the year ended December 31, 2009, UMC and Micronas provided all of our foundry requirements.

 

Assembly and Test

 

We purchase product in wafer form from foundries and contract with third-party subcontractors and one related party to provide chip packaging and testing. Our wafer probe testing is conducted principally by independent wafer probe test subcontractors in Taiwan. After the completion of the wafer probe tests, the dies are assembled into packages and tested by our primary subcontractors, Siliconware Precision Industries Co., Ltd., ASE and NXP in Taiwan and Micronas in Germany. The availability of assembly and testing services from these subcontractors could be materially and adversely affected by the financial conditions of the subcontractors given the recent global economic environment. See “Risk Factors” under Item 1A of this Report for a more detailed discussion of the risks associated with our dependence on third party assembly and test subcontractors.

 

Quality Assurance

 

In order to manage the production and back-end operations, we have maintained personnel closer to our manufacturing and test subcontractors. Our goal is to increase the quality assurance of the products while reducing manufacturing cost. To ensure the integrity of our suppliers’ quality assurance procedures, we develop detailed test procedures and test specifications for each product produced and we require the third-party contractors to follow those procedures and meet our specifications before shipping finished products. In general, we have experienced a relatively low amount of product returns from our customers; however, our future return experience may vary because our more advanced, more complex SoC products are more difficult to manufacture and test. In addition, some of our customers may subject our more advanced products to more rigid testing standards than have been applied to our prior products.

 

Research and Development

 

Developing products based on advanced technological concepts is essential to our ability to compete effectively in the digital media market. We maintain a team of product research and development and engineering staff responsible for product design and engineering. We have conducted substantially all of our product development in-house and, as of December 31, 2010, December 31, 2009 and June 30, 2009, our staff of research and development personnel comprised 1,128, 464, and 517 people, respectively. Research and development expenditures totaled approximately $175 million, $59.7 million and $53 million in the year ended December 31, 2010, year ended December 31, 2009 (unaudited) and the year ended June 30, 2009, respectively.

 

We believe that the achievement of higher levels of SoC integration and the timely introduction of new products is essential to our growth. We have previously invested the largest component of our engineering resources in our Shanghai, China facility. Through the acquisitions of the Micronas and NXP product lines, we also have research and development facilities in Freiburg, Germany, Eindhoven and Nijmegen, The Netherlands, and Bangalore and Hyderabad, India. In addition to our facilities discussed above, we have design centers in Austin, Texas and Sunnyvale, California, San Diego, California, Haifa, Israel and Beijing, China.

Sales, Marketing and Distribution

 

We sell our products primarily to digital television and set-top box OEMs in South Korea, Japan, Europe and Asia Pacific, either directly or through supplier channels. We consider these OEMs to be our customers. Our products are sold through direct sales efforts, distributors and independent sales representatives. Historically, a large portion of our revenues have been generated by sales to a relatively small number of customers. All of our revenues to date have been denominated in U.S. dollars or in Euros. Sales to our largest customers have fluctuated significantly from period to period primarily due to the timing and number of design wins with each customer and will likely continue to fluctuate significantly in the future. Our DTV and STB products are marketed around the world.

 

Our future success depends in large part on the success of our sales to leading DTV and STB manufacturers. Accordingly, the focus of our sales and marketing efforts is to increase sales to the leading DTV and STB manufacturers and OEM channels. Competitive factors of particular importance to success in such markets include platform support, product performance and features, and the integration of functions on a single integrated circuit chip.

 

We service our customers primarily through our offices in the United States, Taiwan, China, Europe, South Korea and Japan. As digital media is rapidly developing in the United States, Europe, Japan, South Korea, China, and elsewhere, we expect that leadership in the digital media industry will also rapidly change. Our goal is to become a leading supplier to a broad range of manufacturers in this marketplace and to manufacturers for other markets as DTV and STB sales increase in those markets.

 

During the year ended December 31, 2010, six months ended December 31, 2009, and years ended June 30, 2009 and 2008, nearly all of our revenues were generated through sales to customers located in Asia and Europe. A small number of customers have historically accounted for a majority of our revenues in any quarter. For the year ended December 31, 2010 and six months ended December 31, 2009, sales to our top three customers represented approximately 40% and 54%, of our total revenues, respectively. For the years ended June 30, 2009 and 2008, sales to our top three customers represented approximately 59% and 76% of our total revenues, respectively. Sales to any particular customer may fluctuate significantly from quarter to quarter and have in fact fluctuated significantly in the past. For additional segment and geographic information, see Note 14, “Geographic Information and Major Customers,” of Notes to Consolidated Financial Statements.

 

Backlog

 

Our sales are primarily made pursuant to standard purchase orders and not pursuant to long term agreements specifying future quantities or delivery dates. Also, we recognize product revenues on sales made to our distributor channel mostly on a deferred revenue basis and this channel represents approximately 27% of our revenues. Backlog comprised of orders from distributors is not directly indicative of our near term revenues. Backlog is influenced by several factors including market demand, pricing and customer order patterns in reaction to product lead times. The semiconductor industry is characterized by short lead time orders and quick delivery schedules. The quantity of products purchased by our customers as well as shipment schedules are subject to revisions that reflect changes in both the customers’ requirements and in manufacturing availability. Backlog quantities and shipment schedules under outstanding purchase orders are frequently revised to reflect changes in customer needs, and agreements calling for the sale of specific quantities are either contractually subject to quantity revisions or, as a matter of industry practice, are sometimes not enforced. Therefore, a significant portion of our order backlog may be cancellable and has in fact been cancelled in the past due to changes in customer needs.

 

For these reasons, in light of industry practice and this experience, we do not believe that backlog as of any particular date is indicative of future results.

 

Seasonality

 

Our products largely serve the consumer electronics market. Typically we experience slower sales of our TV products in the first calendar quarter, and the strongest sales of TV products in the third calendar quarter. There is no

apparent seasonal pattern in demand for our set-top box products. The impact of seasonality is not of a consistent magnitude year to year, but as a general rule it is directionally consistent.

 

Competition

 

The global digital media market and related industries are highly competitive and characterized by rapid technological change. Our ability to compete depends primarily on our ability to commercialize our technology, continually improve our products and develop new products that meet constantly evolving customer requirements. We expect competition to continue. We believe that the principal factors upon which competitors compete in our markets include, but are not limited to:

 

 

We compete with a number of major domestic and international suppliers of integrated circuits and related applications in the digital media market. In TV, our principal competitors are captive solutions from large TV OEMs as well as merchant solutions from Broadcom Corporation, MediaTek Inc., MStar Semiconductor, NEC Corporation, Novatek, STMicroelectronics and Zoran Corporation. In set-top box, our principal competitors are Broadcom and STMicroelectronics. This competition has resulted and will continue to result in declining average selling prices for a given level of functionality and performance as well as requirements for greater functionality, performance, and integration at various price points. In our target markets, we also may face competition from newly established competitors and suppliers of products based on new or emerging technologies. We also expect to encounter further consolidation in the market in which we compete.

 

Many of our current competitors have greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. Consequently, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products. In addition, competitors may develop technologies that more effectively address our target market with products that offer enhanced features, lower power requirements or lower costs. Increased competition could result in pricing pressures, decreased gross margins and loss of market share and may materially and adversely affect our business, financial condition and results of operations.

 

Intellectual Property

 

Our success and future revenue growth depend, in part, on our ability to protect our intellectual property. We attempt to protect our trade secrets and other proprietary information primarily through agreements with customers and suppliers, proprietary information agreements with employees and consultants and other security measures. Although we intend to protect our rights vigorously, there can be no assurance that these measures will be successful. As of December 31, 2010, we had over 340 U.S. patents and 1100 patents in foreign jurisdictions, and 750 patent applications pending in different countries, including patent and patent applications acquired in connection with the May 2009 and February 2010 acquisitions of assets and intellectual property from Micronas and NXP, respectively. The patents and applications cover various technologies, such as motion estimation/motion compensation, video decoding, demodulators and conditional access security, as well as advanced 45nm SoC technology. However, there can be no assurance that third parties will not independently develop similar or competing technology or design around any patents that may be issued to us.

We may from time to time enter into license agreements with third parties permitting them to practice certain of our patents. For example, in December 2010, we entered into a license agreement with MStar Semiconductors, Inc. relating to a part of our motion estimation/motion compensation patent portfolio. The licensed patents are directed to the display of high definition and 3D images for high-quality televisions and other video enabled LCD display devices.

 

The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. From time to time, we have received notices claiming that we or our customers have infringed third-party patents or other intellectual property rights. To date, licenses generally have been available to us where third-party technology was necessary or useful for the development or production of our products. There can be no assurance that third parties will not assert additional claims against us with respect to existing or future products or that licenses will be available on reasonable terms, or at all, with respect to any third-party technology. Any litigation to determine the validity of any third-party claims could result in significant expense to us and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result in any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses to the technology that is the subject of the litigation. There can be no assurance that we will be successful in such development or that any such licenses would be available. Patent disputes in the semiconductor industry have often been settled through cross licensing arrangements. We may not be able to settle any alleged patent infringement claim through a cross-licensing arrangement. In the event any third party made a valid claim against us, or our customers, and a license was not made available to us on commercially reasonable terms, we would be adversely affected. In addition, the laws of certain countries in which our products have been or may be developed, manufactured or sold, including China, Taiwan and South Korea, may not protect our products and intellectual property rights to the same extent as the laws of the U.S.

 

We may in the future initiate claims or proceedings against third parties for infringement of our proprietary rights to determine the scope and validity of our proprietary rights. Any such claims could be time-consuming, result in costly litigation and diversion of technical and management personnel or require us to develop non-infringing technology or enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. In the event of a successful claim of infringement and our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis, our business, operating results and financial condition could be materially adversely affected.

 

Employees

 

As of December 31, 2010, we had 1,522 full-time employees, including 1,128 individuals engaged in research and development, 109 engaged in finance, legal, and general administration, 159 engaged in sales and marketing, and 126 engaged in manufacturing operations. Our future success will depend in great part on our ability to continue to attract, retain and motivate highly qualified technical, marketing, engineering and management personnel, and to successfully integrate the new employees who joined us in connection with the NXP Transaction. Outside of Europe, where certain of our employees are represented by employee works councils, our labor relations with employees are generally not subject to collective bargaining agreements. We have never experienced a work stoppage and we believe that our employee relations are good.

 

 

Set forth below and elsewhere in this Report on Form 10-K are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained herein. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occur, our business, operating results, and financial condition and/or liquidity could be materially adversely affected.

We may fail to realize some or all of the anticipated benefits of our acquisition of the television systems and set-top box business lines from NXP, or the frame rate converter, demodulator and audio decoder product lines from Micronas, which may adversely affect the value of our common stock.

 

On February 8, 2010, we completed the acquisition of the television systems and set-top box business lines from NXP, or NXP Transaction, and on May 14, 2009, we completed the purchase of selected assets of the frame rate converter, demodulator and audio decoder product lines of Micronas, or Micronas Transaction.

 

We continue to integrate these assets, and the operations acquired with these assets, into our existing operations. The integration has required, and will continue to require significant efforts, including the coordination of future product development and sales and marketing efforts. These integration efforts continue to require resources and management’s time and efforts. The success of each of these acquisitions will depend, in part, on our ability to realize the anticipated benefits and cost savings from combining the acquired product lines with our legacy operations. However, to realize these anticipated benefits and cost savings, we must successfully combine the acquired business lines with our legacy operations and integrate our respective operations, technologies and personnel. If we are not able to achieve these objectives within the anticipated time frame, or at all, the anticipated benefits and cost savings of the acquisitions may not be realized fully or at all or may take longer to realize than expected and the value of our common stock may be adversely affected. The integration process has resulted in the loss of some key employees and other senior management, and could result in the disruption of our business or adversely affect our ability to maintain relationships with customers, suppliers, distributors and other third parties, or to otherwise achieve the anticipated benefits of either acquisition.

 

Specifically, risks in integrating the operations of the business lines acquired from NXP and Micronas into our operations in order to realize the anticipated benefits of each acquisition include, among other things:

 

 

Integration efforts will also divert management attention and resources. An inability to realize the anticipated benefits of the acquisitions, as well as any delays encountered in the integration process, could have an adverse effect on our business and results of operations.

 

In addition, as we complete the integration process, we may incur additional and unforeseen expenses, and the anticipated benefits of each acquisition may not be realized. Actual cost synergies may be lower than we expect and may take longer to achieve than anticipated. If we are not able to adequately address these challenges, we may be unable to realize the anticipated benefits of either the NXP Transaction or the Micronas Transaction.

 

We depend on a small number of large customers for a significant portion of our sales. The loss of a significant design win, loss of a key customer or a significant reduction in or cancellation of sales to a key customer could significantly reduce our revenues and negatively impact our results of operations.

 

We are and will continue to be dependent on a limited number of distributors and customers for a substantial amount of our revenue. For the year ended December 31, 2010, for instance, 40% of our revenues were from sales to three major customers. Our revenues to date have been denominated in U.S. dollars and Euros. Sales to our largest customers have fluctuated significantly from period to period primarily due to the timing and number of design wins with each customer and will likely continue to fluctuate significantly in the future. A significant portion of our revenue in any period may also depend on a single product design win with a particular customer. As a result, the loss of any such key design win or any significant delay in the ramp of volume productions of the customer’s products into which our product is designed could materially and adversely affect our financial condition and results of operations. Our results in the fourth quarter of fiscal 2010 were negatively impacted, in part, due to reductions, cancellations or delays in orders from key customers.

 

We may be unable to replace lost revenues by sales to any new customers or increased sales to existing customers. Our operating results in the foreseeable future will continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that incorporate our products. In the future, these customers may decide not to purchase our products at all, purchase fewer products than they did in the past, or alter their purchasing patterns in some other way, particularly because:

 

 

The operation of our business could be adversely affected by the transition of key personnel as we rebuild our executive leadership team and make additional organizational changes.

 

In addition to the uncertainties created among personnel as a result of the Micronas and NXP Transactions and the reorganization of senior management during 2010, we appointed an interim Chief Executive Officer following the January 2011 resignations of our former Chief Executive Officer and former President. Our senior management team, which was reorganized following the NXP Transaction, has only worked together or a short period of time. During 2010 we reorganized our Board of Directors, and now have eight members of the Board of Directors, four of whom joined following completion of the NXP Transaction, and one vacancy. It may take some time for each of the new members of our management team to become fully integrated into our business. Our failure to manage these transitions, or to find and retain experienced management personnel, could adversely affect our ability to compete effectively and could adversely affect our operating results.

We must continue to retain, motivate and recruit executives and other key employees following integration of the NXP Transaction and the Micronas Transaction, and failure to do so could negatively affect our operations.

 

We must retain key employees acquired from Micronas and NXP. Experienced executives are in high demand and competition for their talents can be intense. To be successful, we must also retain and motivate our existing executives and other key employees. Our employees may experience uncertainty about their future role with us as we develop and begin to execute our operational and product development strategies. These potential distractions may adversely affect our ability to attract, motivate and retain executives and other key employees and keep them focused on applicable strategies and goals. A failure to retain and motivate executives and other key employees could have a material and adverse impact on our business.

 

Our success depends to a significant degree upon the continued contributions of the principal members of our technical sales, marketing and engineering teams, many of whom perform important management functions and would be difficult to replace. During the past year, we hired several members of our current executive management team. We have reorganized our sales, marketing and engineering teams and continue to make changes. We depend upon the continued services of key management personnel at our overseas subsidiaries, especially in China, Taiwan and Europe. Our officers and key employees are not bound by employment agreements for any specific term, and may terminate their employment at any time. In order to continue to expand our product offerings both in the U.S. and abroad, we must hire and retain a number of research and development personnel. Hiring technical sales personnel in our industry is very competitive due to the limited number of people available with the necessary technical skills and understanding of our technologies. Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future. Competition for highly skilled personnel continues to be increasingly intense, particularly in the areas where we principally operate. During 2010, we experienced, and may continue to experience, difficulty in hiring and retaining qualified engineering personnel in Shanghai, China, Austin, Texas and Taiwan. If we are not successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, our business may be harmed.

 

As a result of the NXP Transaction and the Micronas Transaction, we are a larger and more geographically diverse organization, and if we are unable to manage this larger organization efficiently, our operating results will suffer.

 

As a result of the acquisitions of assets from NXP and Micronas, we have a larger number of employees in widely dispersed operations in the U.S., Europe, Asia, and other locations, which have increased the difficulty of managing our operations. Prior to 2010, we did not have a significant number of employees in Europe, particularly Germany and The Netherlands, and had none in India. As a result, we now face challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies, benefits and compliance programs. The inability to manage successfully this geographically more diverse and substantially larger organization could have a material adverse effect on our operating results and, as a result, on the market price of our common stock.

 

Our reliance upon a very small number of foundries for the manufacture, assembly and testing of our integrated circuits could make it difficult to maintain product flow and negatively affect our customer relationships, revenues and operating margins.

 

If the demand for our products grows or decreases by material amounts, we will need to adjust the levels of our material purchases, contract manufacturing capacity and internal test and quality functions. Any disruptions in product flow could limit our ability to meet orders, impact our revenue and our ability to consummate sales, adversely affect our competitive position and reputation and result in additional costs or cancellation of orders.

 

We do not own or operate fabrication facilities and do not manufacture our products internally. Prior to the NXP Transaction, we relied principally upon one independent foundry to manufacture substantially all of our SoC products and non-audio discrete products in wafer form and other contract manufacturers for assembly and testing of our products and we rely upon Micronas for the manufacture of our discrete audio products on a turnkey basis pursuant to a services agreement. Following the NXP Transaction, we have begun to manufacture some of our products in wafer form at a second independent foundry. Generally, we place orders by purchase order, and the foundries are not

obligated to manufacture our products on a long-term fixed-price basis, so they are not obligated to supply us with products for any specific period of time, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. Our foundry and contract manufacturers could re-allocate capacity to other customers, even during periods of high demand for our products. In fact, during 2010 we experienced wafer supply constraints and expect to face such constraints in the future. We have limited control over delivery schedules, quality assurance, manufacturing yields, potential errors in manufacturing and production costs. We could experience an interruption in our access to certain process technologies necessary for the manufacture of our products. From time to time, there are manufacturing capacity shortages in the semiconductor industry and current global economic conditions make it more likely those disruptions in supply chain cycles could occur. As a result of these conditions, our foundry subcontractors could experience financial difficulties that would impede their ability to operate effectively. If we encounter shortages and delays in obtaining components, our ability to meet customer orders would be materially adversely affected. In addition, during periods of increased demand, putting pressure on the foundries to meet orders, we may have reduced control over pricing and timely delivery of components, and if the foundries increase the cost of components or subassemblies, our product revenues, cost of product revenues and results of operations would be adversely affected, and we may not have alternative sources of supply to manufacture such components.

 

Constraints or delays in the supply of our products, whether because of capacity constraints, unexpected disruptions at our independent foundries, at NXP or Micronas or at our assembly or testing houses, delays in additional production at existing foundries or in obtaining additional production from existing or new foundries, shortages of raw materials, or other reasons, could result in the loss of customers and other material adverse effects on our operating results, including effects that may result should we be forced to purchase products from higher cost foundries or pay expediting charges to obtain additional supplies. In addition, to the extent we elect to use multiple sources for certain products, our customers may be required to qualify multiple sources, which could adversely affect their desire to design-in our products and reduce our revenues.

 

Intense competition exists in the market for digital media products.

 

The digital media market in which we compete is intensely competitive and characterized by rapid technological change and declining average unit selling prices. Competition typically occurs at the design stage, when customers evaluate alternative design approaches requiring integrated circuits. Because of short product life cycles, there are frequent design win competitions for next-generation systems.

 

We believe the digital media market will remain competitive, and will require us to incur substantial research and development, technical support, sales and other expenditures to stay competitive in this market. In the digital media market, our principal competitors are captive solutions from large TV OEMs as well as merchant solutions from Broadcom Corporation, MediaTek Inc., MStar Semiconductor, NEC Corporation, Novatek, STMicroelectronics, and Zoran Corporation. Industry consolidation has been occurring recently as, in addition to our acquisition of certain assets from NXP and Micronas, some of our competitors have acquired or are considering acquiring other competitors or divisions of companies that provide them with the opportunity to compete against us.

 

Many of our current competitors and many potential competitors have significantly greater technical, manufacturing, financial and marketing resources. Some of them may also have broader product lines and longer standing relationships with key customers and suppliers than we have, which makes competing more difficult. Therefore, we expect to devote significant resources to the digital TV and set-top box markets even though some of our competitors are substantially more experienced than we are in these markets.

 

The level and intensity of competition have increased over the past year. Competitive pricing pressures have resulted in continued reductions in average selling prices of our existing products, and continued or increased competition could require us to further reduce the prices of our products, affect our ability to recover costs or result in reduced gross margins. If we are unable to timely and cost-effectively integrate more functionality onto single chip designs to help our customers reduce costs, we may lose market share, our revenues may decline and our gross margins may decrease significantly.

 

If we have to qualify new contract manufacturers or foundries for any of our products, we may experience delays that result in lost revenues and damaged customer relationships.

 

The lead time required to establish a relationship with a new foundry is long, and it takes time to adapt a product’s design and technological requirements to a particular manufacturer’s processes. Accordingly, there is no readily available alternative source of supply for any specific product. We have already experienced an inability to meet the unconstrained

demand of some of our customers for certain products due to shortages in wafer supply that occurred during 2010. The lack of a readily available second source could cause significant delays in shipping products, or even shortages which could damage our relationships with current and prospective customers and harm our sales and financial results.

 

If we do not achieve additional design wins in the future, our ability to sell additional products could be adversely affected.

 

Our future success depends on manufacturers of consumer televisions, set-top boxes and other digital media products designing our products into their products. To achieve design wins with OEM customers and ODMs, we must define and deliver cost-effective, innovative and high performance integrated circuits on a timely basis, before our competitors do so. In addition, some OEM customers have begun to utilize digital video processor components produced by their own internal affiliates, which decreases our opportunity to achieve design wins. Thus, even if we achieve a design win with an ODM, their OEM customer may subsequently elect to purchase an integrated digital media solution from the ODM that does not incorporate our products. Once a supplier’s products have been designed into a system, a manufacturer may be reluctant to change components due to costs associated with qualifying a new supplier and determining performance capabilities of the component. Customers can choose at any time to discontinue using our products in their designs or product development efforts. Accordingly, we may face narrow windows of opportunity to be selected as the supplier of component parts by significant new customers.

 

It may be difficult for us to sell to a particular customer for a significant period of time once that customer selects a competitor’s product, and we may not be successful in obtaining broader acceptance of our products. If we are unable to achieve broader market acceptance of our products, we may be unable to maintain and grow our business and our operating results and financial condition will be adversely affected.

 

A decline in revenues may have a disproportionate impact on operating results and require further reductions in our operating expense levels.

 

Because expense levels are relatively fixed in the near term for a given quarter and are based in part on expectations of our future revenues, any decline in our revenues to a level that is below our expectations would have a disproportionately adverse impact on our operating results for that quarter. If revenues further decline, we may be required to incur additional material restructuring charges in connection with efforts to contain and reduce costs.

 

Product supply and demand in the semiconductor industry is subject to cyclical variations.

 

The semiconductor industry is subject to cyclical variations in product supply and demand. Downturns in the industry often occur in connection with, or in anticipation of, maturing product cycles for both semiconductor companies and their customers and declines in general economic conditions. These downturns have been characterized by abrupt fluctuations in product demand and production capacity and accelerated decline of average selling prices. The emergence of a number of negative economic factors, including heightened fears of a prolonged recession, could lead to such a downturn.

 

We cannot predict whether we will achieve timely, cost- effective access to that capacity when needed, or what capacity patterns may emerge in the future. A downturn in the semiconductor industry could harm our sales and revenues if demand for our products drops, or cause our gross margins to suffer if average selling prices decline.

 

We do not have long-term commitments from our customers, and we plan purchases based upon our estimates of customer demand, which may require us to contract for the manufacturing of our products based on inaccurate estimates.

 

Our sales are made on the basis of purchase orders rather than long-term purchase commitments. Our customers may cancel or defer purchases at any time. This requires us to forecast demand based upon assumptions that may not be correct. If we or our customers overestimate demand, we will create an obligation to purchase the inventory in excess of expected demand. If such excess inventory becomes obsolete or we cannot sell or use it, our operating results could be harmed. Conversely, if we or our customers underestimate demand, or if sufficient manufacturing capacity is not available, we may lose revenue opportunities, damage customer relationships and we may not achieve expected revenue.

Our success depends upon the digital media market and we must continue to develop new products and to enhance our existing products, including transitioning to smaller geometry process technologies.

 

The digital media industry is characterized by rapidly changing technology, frequent new product introductions, and changes in customer requirements. Our future success depends on our ability to anticipate market needs and develop products that address those needs. As a result, our products could quickly become obsolete if we fail to predict market needs accurately or develop new products or product enhancements in a timely manner. The long-term success in the digital media business will depend on the introduction successive generations of products in time to meet the design cycles as well as the specifications of original equipment manufacturers of televisions. The digital media industry is characterized by an increasing level of integration and incorporation of greater numbers of features on a single chip, using smaller geometry process technologies, in order to permit enhanced systems at the same or lower cost.

 

Our failure to predict market needs accurately or to timely develop new competitively priced products or product enhancements that incorporate new industry standards and technologies, including integrated circuits with increasing levels of integration and new features, using smaller geometry process technologies, may harm market acceptance and sales of our products. If the development or enhancement of these products or any other future products takes longer than we anticipate, or if we are unable to introduce these products to market, our sales could decrease. Even if we are able to develop and commercially introduce these new products, the new products may not achieve the widespread market acceptance necessary to provide an adequate return on our investment.

 

The average selling prices of our products may decline over relatively short periods.

 

Average selling prices for our products may decline over relatively short time periods. This annual pace of price decline for products or technology is generally expected in the consumer electronics industry. It is also possible for the pace of average selling price declines to accelerate beyond these levels for certain products in a commoditizing market. Price declines can be exacerbated by competitive pressures at specific customers and for specific products. When our average selling prices decline, our gross profits decline unless we are able to sell more products at higher gross margin or reduce the cost to manufacture our products. We generally attempt to combat average selling price declines by designing new products for reduced costs, innovating to integrate additional functions or features and working with our manufacturing partners to reduce the costs of manufacturing existing products.

 

We have in the past experienced and may in the future experience declining sales prices, which could negatively impact our revenues, gross profits and financial results. We therefore need to sell our higher margin products in increasing volumes to offset any decline in the average selling prices of our products, and introduce new higher margin products for sale in the future, which we may not be able to do on a timely basis.

 

Our ability to borrow under our credit facility and the financial covenants in the facility may adversely affect our financial position, results of operations and liquidity.

 

Our revolving credit facility agreement with Bank of America contains financial and other covenants that must be met for us to remain in compliance with the agreement, including a covenant which would initially preclude us from accessing funds under the credit facility in excess of our cash and equivalent resources. The agreement also contains customary restrictions, requirements and other limitations, including our ability to incur additional indebtedness, grant liens, make capital expenditures, merge or consolidate, dispose of assets, pay dividends or make distributions, change the method of accounting, make investments and enter into certain transactions with affiliates, in each case subject to materiality and other qualifications, baskets and exceptions customary for a credit facility of this size and type. The agreement also contains a financial covenant that requires us to maintain a specified fixed charge coverage ratio if liquidity or availability under the agreement drops below certain thresholds.

 

We may borrow under the agreement based upon a certain percentage of our eligible accounts receivable outstanding, subject to eligibility requirements, limitations and covenants. As of March 4, 2011 there are no borrowings outstanding under the agreement. However, if we are not in compliance in the future with covenants under the agreement and are therefore unable to borrow under the credit facility or to refinance existing indebtedness, we may be prevented from using the agreement to fund our working capital needs.

Our dependence on sales to distributors increases the risks of managing our supply chain and may result in excess inventory or inventory shortages, which could adversely impact our operating results.

 

Prior to the NXP Transaction, the majority of our sales through distributors were made by companies that function as purchasing conduits for each of two large Japanese OEM customers. Generally, these distributors take certain inventory positions and resell to their respective OEM customers, who build display devices and other products based on specifications provided by branded suppliers. We have a more traditional distributor relationship with our remaining distributors, one that involves the distributor taking inventory positions and reselling to multiple customers. In our significant distributor relationships, we have recognized revenue when the distributors sell the product through to their end user customers. These distributor relationships have reduced our ability to forecast sales and increased risks to our business. Since our distributors act as intermediaries between us and the end user customers, we must rely on our distributors to accurately report inventory levels, production forecasts and sales to their end user customers. Our sales are made on the basis of customer purchase orders rather than long-term purchase commitments. Our distributors and customers may cancel or defer orders at any time, but we must order wafer inventory from our foundries several months in advance. This requires us to manage a more complex supply chain as well as monitor the financial condition and credit worthiness of our distributors and the end user customers. Our failure to manage one or more of these risks could result in excess inventory or shortages that could lead to significant charges for obsolete inventory or cause us to forego significant revenue opportunities, lose market share, damage customer relationships and accurately report revenue derived from distributor sales, any of which could adversely impact our operating results.

 

If we engage in further cost-cutting or workforce reductions, we may be unable to successfully implement new products or enhancements or upgrades to our products.

 

We expect to continue to introduce new and enhanced products, and our future financial performance will depend on customer acceptance of our new products and any upgrades or enhancements that we may make to our products. However, if our efforts to streamline operations and reduce costs and our workforce following our recent acquisitions are insufficient to bring our structure in line with current and projected near-term demand for our products, we may be forced to make additional workforce reductions or implement further cost saving initiatives. Workforce reductions we have already initiated and possible future reductions could impact our research and development and engineering activities, which may slow our development of new or enhanced products. We may be unable to successfully introduce new or enhanced products, and may not succeed in obtaining or maintaining customer satisfaction, which could negatively impact our reputation, future sales of our products and our future revenues.

 

NXP owns approximately 60% of our outstanding shares of common stock, which could cause NXP to be able to exercise significant influence over the outcome of various corporate matters and could discourage third parties from proposing transactions resulting in a change in our control.

 

As a result of the NXP Transaction, NXP owns approximately 60% of our issued and outstanding shares of common stock and has elected four of the nine members of our board of directors. Although the Stockholders Agreement between us and NXP imposes limits on NXP’s ability to take specified actions related to the acquisition of additional shares of our common stock and the voting of its shares of our common stock, among other restrictions, NXP is still able to exert significant influence over the outcome of a range of corporate matters, including significant corporate transactions requiring a stockholder vote, such as a merger or a sale of our company or our assets. Further, as a result of the departure of our prior CEO in January 2011, directors appointed by NXP currently constitute four of the eight members on our Board. NXP’s ownership could affect the liquidity in the market for our common stock.

 

Furthermore, the ownership position of NXP could discourage a third party from proposing a change of control or other strategic transaction concerning Trident. As a result, our common stock could trade at prices that do not reflect a “control premium” to the same extent as do the stocks of similarly situated companies that do not have a stockholder with an ownership interest as large as NXP’s ownership interest.

 

In addition, we issued 7 million shares of our common stock to Micronas and warrants to purchase an additional 3 million shares of our common stock to Micronas. The issuance of these shares to Micronas caused a reduction in the relative percentage interests of Trident stockholders in earnings, voting power, liquidation value and book and market value, and a further reduction will occur if Micronas exercises the warrants in the future.

Sales by NXP of the shares of our common stock acquired in the NXP Transaction following the two year lock up period could cause our stock price to decrease.

 

The sale of shares of common stock that NXP received in the NXP Transaction are restricted and not freely tradeable, but NXP may begin to sell these shares under certain circumstances, including pursuant to a registered underwritten public offering under the Securities Act of 1933, as amended, or in accordance with Rule 144 under the Securities Act, following February 8, 2012. We have entered into a Stockholders Agreement with NXP, which includes registration rights and which gives NXP the right to require us to register all or a portion of its shares of our common stock at any time following this two year period, subject to certain limitations. The sale of a substantial number of shares of our common stock by NXP within a short period of time could cause our stock price to decrease, and make it more difficult for us to raise funds through future offerings of common stock.

 

The impact of changes in global economic conditions on our current and potential customers may adversely affect our revenues and results of operations.

 

Our operating results have been adversely affected over the past quarters by reduced levels of consumer spending and by the overall weak economic conditions affecting our current and potential customers. The economic environment that we faced in 2010 was uncertain, and this uncertainty is expected to continue during 2011. If our end customers continue to refrain from making purchases of products from us until general economic conditions improve, this could continue to adversely affect our business and operating results during calendar 2011.

 

As a result of the difficult global macroeconomic and industry conditions, we have implemented restructuring and workforce reductions, and may be required to make additional such reductions, which may adversely affect the morale and performance of our personnel and our ability to hire new personnel.

 

In connection with our efforts to streamline operations, reduce costs and better align our staffing and structure with current demand for our products, we implemented a restructuring of our company, reducing our workforce and implementing other cost saving initiatives.

 

We recorded restructuring charges of $0.8 million in the quarter ended December 31, 2008, and $1.6 million in the quarter ended September 30, 2009. In connection with the NXP Transaction, we implemented further restructurings or work force reductions that took place during 2010. During the year ended December 31, 2010, we recorded $28.3 million of restructuring expenses related to severance and related employee benefits. Restructuring charges are recorded under “Restructuring charges” in our Consolidated Statement of Operations.

 

Prior to the close of the NXP Transaction, NXP initiated a restructuring plan pursuant to which the employment of some NXP employees was terminated upon the close of the NXP Transaction. We have determined that the restructuring plan was a separate plan from the business combination because the plan to terminate the employment of certain employees was made in contemplation of the acquisition. Therefore, a severance cost of $3.6 million was recognized as an expense on the acquisition date and is included in the total restructuring charge of $28.3 million for the year ended December 31, 2010. The $3.6 million of severance cost was paid by NXP after the close of the NXP transaction, effectively reducing the purchase consideration transferred.

 

Our restructuring may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce and loss of employee morale and decreased performance. In addition, the recent trading levels of our stock have decreased the value of our stock options granted to employees under our stock option plans. As a result of these factors, our remaining personnel may seek employment with companies that they perceive as having less volatile stock prices. Continuity of personnel can be a very important factor in the sales and implementation of our products and completion of our research and development efforts.

 

As a result of our investigation into our historical stock option granting practices and the restatement of our previously filed financial statements, we are subject to civil litigation claims that could have a material adverse effect on our business, customer relationships, results of operations and financial condition.

 

As previously described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 3, “Restatement of Consolidated Financial Statements and Special Committee and Company Findings” of Notes to Consolidated Financial Statements, included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended June 30, 2006 filed on August 7, 2007, we conducted an investigation into our

historical stock option practices and related accounting. Based upon the findings of the investigation, we restated our financial statements for each of the years ended June 30, 1993 through June 30, 2005, and restated our financial statements for the interim first three quarters of the year ended June 30, 2006 as well.

 

Our past stock option granting practices and the restatement of our prior financial statements have exposed and may continue to expose us to greater risks associated with litigation as described in Item 3, “Legal Proceedings.” This litigation could impact our relationships with customers and our ability to generate revenues.

 

We have been named as a party to derivative action lawsuits, and we may be named in additional litigation, all of which will require significant management time and attention and result in significant legal expenses and may result in an unfavorable outcome which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Trident has been named as a nominal defendant in several shareholder derivative lawsuits concerning the granting of stock options. The federal court cases have been consolidated as In re Trident Microsystems Inc. Derivative Litigation, Master File No. C-06-3440-JF. Plaintiffs in all cases alleged that certain of our current or former officers and directors caused us to grant options at less than fair market value, contrary to our public statements (including our financial statements), and that this represented a breach of their fiduciary duties to us, and as a result those officers and directors are liable to us. Our Board of Directors appointed a Special Litigation Committee, or SLC, composed solely of independent directors, to review and manage any claims that we may have relating to the stock option granting practices and related issues investigated by the SLC. The scope of the SLC’s authority includes the claims asserted in the derivative actions.

 

On March 26, 2010, the federal court approved settlements with all defendants other than Frank Lin, our former CEO, and all defendants other than Mr. Lin were dismissed with prejudice from the state and federal actions. The details of that partial settlement, which disposed of the federal litigation as to all individual defendants other than Mr. Lin and as to the consolidated state court action in its entirety, were previously disclosed in our Form 8-K filed on February 10, 2010. On June 8, 2010, Mr. Lin filed a counterclaim against Trident. In that counterclaim, Mr. Lin seeks recovery of payments he claims he was promised during the negotiations surrounding his eventual termination and also losses he claims he has suffered because he was not permitted to exercise his Trident stock options between January 2007 and March 2008.

 

On February 15, 2011, we entered into a Stipulation of Settlement to resolve the federal litigation in its entirety, or Proposed Settlement, and on February 17, 2011, the federal court preliminarily approved the Proposed Settlement. A hearing for consideration of final approval of the Proposed Settlement has been scheduled for April 15, 2011. Final approval, without appeal, of the Proposed Settlement would satisfy the contingency in the settlement of Mr. Lin’s claims against us. We cannot predict whether the federal court will order the final approval of the Proposed Settlement and, if it does, whether such decision will be successfully appealed. As a result, we cannot predict whether Mr. Lin’s counterclaims against us in the federal litigation are likely to result in any material recovery by or expense to Trident. We expect to continue to incur legal fees in responding to this lawsuit and relating to the Proposed Settlement, including expenses for the reimbursement of certain legal fees of at least Mr. Lin under our advancement obligations. The expense of defending such litigation may be significant. The amount of time to resolve this and any additional lawsuits is unpredictable and these actions may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows.

 

We may be required to record future charges to earnings if our intangible assets become impaired.

 

We are required under generally accepted accounting principles in the United States of America to review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Factors that may be considered a change in circumstances indicating that the carrying value of our intangible assets may not be recoverable include a decline in stock price and market capitalization, slower growth rates, and changes in our financial results and outlook. We may be required to incur additional charges in our Consolidated Financial Statements during the period in which any impairment of our intangible assets is determined. In determining the fair value of intangible assets in connection with our impairment analysis, we consider various factors including Trident’s estimates of future market growth and trends, forecasted revenue and costs, discount rates, expected periods over which our assets will be utilized and other variables. Our assumptions are based on historical data and internal estimates developed as part of our long-term planning process. We base our

fair value estimates on assumptions believed to be reasonable, but which are inherently uncertain. For example, in the year ended December 31, 2010, we recorded a $2.5 million impairment charge for technology licenses and prepaid royalties. If future conditions are different from management’s estimates at the time of an acquisition or market conditions change subsequently, we may incur future charges for impairment of our goodwill or intangible assets, which could adversely impact our results of operations.

 

The demand for our products depends to a significant degree on the demand for the end products of customers of the acquired business lines into which they are incorporated.

 

The vast majority of our revenues are from sales to manufacturers in the consumer electronics industry. Demand from these customers fluctuates significantly by year and by quarter, driven by consumer preferences, the development of new technologies and brand performance. Downturns in this industry can cause abrupt fluctuations in product demand, production over-capacity and accelerated average selling price declines. The success of our products depends on the success of the end customers for these products in the market place. The current global downturn makes it difficult for our customers, our suppliers and us to accurately forecast and plan future business activities. Our customers may vary order levels significantly from period to period, request postponements to scheduled delivery dates, modify their orders or reduce lead times, any of which could have a material adverse effect on our business, financial condition or results of operations.

 

We have had fluctuations in quarterly results in the past and may continue to experience such fluctuations in the future.

 

Our quarterly revenue and operating results have varied in the past and may fluctuate in the future due to a number of factors including:

 

 

These factors are often difficult or impossible to forecast or predict, and these or other factors could cause our revenue and expenses to fluctuate over interim periods, increase our operating expenses, or adversely affect our results of operations or business condition.

 

We are vulnerable to undetected product problems.

 

Although we establish and implement test specifications, impose quality standards upon our suppliers and perform separate application-based compatibility and system testing, our products may contain undetected defects, which may or may not be material, and which may or may not have a feasible solution. Although we have experienced such errors in the past, significant errors have generally been detected relatively early in a product’s life cycle and therefore the costs

associated with such errors have been immaterial. We cannot ensure that such errors will not be found from time to time in new or enhanced products after commencement of commercial shipments. These problems may materially adversely affect our business by causing us to incur significant warranty and repair costs, diverting the attention of our engineering personnel from our product development efforts and causing significant customer relations problems. Defects or other performance problems in our products could result in financial or other damages to our customers or could damage market acceptance of our products. Our customers could seek damages from us for their losses as a result of problems with our products or order less of our products, which would harm our financial results.

 

Our success depends in part on our ability to protect our intellectual property rights, which may be difficult.

 

The digital media market is a highly competitive industry in which we, and most other participants, rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect proprietary rights. The competitive nature of our industry, rapidly changing technology, frequent new product introductions, changes in customer requirements and evolving industry standards heighten the importance of protecting proprietary technology rights. Since patent applications with the United States Patent and Trademark Office may be kept confidential, our pending patent applications may attempt to protect proprietary technology claimed in a third-party patent application.

 

Our existing and future patents may not be sufficiently broad to protect our proprietary technologies as policing unauthorized use of our products is difficult. The laws of certain foreign countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of piracy of our technology and products more likely in these countries. Our competitors may independently develop similar technology, duplicate our products or design around any of our patents or other intellectual property. If we are unable to adequately protect our proprietary technology rights, others may be able to use our proprietary technology without having to compensate us, which could reduce our revenues and negatively impact our ability to compete effectively. We have filed in the past, and may file in the future, lawsuits to enforce our intellectual property rights or to determine the validity or scope of the proprietary rights of others. As a result of any such litigation or resulting counterclaims, we could lose our proprietary rights and incur substantial unexpected operating costs. Any action we take to protect our intellectual property rights could be costly and could absorb significant management time and attention. In addition, failure to adequately protect our trademark rights could impair our brand identity and our ability to compete effectively.

 

The television systems and set-top box business lines that we acquired from NXP depend on patents and other intellectual property rights to protect against misappropriation by competitors or others. The patents we have acquired as part of the acquired business lines may be insufficient to provide meaningful protection. We may not be able to obtain patent protection or secure other intellectual property rights in all the countries in which the acquired business lines operate, and, under the laws of such countries, patents and other intellectual property rights may be unavailable or limited in scope. Any inability to adequately protect the intellectual property rights of the acquired business lines may have an adverse effect on our results.

 

We have been involved in intellectual property infringement claims, and may be involved in other claims in the future, which can be costly.

 

Our industry is very competitive and is characterized by frequent litigation alleging infringement of intellectual property rights. Numerous patents in our industry have already been issued and as the market further develops and additional intellectual property protection is obtained by participants in our industry, litigation is likely to become more frequent. From time to time, third parties have asserted and are likely in the future to assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business. Historically we have been involved in such disputes. For example, in March 2010, Intravisual Inc. filed complaints against us and multiple other defendants, including NXP, in the United States District Court for the Eastern District of Texas, No. 2:10-CV-90 TJW alleging that certain Trident video decoding products infringe a patent relating generally to compressing and decompressing digital video. The complaint seeks a permanent injunction against us as well as the recovery of monetary damages and attorneys’ fees. We filed an answer on

May 28, 2010, however, no date for trial has been set. The pending proceeding involves complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to defend. In addition, we have and may in the future enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. Litigation or other disputes or negotiations arising from claims asserting that our products infringe or may infringe the proprietary rights of third parties, whether with or without merit, has been and may in the future be, time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel. We do not have insurance against any alleged infringement of intellectual property of others. Any such claims that may be filed against us in the future, if resolved adversely to us, could cause us to stop sales of our products which incorporate the challenged intellectual property and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements. These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all. If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely and reasonable basis, our business could be harmed.

 

Certain intellectual property used in the television systems and set-top box business lines acquired from NXP was transferred or licensed to NXP from Philips and may not be sufficient to protect the position of the acquired business lines in the industry.

 

Some of the intellectual property that we acquired from NXP was originally acquired by NXP in connection with its separation from Koninklijke Philips Electronics N.V., or Philips. In connection with the separation of NXP from Philips, Philips transferred a set of patent families to NXP, subject to certain limitations. These limitations give Philips the right to sublicense to third parties in certain circumstances. The strength and value of this intellectual property may be diluted if Philips licenses or otherwise transfers such intellectual property or such rights to third parties, especially if such third parties compete with the acquired business lines.

 

If necessary licenses of third-party technology are not available to us or are very expensive, our products could become obsolete.

 

From time to time, we may be required to license technology from third parties to develop new products or enhance current products. Third-party licenses may not be available on commercially reasonable terms, if at all. If we are unable to obtain any third-party license required to develop new products and enhance current products, or if our licensor’s technology is no longer available to us because it is determined to infringe another third-party’s intellectual property rights, we may have to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm the competitiveness of our products.

 

The market price of our common stock has been, and may continue to be, volatile.

 

The market price of our common stock has been, and may continue to be volatile. Factors such as new product announcements by us or our competitors, quarterly fluctuations in our operating results, changes in our senior management, unfavorable conditions in the digital media market, failure to obtain design wins, industry consolidation, wafer supply constraints, and any litigation or regulatory actions arising in connection with these matters, may have a significant impact on the market price of our common stock.

 

These conditions, as well as factors that generally affect the market for publicly traded securities, particularly those of high-technology companies, could cause the price of our stock to fluctuate from time to time.

 

Our operating results may be adversely affected by the European financial restructuring and related global economic conditions.

 

The current debt crisis and related European financial restructuring efforts may cause the value of the Euro to further deteriorate, thus reducing the purchasing power of European customers. In addition, this European crisis is contributing to instability in global credit markets. The world has recently experienced a global macroeconomic downturn, and if global economic and market conditions, or economic conditions in Europe, the U.S. or other key

markets, remain uncertain, persist, or deteriorate further, we may experience material impacts on our business, operating results, and financial condition.

 

We currently rely on certain international customers for a substantial portion of our revenue and are subject to risks inherent in conducting business outside of the U.S.

 

As a result of our focus on digital media products, we expect to be primarily dependent on international sales and operations, particularly in Japan, South Korea, Europe, and Asia Pacific. Our revenues may continue to be highly concentrated in a small number of geographic regions in the future. There are a number of risks arising from our international business, which could adversely affect future results, including:

 

 

Our international sales for the year ended December 31, 2010, are principally U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. We cannot be sure that those of our international customers who currently place orders in U.S. dollars will continue to be willing to do so. If they do not, our revenues would become subject to foreign exchange fluctuations.

 

Changes in, or interpretations of, tax rules and regulations may adversely affect our effective tax rates.

 

Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be unfavorably affected by changes in tax laws or the interpretation of tax laws, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities. We are also subject to the interpretations of foreign regulatory bodies in connection with reviews conducted of our subsidiaries and their operations. While we believe our tax reserves adequately provide for any tax contingencies, the ultimate outcomes of any current or future tax audits are uncertain, and we can give no assurance as to whether an adverse result from one or more of them will have a material effect on our financial position, results of operation or cash flows.

 

Our operations are vulnerable to interruption or loss due to natural disasters, power loss, strikes and other events beyond our control, which would adversely affect our business.

 

We conduct a significant portion of our activities including manufacturing, administration and data processing at facilities located in the State of California, Taiwan and other seismically active areas that have experienced major earthquakes in the past, as well as other natural disasters. The insurance coverage may not be adequate or continue to be available at commercially reasonable rates and terms. A major earthquake or other disaster affecting our suppliers’ facilities and our administrative offices could significantly disrupt our operations, and delay or prevent product manufacture and shipment during the time required to repair, rebuild or replace our suppliers’ manufacturing facilities and our administrative offices; these delays could be lengthy and result in significant expenses. In addition, our administrative offices in the State of California may be subject to a shortage of available electrical power and other energy supplies. Any shortages may increase our costs for power and energy supplies or could result in blackouts, which could disrupt the operations of our affected facilities and harm our business. In addition, our products are typically shipped from a limited number of ports, and any natural disaster, strike or other event blocking shipment from these ports could delay or prevent shipments and harm our business.

 

None.

 

 

Information regarding our principal properties as of December 31, 2010 is set forth below:

 

 

 

 

As of December 31, 2010, we owned or leased a total of approximately 445,243 square feet of space worldwide including the locations listed above and office space for smaller sales and service offices in several locations throughout the world. Our operating leases expire at various times through August 31, 2019. Additional information regarding these leases is incorporated herein by reference from Note 6, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements. We believe our properties are adequately maintained and suitable for our intended use.

 

 

Intellectual Property Proceedings

 

In March 2010, Intravisual Inc. filed complaints against Trident and multiple other defendants, including NXP, in the United States District Court for the Eastern District of Texas, No. 2:10-CV-90 TJW alleging that certain Trident video decoding products infringe a patent relating generally to compressing and decompressing digital video. The complaint seeks a permanent injunction against Trident as well as the recovery of unspecified monetary damages and attorneys’ fees. On May 28, 2010, Trident filed its answer, affirmative defenses and counterclaims. No date for trial has been set. We intend to contest this action vigorously. Because this action is in the very early stages, and due to the inherent uncertainty surrounding the litigation process, we are unable to reasonably estimate the ultimate outcome of this litigation at this time.

 

Shareholder Derivative Litigation

 

Trident has been named as a nominal defendant in several purported shareholder derivative lawsuits concerning the granting of stock options. The federal court cases have been consolidated as In re Trident Microsystems Inc. Derivative Litigation, Master File No. C-06-3440-JF. Plaintiffs in all cases alleged that certain of our current or former officers and directors caused us to grant options at less than fair market value, contrary to our public statements (including its financial statements); and that as a result those officers and directors are liable to us. No particular amount of damages has been alleged, and by the nature of the lawsuit no damages will be alleged against us. Our Board of Directors appointed a Special Litigation Committee (“SLC”) composed solely of independent directors to review and manage any claims that we may have relating to the stock option grant practices investigated by the Special Committee. The scope of the SLC’s authority includes the claims asserted in the derivative actions.

 

On March 26, 2010, the federal court approved settlements with all defendants other than Frank Lin, our former CEO. The details of that partial settlement, which disposed of the federal litigation as to all individual defendants other than Mr. Lin and as to the consolidated state court action in its entirety, were previously disclosed in our Form 8-K filed on February 10, 2010.

 

On June 8, 2010, Mr. Lin filed a counterclaim against Trident. In that counterclaim, Mr. Lin sought recovery of payments he claimed he was promised during the negotiations surrounding his eventual termination and also losses he claimed he has suffered because he was not permitted to exercise his Trident stock options between January 2007 and March 2008. On February 11, 2011, we entered into a settlement agreement with Mr. Lin regarding his counterclaims, contingent on the settlement of the derivative litigation pursuant to certain terms.

On February 15, 2011, we entered into a Stipulation of Settlement to resolve the federal litigation in its entirety, or Proposed Settlement, and on February 17, 2011, the federal court preliminarily approved the Proposed Settlement. A hearing for consideration of final approval of the Proposed Settlement has been scheduled for April 15, 2011 at 9:00 a.m. in Courtroom 3 of the United States District Court in San Jose, California. Final approval, without appeal, of the Proposed Settlement would satisfy the contingency in the settlement of Mr. Lin’s counterclaims against us. We cannot predict whether the federal court will order the final approval of the Proposed Settlement and, if it does, whether such decision will be appealed. As a result, we cannot predict whether Mr. Lin’s counterclaims against us in the federal litigation are likely to result in any material recovery by or expense to Trident. We expect to continue to incur legal fees in responding to this lawsuit and related to the Proposed Settlement, including expenses for the reimbursement of certain legal fees of at least Mr. Lin under our advancement obligations. The expense of defending such litigation may be significant. The amount of time to resolve this and any additional lawsuits is unpredictable and these actions may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows.

 

Regulatory Actions

 

As previously disclosed, we were subject to a formal investigation by the Securities and Exchange Commission, or SEC, in connection with its investigation into our historical stock option granting practices and related issues. On July 16, 2010, we entered into a settlement with the SEC regarding this investigation. We agreed to settle with the SEC without admitting or denying the allegations in the SEC’s complaint. We consented to entry of a permanent injunction against future violations of anti-fraud provisions, reporting provisions and the books and records requirements of the Securities Exchange Act of 1934 and the Securities Act of 1933. On July 19, 2010, the U.S. District Court for the District of Columbia entered a final judgment incorporating the judgment consented to by us. The final judgment did not require us to pay a civil penalty or other money damages. . Pursuant to the same judgment, we received a payment of $817,509 from Mr. Lin, representing $650,772 in disgorged profits gained as a result of conduct alleged by the SEC in its civil complaint against him, together with prejudgment interest thereon of $166,737. Although the Department of Justice, or DOJ, commenced an informal investigation relating to the same issues, the DOJ has not requested information from us since February 20, 2009 and we believe that the DOJ has concluded its investigation without taking any action against us. We believe that the settlement with the SEC concluded the government’s investigations into our historical stock option practices.

 

Special Litigation Committee

 

Effective at the close of trading on September 25, 2006, we temporarily suspended the ability of optionees to exercise vested options to purchase shares of our common stock, until we became current in the filing of our periodic reports with the SEC and filed a Registration Statement on Form S-8 for the shares issuable under the 2006 Plan, or 2006 Plan S-8. This suspension continued in effect through August 22, 2007, the date of the filing of the 2006 Plan S-8, which followed our filing, on August 21, 2007, of our Quarterly Reports on Form 10-Q for the periods ended September 30, 2006, December 31, 2006 and March 31, 2007. As a result, we extended the exercise period of approximately 550,000 fully vested options held by 10 employees, who were terminated during the suspension period, giving them either 30 days or 90 days after we became current in the filings of our periodic reports with the SEC and filed the 2006 Plan S-8 in order to exercise their vested options. During the three months ended September 30, 2007, eight of these ten former employees stated above exercised all of their vested options. However, on September 21, 2007, the SLC decided that it was in the best interests of our stockholders not to allow the remaining two former employees, as well as our former CEO and two former non-employee directors, to exercise their vested options during the pendency of the SLC’s proceedings, and extended, until March 31, 2008, the period during which these five former employees could exercise approximately 428,000 of their fully vested options. Moreover, the SLC allowed one former employee to exercise all of his fully vested stock options and another former employee agreed to cancel all of such individual’s fully vested stock options during the three months ended March 31, 2008.

 

On January 31, 2008, the SLC extended, until August 31, 2008, the period during which the two former non-employee directors could exercise their unexpired vested options. On March 31, 2008, the SLC entered into an

agreement with our former CEO allowing him to exercise all of his fully vested stock options. Under this agreement, he agreed that any shares obtained through these exercises or net proceeds obtained through the sale of such shares would be placed in an identified securities brokerage account and not withdrawn, transferred or otherwise removed without either (i) a court order granting him permission to do so or (ii) the written permission of us.

 

On May 29, 2008, the SLC permitted one of our former non-employee directors to exercise his fully vested stock and entered into an agreement with the other former non-employee director on terms similar to the agreement entered into with our former CEO, allowing him to exercise all of his fully vested stock options. Because Trident’s stock price as of June 30, 2008 was lower than the prices at which our former CEO and each of the two former non-employee directors had desired to exercise their options, as indicated in previous written notices to the SLC, we recorded a contingent liability in accordance accounting guidance, totaling $4.3 million, which was included in “Accrued expenses and other current liabilities” in the Consolidated Balance Sheet as of June 30, 2008 and the related expenses were included in “Selling, general and administrative expenses” in the Consolidated Statement of Operations for the year then ended. Following the March 2010 partial settlement of the derivative litigation, which included a release of claims by our two former non-employee directors, we reduced the contingent liability by $1.5 million. However, because the derivative litigation is still pending with respect to Mr. Lin, who may seek compensation from us relating to the exercise of his fully vested stock options in the event that the Proposed Settlement entered into during February 2011 is either not finally approved by the federal court or successfully appealed thereafter; a $2.8 million contingent liability remained in “Accrued expenses and other current liabilities” in the Consolidated Balance Sheet as of December 31, 2010.

 

Indemnification Obligations

 

We indemnify, as permitted under Delaware law and in accordance with our Bylaws, our officers, directors and members of our senior management for certain events or occurrences, subject to certain limits, while they were serving at our request in such capacity. In this regard, we have received, or expect to receive, requests for indemnification by certain current and former officers, directors and employees in connection with our investigation of our historical stock option granting practices and related issues, and the related governmental inquiries and shareholder derivative litigation. The maximum amount of potential future indemnification is unknown and potentially unlimited; therefore, it cannot be estimated. We have directors’ and officers’ liability insurance policies that may enable us to recover a portion of such future indemnification claims paid, subject to coverage limitations of the policies, and plan to make claim for reimbursement from our insurers of any potentially covered future indemnification payments.

 

Commercial Litigation

 

In June 2010, Exatel Visual Systems, Ltd (“Exatel”) filed a complaint against Trident and NXP Semiconductors USA, Inc. (“NXP”), in Superior Court for the State of California, No. 1-10-CV-174333, alleging the following five counts: (1) breach of contract, (2) breach of implied covenant of good faith and fair dealing, (3) fraud by misrepresentation and concealment, (4) negligent misrepresentation, and (5) breach of fiduciary duty. The complaint arises from a series of alleged transactions between Exatel and NXP’s predecessor, Conexant Systems, Inc. pertaining to a joint product development project they undertook commencing in 2007. Trident and NXP have each tendered an indemnity claim to the other for damages and fees arising out of the lawsuit pursuant to a contractual indemnity agreement between them. Both have refused. We have filed a demurrer seeking to dismiss the lawsuit primarily on the grounds that we are not a party to any contract with Exatel. Prior to the hearing on demurrer, Exatel dismissed NXP without prejudice from the lawsuit and agreed to arbitration after NXP filed a motion to compel arbitration for the claims against it pursuant to contractual arbitration provisions within the relevant contracts. On December 7, 2010, the court sustained our demurrer as to all causes of action, with leave to amend. Exatel has filed an amended complaint. We will demur again, with the hearing set for June 23, 2011. Because this action is in the very early stages, and due to the inherent uncertainty surrounding the litigation process, we are unable to reasonably estimate the ultimate outcome of this litigation at this time.

General

 

From time to time, we are involved in other legal proceedings arising in the ordinary course of our business. While we cannot be certain about the ultimate outcome of any litigation, management does not believe any pending legal proceeding will result in a judgment or settlement that will have a material adverse effect on our business, financial position, results of operation or cash flows.

 

 

Market Information and Holders

 

Our common stock has been traded on the NASDAQ Global Select Market since our initial public offering on December 16, 1992 under the symbol “TRID.” The following table sets forth, for the periods indicated, the quarterly high and low sales prices for our common stock as reported by NASDAQ:

 

 

Approximate Number of Stockholders

 

As of December 31, 2010 and December 31, 2009, there were 70 and 166 registered holders of record of our common stock, respectively. The number of beneficial stockholders of our shares is greater than the number of stockholders of record.

 

Dividends

 

Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends.

 

Issuer Repurchases of Equity Securities

 

We did not repurchase any of our equity securities during the year ended December 31, 2010. However, from time to time we evaluate whether to repurchase our equity securities.

Stock Performance Graphs and Cumulative Total Return

 

The following graph compares the cumulative 5 year total return attained by shareholders of our common stock relative to the cumulative total returns of the NASDAQ Composite Index and the Philadelphia Semiconductor Index for the year ended December 31, 2010 and each of the last five years, assuming an investment of $100 at the beginning of such period and the reinvestment of any dividends. The comparisons in the graphs below are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common stock.

 

COMPARISON OF 5 YEARS CUMULATIVE RETURN
Among Trident Microsystems, Inc., The NASDAQ Composite Index and
The Philadelphia Semiconductor Sector Index

 

 

 

 

Change in Fiscal Year End

 

The following selected financial data should be read in conjunction with our financial statements and the notes thereto, and with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The consolidated statements of operations data and consolidated balance sheet data have been derived from and should be read in conjunction with our audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. As previously announced, in 2009, we changed our fiscal year end to December 31 from June 30. We made this change to better align our financial reporting period, as well as our annual planning and budgeting process, with our business cycle. The change became effective at the end of the quarter ended December 31, 2009. All references to “years”, unless otherwise noted, refer to the 12-month fiscal year, which prior to July 1, 2009, ended on June 30, and beginning with December 31, 2009, ends on December 31, of each year.

 

The following tables include selected consolidated summary financial data for the year ended December 31, 2010 and each of the last five years.

 

TRIDENT MICROSYSTEMS, INC.
SELECTED CONSOLIDATED FINANCIAL DATA

 

 

 

 

 

Forward-Looking Statements

 

This section and other parts of this Report on Form 10-K contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking

statements. Factors that might cause such differences include, but are not limited to, those discussed in “Item 1A — Risk Factors” above. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of this report. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes to consolidated financial statements included elsewhere in this Form 10-K. This Report on Form 10-K contains forward — looking statements that involve risks and uncertainties. See the disclosure regarding “Forward-Looking Statements” on page 3 of this Form 10-K. All references to “years”, unless otherwise noted, refer to the 12-month calendar year. For example a reference to “2010” or “fiscal year 2010” means the 12-month period that ended on December 31, 2010.

 

Change in Fiscal Year End

 

As previously announced, on November 16, 2009, we changed our fiscal year end to December 31 from June 30. We made this change to better align our financial reporting period, as well as our annual planning and budgeting process, with our business cycle. This Form 10-K reports our financial results for the year ended December 31, 2010. Our financial results for the comparable year ended December 31, 2009 have not been audited. All references to “years”, unless otherwise noted, refer to the 12-month fiscal year, which prior to July 1, 2009, ended on June 30, and beginning with December 31, 2009, ends on December 31, of each year.

 

Overview

 

Trident Microsystems, Inc. (including our subsidiaries, referred to collectively in this Report as “Trident,” “we,” “our” and “us”) is a provider of high-performance multimedia semiconductor solutions for the digital home entertainment market. We design, develop and market integrated circuits, or ICs, and related software for home consumer electronics applications such as digital TVs (DTV), PC and analog TVs, and set-top boxes. Our product line includes system-on-a-chip, or SoC, semiconductors that provide completely integrated solutions for managing digital content from multiple sources and processing and optimizing video, audio and computer graphic signals to produce high-quality and realistic images and sound. Our products also include frame rate converter, or FRC, demodulator or DRX and audio decoder products, interface devices and media processors. Trident’s customers include many of the world’s leading original equipment manufacturers, or OEMs, of consumer electronics, computer display and set-top box products. Our goal is to become a leading provider for the “connected home,” with innovative semiconductor solutions that make it possible for consumers to access their entertainment and content (music, pictures, internet, data) anywhere and at any time throughout the home.

 

Although our revenues grew substantially in 2010, revenues in the fourth quarter ended December 31, 2010 declined 33 percent from the prior sequential quarter. Our TV-related revenues typically decline sequentially due to seasonal factors in the calendar fourth and first quarters of every year. However our revenue decline in the fourth quarter exceeded the normal seasonal pattern. We believe that capacity constraints at our foundry partners generally led to over-ordering earlier in 2010 as our customers had high expectations for consumer demand for higher-end TVs, including TVs featuring 3-D technology. When this consumer demand did not materialize as expected, our FRC and SOC business turned down dramatically in Q4. In addition, we lost market share with our largest customer as a result of the capacity constraints in 2010, which led to lower revenues from this customer in the fourth quarter of 2010 and will result in significantly reduced revenues from this customer in 2011. Finally, in the fourth quarter of 2010, we experienced weak sales of our standard definition set-top box products that are sold in the non-cable and non-satellite operator channels. We expect these factors as well as slower than expected program ramp-up and a weaker retail segment for our set-top box products to negatively impact our financial results in the first quarter ending March 31, 2011 and in general we believe that the first half of calendar 2011 will be challenging.

 

We ended the year ended December 31, 2010 with cash and cash equivalents of $93.2 million, consisting of cash and money market funds invested in U.S. treasuries. Our primary source of liquidity is our current cash balance and we expect a significant decline in our cash balance during the first half of calendar 2011. On February 9, 2011, we entered into a $40 million revolving line of credit agreement with Bank of America, N.A., to finance working capital. The new credit facility matures in February 2014. However, this credit facility has restrictive financial

covenants which would initially preclude us from accessing funds under the credit facility in excess of our cash and equivalent resources. Our current cash balance together with our new revolving credit facility, should provide us with adequate resources to fund our anticipated ongoing cash requirements.

 

We have and may continue to access external financing from time to time depending on our cash requirements, assessments of current and anticipated market conditions and after-tax cost of capital. Our access to capital markets can be impacted by factors outside our control, including economic conditions and there are no guarantees that funds will be available at terms that will be acceptable to us.

 

We expect to ramp new products and customer programs in the second half of 2011 and will see the benefit of ongoing cost reduction activities, with the goal of positioning us for cash flow positive operations in the second half of calendar 2011.

 

Recent Acquisitions

 

On May 14, 2009, we completed our acquisition of selected assets of the frame rate converter, or FRC, demodulator, or DRX, and audio decoder product lines from Micronas Semiconductor Holding AG, or Micronas, a Swiss corporation. In connection with the acquisition, we issued 7.0 million shares of our common stock and warrants to acquire up to 3.0 million additional shares of our common stock, with a combined fair value of approximately $12.1 million, and incurred approximately $5.2 million of acquisition-related transaction costs and liabilities, for a total purchase price of approximately $17.3 million. In connection with the acquisition, we established three new subsidiaries in Europe, Trident Microsystems (Europe) GmbH, or TMEU, Trident Microsystems Nederland B.V., or TMNM, and Trident Microsystems Holding B.V., or TMH, to primarily provide sales liaison, marketing and engineering services in Europe. TMEU is located in Freiburg, Germany and TMNM and TMH are located in Nijmegen, The Netherlands.

 

On February 8, 2010, we and our wholly-owned subsidiary Trident Microsystems, (Far East), Ltd., or TMFE, a corporation organized under the laws of the Cayman Islands, completed the acquisition of the television systems and set-top box business lines from NXP B.V., a Dutch besloten vennootschap, or NXP. As a result of the acquisition, we issued 104,204,348 shares of Trident common stock to NXP, equal to 60% of our total outstanding shares of Common Stock, after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines from NXP and cash proceeds in the amount of $44 million. In accordance with U.S. generally accepted accounting principles, the closing price on February 8, 2010 was used to value Trident common stock issued which is traded in an active market and considered a level 1 input. In addition, we issued to NXP four shares of a newly created Series B Preferred Stock or the Preferred Shares.

 

The purchase price and fair value of the consideration transferred by Trident was $140.8 million. For details of the acquisition, see Note 13, “Business Combinations,” of Notes to Consolidated Financial Statements.

 

Critical Accounting Estimates

 

The preparation of our financial statements and related disclosures in conformity with US Generally Accepted Accounting Principles, or “GAAP”, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. References included in this Form 10-K to “accounting guidance” means GAAP. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our accounting policies and estimates and make adjustments when facts and circumstances dictate. In addition to the accounting policies that are more fully described in the Notes to Consolidated Financial Statements included in this Report on Form 10-K, we consider the critical accounting policies described below to be affected by critical accounting estimates. Our critical accounting policies that are affected by accounting estimates include revenue recognition, stock-based compensation expense, goodwill and acquired intangible assets, long-lived assets, inventories, fair value measurements, product warranty, income taxes, litigation and other loss contingencies and business combinations. Such accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements, and actual results could differ materially from these estimates. For a discussion of how these estimates and other factors may affect our business, also see “Risk Factors” In Item 1A.

Revenue Recognition

 

We recognize revenues in accordance with GAAP when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured.

 

A portion of our sales are made through distributors under agreements allowing for rights of return. We defer recognition of product revenue and costs from sales to significant distributors which contain such rights of return until the products are resold by the distributor to the end user customers. Our revenue reporting is highly dependent on receiving pertinent and accurate data from such distributors in a timely fashion. Distributors provide us with periodic data regarding the product, price, quantity, and end customer when products are resold as well as the quantities of our products they still have in stock. At times, we must use estimates and apply judgments to reconcile distributors’ reported inventories to their activities. Any error in our judgment could lead to inaccurate reporting of our revenues, deferred income and allowances on sales to distributors, and net income.

 

We record estimated reductions to revenue for customer incentive offerings and sales returns allowance in the same period that the related revenue is recognized. Our customer incentive offerings primarily involve volume rebates for our products in various target markets. If market conditions were to decline, we may take actions to increase customer incentive offerings, possibly resulting in an incremental reduction of revenue at the time the incentive is offered. Our sales returns allowance for estimated product returns is based primarily on historical sales returns, analysis of credit memo data and other known factors at that time. If product returns for a particular year exceed historical return rates, we may determine that additional sales returns allowance are required to properly reflect our estimated exposure for product returns.

 

Stock-based Compensation Expense

 

We account for share-based payments, including grants of stock options and awards to employees and directors, in accordance with GAAP, which requires that share-based payments be recognized in our consolidated statements of operations based on their fair values and the estimated number of shares we ultimately expect will vest. In addition, we recognize stock-based compensation expense on a straight-line basis over the service period of all stock options and awards other than the performance-based awards with market conditions that are expensed using the accelerated method.

 

We value our stock-based compensation awards using the Black-Scholes option pricing model, except for performance-based options with market conditions, for which we use a Monte Carlo simulation to value the award. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model requires the input of certain assumptions. Trident’s stock options have characteristics significantly different from those of traded options. Changes in the assumptions used in Black-Scholes model can materially affect the fair value estimates. The expected term of stock options represents the weighted average period the stock options are expected to remain outstanding. The expected term is based on the observed and expected time to exercise and post-vesting cancellations of options by employees. We use historical volatility in deriving our expected volatility assumption as allowed under GAAP because we believe that future volatility over the expected term of the stock options is not likely to differ materially from the past. The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of our stock options. The expected dividend assumption is based on our history and expectation of not paying dividends in the foreseeable future.

 

Goodwill and Acquired Intangible Assets

 

We record goodwill when the consideration paid for an acquisition exceeds the fair value of net tangible and intangible assets acquired. We record gains on acquisitions when the fair value of net tangible and intangible assets acquired exceeds the consideration paid for an acquisition. We amortize acquisition-related identified intangibles on a straight-line basis, reflecting the pattern in which the economic benefits of the intangible asset is consumed, over their estimated economic lives of 4 to 5 years for core and developed technology, 2 to 3 years for customer relationships, 1 year for backlog, 4 to 5 years for patents and the contractual term for service agreements.

Goodwill is not amortized. However, we measure and test goodwill on an annual basis during the quarter ended June 30 or more frequently if we believe indicators of impairment exist. The performance of the test involves a two-step process. Each step requires us to make judgments and involves the use of significant estimates and assumptions, we believe to be reasonable but that are unpredictable and inherently uncertain.

 

The first step requires comparing the fair value of the reporting unit to its net book value, including goodwill. We operate under two reporting units, television systems and set top boxes. To determine the fair values of the reporting units used in the first step, we use a discounted cash flow approach. A potential impairment exists if the fair value of the reporting unit is lower than its net book value. The television systems reporting unit failed step one of the annual goodwill impairment test at June 30, 2010. We perform the second step of the process, and it involved determining the difference between the fair value of the reporting unit’s net assets other than goodwill to the fair value of the reporting unit and the difference was less than the net book value of goodwill. Consequently, we recorded an impairment of Goodwill.

 

We have acquired in-process research and development, or IPR&D, projects as the result of our business combinations. The fair values of the acquired IPR&D projects were determined through estimates and valuation techniques based on the terms and details of the related acquisitions. The amounts allocated to IPR&D projects are not expensed until technological feasibility is reached for each project. Upon completion of development for each project, the acquired IPR&D will be amortized over its useful life.

 

Long-lived Assets.

 

We account for long-lived assets, including other purchased finite-lived intangible assets, in accordance with current authoritative guidance, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns in the semiconductor industry, are present. Reviews are performed to determine whether the carrying value of an asset is impaired, based on comparisons to undiscounted expected future cash flows. If this comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using: (1) quoted market prices or (2) discounted expected future cash flows. Impairment is based on the excess of the carrying amount over the fair value of those assets. Our estimates regarding future anticipated net revenue and cash flows, the remaining economic life of the products and technologies, or both, may differ from those used to assess the recoverability of assets. In that event, impairment charges or shortened useful lives of certain long-lived assets may be required, resulting in a reduction in net income or an increase to net loss in the period when such determinations are made.

 

Inventories

 

Inventories are computed using the lower of cost or market, which approximates actual cost on a first-in-first-out basis. Inventory components are work-in-process and finished goods. Finished goods are reported as inventories until the point of title transfer to the customer. We write down our inventory value for excess and for estimated obsolescence for the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand, and such differences may have a material effect on recorded inventory values. At December 31, 2010, we had an inventory reserve balance of $4.6 million. In addition, we recorded a $2.8 million liability for ordered product with no expected demand from customers for the year ended December 31, 2010.

 

Income Taxes

 

We account for income taxes in accordance with applicable accounting guidance, which requires that deferred tax assets and liabilities be recognized by using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities.

 

We also have to assess the likelihood that we will be able to realize our deferred tax assets. If realization is not more likely than not, we are required to record a valuation allowance against the deferred tax assets that we estimate

we will not ultimately realize. We believe that we will not ultimately realize a substantial amount of the deferred tax assets recorded on our consolidated balance sheets. However, should there be a change in our ability to realize our deferred tax assets, our valuation allowance will be released, resulting in a corresponding reduction in income tax expense in the period in which we determined that the realization is more likely than not.

 

Under GAAP, we are required to make certain estimates and judgments in determining income tax expense for financial statement purposes. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on the two-step process prescribed within the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Because we are required to determine the probability of various possible outcomes, such estimates are inherently difficult and subjective. We reevaluate these uncertain tax positions on a quarterly basis based on factors including, but not limited to, changes in facts or circumstances and changes in tax law. A change in recognition or measurement would result either in the recognition of a tax benefit or in an additional charge to the tax provision for the period.

 

Business Combinations

 

We estimate the fair value of assets acquired and liabilities assumed in a business combination. Our assessment of the estimated fair value of each of these might have a significant effect on our reported results as intangible assets are amortized over various lives. Furthermore, a change in the estimated fair value of an asset or liability often has a direct impact on the amount to recognize as goodwill, which is an asset that is not amortized. Often determining the fair value of these assets and liabilities assumed requires an assessment of expected use of the asset, the expected cost to extinguish the liability or our expectations related to the timing and the successful completion of development of an acquired in-process technology. Such estimates are inherently difficult and subjective and can have a material impact on our financial statements.

 

Results of Operations

 

Our results of operations for the year ended December 31, 2010, year ended December 31, 2009 (unaudited) and the years ended June 30, 2009 and 2008, respectively, were as follows:

 

 

The scale of our business has expanded significantly as a result of the acquisition of the NXP TV and Set Top Box product lines in February 2010 and, to a lesser extent, the Micronas Frame Rate Converter, Demodulator, and Audio Decoder product lines in May 2009. This is reflected in prior-year comparisons of most operating metrics for the years ended December 31, 2010 and 2009 (unaudited).

 

Revenues for the year ended December 31, 2010 increased to $557.2 million compared to $84.8 million (unaudited) in the year ended December 31, 2009 and $75.8 million in the year ended June 30, 2009. Revenues in the year ended December 31, 2010 increased over the year ended December 31, 2009 primarily as a result of revenue contributions from the acquired NXP products. In addition, we realized significant revenue in 2010 from its Pro SA-1 product, which was new in 2010 and was based on existing Trident technology as well as acquired Micronas audio and demod technology. We also benefited from a full year of revenue contribution from the Micronas products acquired in May 2009.

 

Net loss for the year ended December 31, 2010 was $128.9 million compared to a net loss of $78.2 million (unaudited) for the year ended December 31, 2009 and a net loss of $70.2 million for the year ended June 30, 2009.

The increased loss in 2010 compared with 2009 is primarily the result of increased amortization of intangible assets acquired in the NXP transaction of $55.7 million, restructuring costs of $28.3 million, goodwill impairment of $7.9 million and significantly higher operating expenses related to the acquired NXP product lines, particularly labor costs related to the addition of former NXP employees and transitional support services from NXP. The increase was partially offset by a gain on acquisition of the NXP product lines of $43.4 million.

 

Financial Data for the Year Ended December 31, 2010 and 2009 (unaudited).

 

Net Revenues

 

Digital media product solutions revenues represented all of our revenues for the year ended December 31, 2010 and year ended December 31, 2009 (unaudited). Our digital media solutions products include integrated circuit chips used in digital television and liquid crystal display television, or LCD TV, as well as set-top boxes. Net revenues are revenues less reductions for rebates and allowances for sales returns.

 

The following tables present the comparison of net revenues by regions in dollars and in percentages for the year ended December 31, 2010 and 2009 (unaudited):

 

Net revenues comparison by dollars

 

 

Net revenues comparison by percentage of total net revenues

 

 

 

 

During the year ended December 31, 2010 compared to the year ended December 31, 2009, net revenues increased in all regions. The increase in all regions is primarily attributable to revenues resulting from the acquisition of the NXP product lines in February of 2010 and the Trident Micronas SA1 new product revenue.

Our commitments to and from customers are typically of very limited duration and customer actions can be unpredictable, making impracticable reliable evaluations of trends likely to have a material adverse effect on our financial condition or results of operations.

 

Gross Profit

 

 

Cost of revenues includes the cost of purchasing wafers manufactured by independent foundries, costs associated with our purchase of assembly, test and quality assurance services, royalties, product warranty costs, provisions for excess and obsolete inventories, provisions related to lower of cost or market adjustments for inventories, operation support expenses that consist primarily of personnel-related expenses including payroll, stock-based compensation expenses, and manufacturing costs related principally to the mass production of our products, tester equipment rental and amortization of acquisition-related intangible assets. Gross profit is calculated as net revenues less cost of revenues.

 

Our gross profit margin can vary significantly based on product mix and, to a lesser extent, absorption of our fixed manufacturing support costs.

 

Gross profit dollars increased 464% for the year ended December 31, 2010 compared to the year ended December 31, 2009, principally as a result of the additional revenues from the acquired NXP products. Gross profit margin percentage decreased for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as a result of the amortization of intangible assets acquired from NXP.

 

Gross profit dollars were impacted by intangible asset amortization expense of $48.2 million or 8.7% of net revenues for the year ended December 31, 2010.

 

The net impact on gross profit due to an increase in inventory write-downs and reserves and sales of previously reserved product is as follows:

 

 

In the year ended December 31, 2010 and 2009 (unaudited), as shown in the table above, inventory write-downs and reserves and sales of previously reserved product represents 0.1% and 0.6% (unaudited) of total net revenues respectively.

 

Sales of previously reserved inventory largely depend on the timing of transitions to newer generations of similar products. We typically expect declines in demand of current products when we introduce new products that are designed to enhance or replace our older products. We provide inventory reserves on our older products based on the expected decline in customer purchases of the new product. The timing and volume of the new product introductions can be significantly affected by events outside of our control, including changes in customer product introduction schedules. Accordingly, we may sell older fully reserved product until the customer is able to execute on its changeover plan.

Research and Development

 

 

Research and development expenses consist primarily of personnel-related expenses including payroll expenses, stock-based compensation, engineering costs related principally to the design of our new products and depreciation of property and equipment. Because the number of new designs we release to our third-party foundries can fluctuate from period to period, research, development and related expenses may fluctuate significantly.

 

Research and development expenses increased for the year ended December 31, 2010, compared to the year ended December 31, 2009, primarily due to significant increases in headcount resulting from the acquisition from NXP. As a result of these activities, we incurred $57.8 million of additional headcount related costs for the year ended December 31, 2010 that was not incurred in the year ended December 31, 2009. In addition, during the year ended December 31, 2010, we incurred $21.5 million of additional depreciation and amortization expense compared with the year ended December 31, 2009. Research and development expenses also included $17.6 million of transition service costs related to the acquisition of NXP assets during the year ended December 31, 2010. These transition service costs consisted principally of personnel and facilities provided by NXP. Research and development expenses also included $5.7 million of additional mask tooling costs for the year ended December 31, 2010 that were not incurred during the year ended December 31, 2009.

 

Selling, General and Administrative

 

 

Selling, general and administrative expenses consist primarily of personnel related expenses including stock-based compensation, commissions paid to sales representatives and distributors and professional fees.

 

Selling, general and administrative expenses increased for the year ended December 31, 2010, compared to the same period last year, primarily due to significant increases in headcount from the acquisition of the NXP business lines, as well as subsequent restructuring, attrition, and hiring activity. As a result of these activities, we incurred $21.4 million of additional headcount related costs for the year ended December 31, 2010 that were not incurred in the comparable periods last year. We also incurred $11.5 million of additional professional fees, temporary labor and transition support services-related costs during 2010, not incurred during 2009 principally related the integration of the NXP product line acquisition.

 

Goodwill Impairment

 

 

We assess potential impairment of goodwill on an annual basis, and more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. We performed the annual goodwill impairment analysis and recorded an impairment charge of $7.9 million for the year ended December 31,

2010, due to the excess of the carrying value over the estimated market value for the television systems operating segment. During the three months ended June 30, 2009, an impairment test was conducted due to a redeployment of engineering resources conducted at our subsidiary TMBJ, to focus on other development projects. As a result, we wrote off the entire goodwill balance of TMBJ, and recorded an impairment charge of $1.4 million (unaudited) for the year ended December 31, 2009.

 

In Process Research and Development

 

 

We acquired in-process research and development of $18.0 million in 2010 in connection with the acquisition of the NXP products, which has been capitalized in accordance with the updated business combination guidance, whereas under prior authoritative guidance the amount would have been expensed immediately. During the year ended December 31, 2009, in-process research and development was expensed in connection with the acquisition of certain product lines of Micronas.

 

Restructuring Charges

 

 

During 2010, we implemented restructuring related to integration of the NXP product lines acquisition. The intent of the integration is to retain technical expertise in those geographic locations where we develop unique technology and to transition the majority of our software and SoC development and certain customer support activities to lower cost regions in Asia. As a result of these activities, during 2010 we substantially reduced our headcount in multiple European and U.S. locations and closed facilities in Munich, Germany and Chicago, Illinois. We also moved our corporate headquarters in California to consolidate our local workforce into one facility and restructured the lease of the property we vacated. As a result of these activities, we recorded $28.3 million of restructuring expenses for severance, related employee benefits and costs related to closure of certain facilities.

 

We anticipate conducting additional restructuring in 2011 to further integrate our operations. Restructuring charges are recorded under “Restructuring charges” in our Consolidated Statement of Operations.

 

Prior to the close of our acquisition of selected assets and liabilities of NXP’s television systems and set-top box business lines, NXP initiated a restructuring plan pursuant to which the employment of some NXP employees was terminated upon the close of the merger. We have determined that the restructuring plan was a separate plan from the business combination because the plan to terminate the employment of certain employees was made in contemplation of the acquisition.

 

Therefore, a severance cost of $3.6 million was recognized by us as an expense on the acquisition date and is included in total restructuring charges of $28.3 million for the year ended December 31, 2010. The $3.6 million of severance cost was paid by NXP after the close of the acquisition, effectively reducing the purchase consideration transferred. See Note 13, “Business Combinations,” of Notes to Consolidated Financial Statements.

Interest Income

 

 

We invest our cash and cash equivalents in interest-bearing accounts consisting primarily of certificates of deposits and money market funds investing in U.S. Treasuries.

 

Other Income (Expense), Net

 

 

The increase in other income, net for year ended December 31, 2010, compared to the year ended December 31, 2009 (unaudited), was primarily attributable to (i) a $2.5 million legal settlement of the shareholder derivative lawsuit, as described in Note 6 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, (ii) a $0.4 million increase in gains from the sale of available-for-sale securities, and partially offset by (iii) a $1.9 million foreign currency remeasurement loss related to income taxes payable in foreign jurisdictions, which resulted from the relative weakening of the U.S. dollar in year ended December 31 2010 compared to a $1.5 million foreign currency remeasurement loss in year ended December 31, 2009 (unaudited).

 

Provision for Income Taxes

 

 

A provision for income taxes of $1.1 million and $3.9 million was recorded for the years ended December 31, 2010 and 2009 (unaudited), respectively. The change in our effective tax rate from year ended December 31, 2009 was primarily due to the recognition of the tax benefit resulting from net operating losses in foreign jurisdictions, the release of tax reserves in a foreign jurisdiction associated with the remeasurement of an unrecognized tax benefit due to new information received in the period associated with legal guidance provided, and a lapse of a statute of limitation in the jurisdiction relevant to our business operations.

 

Financial Data for the Years Ended June 30, 2009 and 2008

 

Net Revenues

 

Digital media product revenues represented all of our total revenues in years ended June 30, 2009 and 2008. Our digital media products include integrated circuit chips used in digital television and liquid crystal display television, or LCD TV. Net revenues are revenues less reductions for rebates and allowances for sales returns. The following tables present the comparison of net revenues by regions in dollars and in percentages for the years ended June 30, 2009 and 2008.

Net revenues comparison by dollars

 

 

Net revenues comparison by percentage of total net revenues

 

 

 

 

Digital media product revenues decreased by $182.2 million in the year ended June 30, 2009 compared to the year ended June 30, 2008. In year ended June 30, 2009, total SVP revenues decreased by $188.6 million, while SoC revenues decreased by $1.5 million. These decreases were partially offset by increased revenues of $7.9 million resulting from the sale of FRC, demodulator and audio decoder products that were acquired from Micronas following the acquisition which closed on May 14, 2009. Our unit sales volume of digital media products decreased by 58% in the year ended June 30, 2009 compared to the year ended June 30, 2008 and the year-over-year average selling prices of these products decreased by approximately 29%.

 

During the year ended June 30, 2009, net revenues decreased in all regions. Revenues in South Korea decreased significantly primarily due to a major South Korean customer shifting its strategy to design and produce portions of its silicon products internally rather than outsourcing the design to a third-party vendor. Revenues in Japan and Europe decreased primarily due to the absence of major design wins for our SoC products at tier one customers and lower revenues generated from our existing products that are going to be phased out of production. Revenues in Asia Pacific decreased primarily due to the continued decrease in sales of SVP products and intense price competition in the market where we sell discrete image process controllers. Overall, the revenue decline in the year ended June 30, 2009 was primarily due to decreased sales of our legacy SVP products, the loss of design win opportunities relating to our new SoC products, and to a lesser extent, due to the global economic downturn.

 

Gross Margin

 

Cost of revenues includes the cost of purchasing wafers manufactured by an independent foundry, costs associated with our purchase of assembly, test and quality assurance services, royalties, product warranty costs, provisions for excess and obsolete inventories, operation support expenses that consist primarily of personnel-related expenses including payroll, stock-based compensation expenses, and manufacturing costs related principally to the mass production of our products, tester equipment rental and amortization of acquisition-related intangible assets.

 

Gross margin is calculated as net revenues less cost of revenues as a percentage of net revenue. Gross margin has continued to be impacted by our product mix and volume of product sales, including sales to high volume customers, royalties, competitive pricing programs, product warranty costs, provisions for excess and obsolete inventories, and cost associated with operational support.

 

Gross margin decreased 15.7 percentage points in the year ended June 30, 2009 compared to the year ended June 30, 2008, principally as a result of (i) significantly lower revenues that did not offer the economies of scale needed to cover fixed manufacturing support costs, (ii) a weaker product mix of SVP and SoC products, (iii) write down of acquisition-related intangible assets, and (iv) an increase in intangible assets amortization as a percentage of decreasing revenues.

 

The net impact on gross profit of the increases in inventory write-downs and sales of previously reserved products is as follow:

 

 

In the year ended June 30, 2009, as shown in the table above, revenues from the sale of previously reserved products were $5.1 million or 6.7% of total net revenues. Due to the previously recorded reserves, there was no cost of revenues reflected with respect to these product sales, which in effect, provided a benefit to the current income statement to the extent of the selling price. Concurrently, we recorded additional inventory reserves for year ended June 30, 2009 in the amount of approximately $3.1 million.

 

Sales of previously reserved inventory largely depend on the timing of transitions to newer generations of similar products. When we introduce new products that are designed to enhance or replace our older products, we typically provide inventory reserves on our older products based on the expected timing and volume of customer purchases of the new product. The timing and volume of the new product introductions can be significantly affected by events out of our control, including changes in customer product introduction schedules. Accordingly, we may end up selling more of our older fully reserved product until the customer is able to execute on its changeover plan.

 

Research and Development

 

 

Research and development expenses as a percentage of net revenues increased significantly from the year ended June 30, 2008 to the year ended June 30, 2009 due primarily to the significant decrease in revenues in the year ended June 30, 2009. The increase in research and development expenses for the year ended June 30, 2009 compared to the year ended June 30, 2008 was primarily due to (i) a $4.5 million increase in third-party IP licenses, (ii) a $2.8 million increase in employee-related expenses associated with increased employee headcount in connection with the acquisition in May 2009 and (iii) $1.7 million third-party IP impairment write-off due to a change in business strategy and a change in business use of assets associated with the acquisition, offset by (iv) a

$4.1 million decrease in stock-based compensation expense principally due to certain option modifications and contingent liabilities associated with vested options of certain terminated employees that occurred only during the year ended June 30, 2008, (v) a $2.6 million decrease in new product development expenditures was attributable to a $1.4 million reversal of software license fee adjustment for prior software usage during the year ended June 30, 2009, and (vi) a $1.9 million decrease from lower mask tooling fees due to decrease in production.

 

Selling, General and Administrative

 

 

Selling, general and administrative expenses as a percentage of net revenues increased significantly from the year ended June 30, 2008 to the year ended June 30, 2009 due primarily to the significant decrease in revenues in the year ended June 30, 2009. The decrease in selling, general and administrative expenses for year ended June 30, 2009 compared to year ended June 30, 2008, resulted primarily from (i) a $10.9 million decrease in stock-based compensation expense primarily related to the extension of the option exercise period and contingent liabilities associated with vested options of certain terminated employees that occurred only in year ended June 30, 2008, (ii) a $5.7 million decrease in sales commission paid to distributors’ representatives due to the decreased product sales in year ended June 30, 2009 compared to year ended June 30, 2008, (iii) a $5.3 million decrease in legal and professional fees due to the completion of our investigation into our stock option granting process in September 2007, partially offset by (iv) a $1.5 million increase in salary and payroll-related expense associated with increased employee headcount in the year ended June 30, 2009 compared to the year ended June 30, 2008 and (v) a $1.3 million increase in consulting fees.

 

During the year ended June 30, 2009, we capitalized approximately $4.1 million of legal and professional fees related to due diligence in connection with the acquisition of Micronas.

 

Goodwill Impairment

 

 

During the year ended June 30, 2009, an impairment test was conducted resulting from redeploying our engineering resources in TMBJ and by canceling our STB efforts to better support our focus on SoC development. This factor was considered an indicator of potential impairment, and as a result, we performed an interim impairment analysis of our goodwill. Based on the results of this goodwill impairment analysis, we determined that there would be no remaining implied value attributable to goodwill at TMBJ, and accordingly, we wrote off the entire goodwill balance at TMBJ and recognized goodwill impairment charges of $1.4 million under “Goodwill impairment” in the Consolidated Statement of Operations for year ended June 30, 2009.

 

In-Process Research and Development

 

 

The in-process research and development (“IPR&D”) expense was incurred in connection with the acquisition of certain product lines of Micronas in year ended June 30, 2009. The IPR&D relates to masks and tools that were

completed after the announcement date but prior to the closing date of the acquisition and that have no alternative future use.

 

Restructuring Charges

 

 

During year ended June 30, 2009, we implemented a global cost reduction plan that reduced the number of our employees by approximately 100 employees worldwide. The reduction plan consisted primarily of involuntary employee termination and benefit costs. We recorded a restructuring charge of $0.8 million for the year ended June 30, 2009, in connection with the restructuring.

 

Loss on Sale of Short-term Investments

 

 

During the year ended June 30, 2009, we sold all of our 52.5 million shares of UMC common stock for net proceeds of $17.2 million and recorded a loss on sale of approximately $9.0 million under “Loss on sale of short-term investments” in our Consolidated Statement of Operations.

 

Impairment Loss on UMC Investment

 

 

Impairment loss on UMC investment represents the impairment charge when the decline in the fair value of our investment below our cost basis is determined to be other-than-temporary. For the years ended June 30, 2009 and 2008, we recorded impairment charges of $0.6 million and $6.5 million, respectively, to reflect the decrease in carrying value of the UMC securities we held. We have determined whether an impairment charge is other-than-temporary in nature in accordance with accounting guidance.

 

Interest Income, Net

 

 

We invest our cash and cash equivalents in interest-bearing accounts consisting primarily of certificates of deposits and U.S. Treasuries. The average interest rates earned during the years ended June 30, 2009 and 2008 were 1.6% and 2.9%, respectively. The decrease in the average interest income for the year ended June 30, 2009 was primarily due to (i) the reduction of federal funds rate from 2.0% to 0.21% by the Federal Reserve Bank and (ii) a larger percentage of our investment portfolio having been shifted from money market funds to lower yielding U.S. Treasuries during the year ended June 30, 2009.

Other Income, Net

 

 

Other income, net primarily represents dividend income received from our investments and the foreign currency remeasurement gain or loss. The increase in other income, net for year ended June 30, 2009, compared to the year ended June 30, 2008, was primarily attributable to (i) a $2.6 million foreign currency remeasurement gain related to income taxes payable in foreign jurisdictions, which resulted from the relative strengthening of the U.S. dollar in year ended June 30 2009 compared to a $2.7 million foreign currency remeasurement loss related to income taxes payable in foreign jurisdictions, which resulted from the relative weakness of the U.S. dollar in year ended June 30, 2008, partially offset by (ii) a $1.0 million decrease in gains from the sale of available-for-sale investments and (iii) a $0.6 million decrease in dividend income from the UMC investment compared to the year ended June 30, 2008.

 

Provision for Income Taxes

 

 

A provision for income taxes of $5.5 million and $8.8 million was recorded for years ended June 30, 2009 and 2008, respectively. The decrease in our effective tax rate from the year ended June 30, 2008 to the year ended June 30, 2009 was primarily due to a decrease in $4.4 million of amortization of foreign taxes associated with intercompany profit on assets remaining within Trident’s consolidated group. The amortization of foreign taxes associated with intercompany profit on assets remaining within Trident’s consolidated group was completed in year ended June 30, 2009.

 

Liquidity and Capital Resources

 

Our principal uses of cash include funding operating activities, the creation of new products, acquisitions of intangible assets, ongoing investments in our businesses, capital expenditures, commitments to equity affiliates and acquisitions of businesses. We manage our use of cash with a goal of maintaining adequate cash resources to fund our future operations.

 

Sources and Uses of Cash

 

Cash and cash equivalents at December 31, 2010 and 2009 were as follows:

 

Our primary cash inflows and outflows for the year ended December 31, 2010 and 2009 (unaudited) were as follows:

 

 

Operating Activities

 

Cash used in operating activities is net loss adjusted for certain non-cash items and changes in current assets and current liabilities. For the year ended December 31, 2010, cash used in operating activities was $79.0 million compared to $50.8 million (unaudited) cash used in operating activities for year ended December 31, 2009. The increase was primarily due to a net loss of $128.9 million in the year ended December 31, 2010 versus a net loss of $78.2 million (unaudited) in year ended December 31, 2009 which resulted from a significant increase in operating expenses related to the NXP acquisition.

 

On our consolidated balance sheet as of December 31, 2010, accounts receivable increased compared to December 31, 2009, primarily due to our granting credit terms to the new customers which were acquired as a result of the NXP acquisition. Inventories increased primarily due to sales demand from the acquired NXP product lines. Accounts payable decreased due to decreased manufacturing activities and inventory purchases as well as the general timing of payments.

 

Investing Activities

 

Cash used in investing activities consists primarily of cash used in business combinations, capital expenditures and purchases of intellectual property. For the year ended December 31, 2010, cash provided by investing activities was $24.1 million compared to a $13.6 million (unaudited) cash used in investing activities for year ended December 31, 2009. The increase in net cash provided by investing activities was primarily attributable to the NXP acquisition, partially offset by the purchase of technologies licenses and the purchase of fixed assets.

 

Financing Activities

 

Cash provided by financing activities consists primarily of cash proceeds from the issuance of common stock to employees upon exercise of stock options. Cash provided by financing activities for the year ended December 31, 2010 was $0.2 million.

 

Liquidity

 

Our liquidity is affected by many factors, some of which result from the normal ongoing operations of our business and some of which arise from uncertainties and conditions in Asia and the global economy. The majority of our cash and cash equivalents are held outside the United States, and, therefore, might be subjected to uncertainties in foreign countries. We believe our current resources are sufficient to meet our needs for at least the next 12 months.

 

On February 8, 2010, we issued 104,204,348 new shares of our common stock to NXP, equal to 60% of the total outstanding shares of our Common Stock after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines acquired from NXP and cash proceeds in the amount of $44.0 million. Our liquidity may also be affected if we fail to realize some or all of the anticipated benefits of our acquisitions of business lines of NXP and Micronas. See Note 13, “Business Combinations,” Notes to Consolidated Financial Statements of Notes to Consolidated Financial Statements.

On February 9, 2011, Trident, TMFE and Trident Microsystems (HK) Ltd., or TMHK, entered into a $40 million revolving line of credit agreement with Bank of America, N.A., to finance working capital. Borrowings under the agreement will bear interest at the base rate, as defined in the agreement, plus a margin ranging from 1.50% to 3.00% per annum, or at our option, rates based on LIBOR plus a margin ranging from 2.25% to 3.75% per annum. Under the credit agreement, we may access credit based upon a certain percentage of our eligible accounts receivable outstanding, subject to eligibility requirements, limitations and covenants. The credit agreement contains both affirmative and negative covenants, including covenants that limit or restrict our ability to, among other things, incur indebtedness, grant liens, make capital expenditures, merge or consolidate, dispose of assets, pay dividends or make distributions, change the method of accounting, make investments and enter into certain transactions with affiliates, in each case subject to materiality and other qualifications, baskets and exceptions customary for a credit agreement of this size and type. The credit agreement also contains a financial covenant that requires us to maintain a specified fixed charge coverage ratio if either our liquidity or availability under the credit agreement drops below certain thresholds.

 

Contractual Obligations

 

The following summarizes our contractual obligations as of December 31, 2010:

 

 

 

 

Rental expense for the year ended December 31, 2010, six months ended December 31, 2009 and the years ended June 30, 2009 and 2008, was $5.9 million, $1.4 million, $1.5 million, and $1.5 million, respectively.

 

NXP Acquisition Related Commitments

 

On February 8, 2010, as a result of the acquisition of selected assets and liabilities of the television systems and set-top box business lines acquired from NXP, we entered into a Transition Services Agreement, pursuant to which NXP provides to the us, for a limited period of time, specified transition services and support. Depending on the service provided, the term for the majority of services range from three to eighteen months, and limited services could continue into the fourth quarter of 2011. The total remaining payment obligation under the Transition Services Agreement is approximately $0.6 million as of December 31, 2010.

 

Also, as a result of the acquisition of the NXP business lines, we entered into a Manufacturing Services Agreement pursuant to which NXP provides manufacturing services to us for a limited period of time. The term of

the agreement ends on the readiness of our enterprise resource planning system which is planned to occur in fiscal 2012. The terms of the agreements allow cancellation of either or both the Transition Services Agreement and the Manufacturing Services Agreement with minimum notice periods.

 

Contingencies

 

Shareholder Derivative Litigation

 

Trident has been named as a nominal defendant in several purported shareholder derivative lawsuits concerning the granting of stock options. The federal court cases have been consolidated as In re Trident Microsystems Inc. Derivative Litigation, Master File No. C-06-3440-JF. Plaintiffs in all cases alleged that certain of our current or former officers and directors caused us to grant options at less than fair market value, contrary to our public statements (including its financial statements); and that as a result those officers and directors are liable to the Company. No particular amount of damages has been alleged, and by the nature of the lawsuit no damages will be alleged against the Company. Our Board of Directors appointed a Special Litigation Committee (“SLC”) composed solely of independent directors to review and manage any claims that we may have relating to the stock option grant practices investigated by the Special Committee. The scope of the SLC’s authority includes the claims asserted in the derivative actions.

 

On March 26, 2010, the federal court approved settlements with all defendants other than Frank Lin, our former CEO. The details of that partial settlement, which disposed of the federal litigation as to all individual defendants other than Mr. Lin and as to the consolidated state court action in its entirety, were previously disclosed in our Form 8-K filed on February 10, 2010.

 

On June 8, 2010, Mr. Lin filed a counterclaim against Trident. In that counterclaim, Mr. Lin sought recovery of payments he claimed he was promised during the negotiations surrounding his eventual termination and also losses he claimed he has suffered because he was not permitted to exercise his Trident stock options between January 2007 and March 2008. On February 11, 2011, we entered into a settlement agreement with Mr. Lin regarding his counterclaims, contingent on the settlement of the derivative litigation pursuant to certain terms.

 

On February 15, 2011, we entered into a Stipulation of Settlement to resolve the federal litigation in its entirety, or Proposed Settlement, and on February 17, 2011, the federal court preliminarily approved the Proposed Settlement. A hearing for consideration of final approval of the Proposed Settlement has been scheduled for April 15, 2011 at 9:00 a.m. in Courtroom 3 of the United States District Court in San Jose, California. Final approval, without appeal, of the Proposed Settlement would satisfy the contingency in the settlement of Mr. Lin’s counterclaims against us. We cannot predict whether the federal court will order the final approval of the Proposed Settlement and, if it does, whether such decision will be appealed. As a result, we cannot predict whether Mr. Lin’s counterclaims against us in the federal litigation are likely to result in any material recovery by or expense to Trident. We expect to continue to incur legal fees in responding to this lawsuit and related to the Proposed Settlement, including expenses for the reimbursement of certain legal fees of at least Mr. Lin under our advancement obligations. The expense of defending such litigation may be significant. The amount of time to resolve this and any additional lawsuits is unpredictable and these actions may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows.

 

Regulatory Actions

 

As previously disclosed, we were subject to a formal investigation by the Securities and Exchange Commission, or SEC, in connection with its investigation into our historical stock option granting practices and related issues. On July 16, 2010, we entered into a settlement with the SEC regarding this investigation. We agreed to settle with the SEC without admitting or denying the allegations in the SEC’s complaint. We consented to entry of a permanent injunction against future violations of anti-fraud provisions, reporting provisions and the books and records requirements of the Securities Exchange Act of 1934 and the Securities Act of 1933. On July 19, 2010, the U.S. District Court for the District of Columbia entered a final judgment incorporating the judgment consented to by us. The final judgment did not require us to pay a civil penalty or other money damages.

Pursuant to the same judgment, we received a payment of $817,509 from Mr. Lin, representing $650,772 in disgorged profits gained as a result of conduct alleged by the SEC in its civil complaint against him, together with prejudgment interest thereon of $166,737. Although the Department of Justice, or DOJ, commenced an informal investigation relating to the same issues, the DOJ has not requested information from us since February 20, 2009 and we believe that the DOJ has concluded its investigation without taking any action against us. We believe that the settlement with the SEC concluded the government’s investigations into our historical stock option practices.

 

Special Litigation Committee

 

Effective at the close of trading on September 25, 2006, we temporarily suspended the ability of optionees to exercise vested options to purchase shares of our common stock, until we became current in the filing of our periodic reports with the SEC and filed a Registration Statement on Form S-8 for the shares issuable under the 2006 Plan, or 2006 Plan S-8. This suspension continued in effect through August 22, 2007, the date of the filing of the 2006 Plan S-8, which followed our filing, on August 21, 2007, of our Quarterly Reports on Form 10-Q for the periods ended September 30, 2006, December 31, 2006 and March 31, 2007. As a result, we extended the exercise period of approximately 550,000 fully vested options held by 10 employees, who were terminated during the suspension period, giving them either 30 days or 90 days after we became current in the filings of our periodic reports with the SEC and filed the 2006 Plan S-8 in order to exercise their vested options. During the three months ended September 30, 2007, eight of these ten former employees stated above exercised all of their vested options. However, on September 21, 2007, the SLC decided that it was in the best interests of our stockholders not to allow the remaining two former employees, as well as our former CEO and two former non-employee directors, to exercise their vested options during the pendency of the SLC’s proceedings, and extended, until March 31, 2008, the period during which these five former employees could exercise approximately 428,000 of their fully vested options. Moreover, the SLC allowed one former employee to exercise all of his fully vested stock options and another former employee agreed to cancel all of such individual’s fully vested stock options during the three months ended March 31, 2008.

 

On January 31, 2008, the SLC extended, until August 31, 2008, the period during which the two former non-employee directors could exercise their unexpired vested options. On March 31, 2008, the SLC entered into an agreement with our former CEO allowing him to exercise all of his fully vested stock options. Under this agreement, he agreed that any shares obtained through these exercises or net proceeds obtained through the sale of such shares would be placed in an identified securities brokerage account and not withdrawn, transferred or otherwise removed without either (i) a court order granting him permission to do so or (ii) our written permission.

 

On May 29, 2008, the SLC permitted one of our former non-employee directors to exercise his fully vested stock and entered into an agreement with the other former non-employee director on terms similar to the agreement entered into with our former CEO, allowing him to exercise all of his fully vested stock options. Because Trident’s stock price as of June 30, 2008 was lower than the prices at which our former CEO and each of the two former non-employee directors had desired to exercise their options, as indicated in previous written notices to the SLC, we recorded a contingent liability in accordance with applicable accounting guidance, totaling $4.3 million, which was included in “Accrued expenses and other current liabilities” in the Consolidated Balance Sheet as of June 30, 2008 and the related expenses were included in “Selling, general and administrative expenses” in the Consolidated Statement of Operations for the fiscal year then ended. On March 26, 2010, the claims by these two former non-employee directors against us, valued at approximately $1.6 million, were waived as part of a comprehensive settlement with us. Currently, the SLC investigation is still in progress only with respect to our former CEO. In June 2010, he filed a claim seeking compensation from us relating to the exercise of his fully vested stock options. As a result, as of December 31, 2010, we maintained a contingent liability totaling $2.7 million in “Accrued expenses and other current liabilities” in the Condensed Consolidated Balance Sheets and the related expenses were included in “Selling, General and Administrative Expenses” in the Consolidated Statement of Operations for the year ended December 31, 2010. See Note 5, “Shareholder Derivative Litigation” in “Commitment and Contingencies,” of Notes to Condensed Consolidated Financial Statements.

Indemnification Obligations

 

We indemnify, as permitted under Delaware law and in accordance with our Bylaws, our officers, directors and members of our senior management for certain events or occurrences, subject to certain limits, while they were serving at our request in such capacity. In this regard, we have received, or expect to receive, requests for indemnification by certain current and former officers, directors and employees in connection with our investigation of our historical stock option granting practices and related issues, and the related governmental inquiries and shareholder derivative litigation. The maximum amount of potential future indemnification is unknown and potentially unlimited; therefore, it cannot be estimated. We have directors’ and officers’ liability insurance policies that may enable us to recover a portion of such future indemnification claims paid, subject to coverage limitations of the policies, and plan to make claim for reimbursement from our insurers of any potentially covered future indemnification payments.

 

General

 

From time to time, we are involved in other legal proceedings arising in the ordinary course of our business. While we cannot be certain about the ultimate outcome of any litigation, management does not believe any pending legal proceeding will result in a judgment or settlement that will have a material adverse effect on our business, financial position, results of operation or cash flows.

 

Recent Accounting Pronouncements

 

See “Recent Accounting Pronouncements” in Note 2, “Significant Accounting Policies,” of Notes to Consolidated Financial Statements in Item 8, of this Report, which is incorporated herein by reference.

 

 

We are exposed to two primary types of market risks: foreign currency exchange rate risk and interest rate risk.

 

Foreign currency exchange rate risk

 

As of December 31, 2010, we had operations in the United States, Taiwan, China, Hong Kong, India, Germany, The Netherlands, Japan, Singapore and South Korea. The functional currency of all of these operations is the U.S. dollar. Approximately $66.7 million, or 71.5% of our cash and cash equivalents, were held outside the United States as of December 31, 2010, a majority of which is denominated in U.S. dollars. In addition, income tax payable in foreign jurisdictions is denominated in foreign currencies and is subject to foreign currency exchange rate risk. Although personnel and facilities-related expenses are primarily incurred in local currencies due to the location of our subsidiaries outside the United States, substantially all of our other expenses are incurred in U.S. dollars. Since we acquired certain product lines from Micronas in May 2009, we have also incurred manufacturing and related expenses in Euros, and expect to incur additional expenses in Euros in the future as a result of the NXP Transaction.

 

While we expect our international revenues to continue to be denominated primarily in U.S. dollars, an increasing portion of our international revenues may be denominated in foreign currencies, such as Euros. In addition, our operating results may become subject to significant fluctuations based upon changes in foreign currency exchange rates of certain currencies relative to the U.S. dollar. We analyze our exposure to foreign currency fluctuations and may engage in financial hedging techniques in the future to attempt to minimize the effect of these potential fluctuations; however, foreign currency exchange rate fluctuations may adversely affect our financial results in the future. Following the NXP Transaction, we now have research and development facilities in additional foreign locations and a large percentage of our international operational expenses are denominated in foreign currencies. As a result, foreign currency exchange rate volatility, particularly in Euros and China’s currency, Renminbi, could negatively or positively affect our operating costs in the future.

 

Fluctuations in foreign exchange rates may have an adverse effect on our financial results due to the NXP acquired business lines, as a substantial proportion of expenses of the acquired business lines are incurred in various denominations, while most of the revenues are denominated in U.S. dollars.

Interest rate risk

 

We currently maintain our cash equivalents primarily in certificates of deposit, U.S. Treasuries, and other highly liquid investments. We do not have any derivative financial instruments. We place our cash investments in instruments that meet high credit quality standards, as specified in our investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issue, issuer or type of instrument.

 

Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of December 31, 2010, we have approximately $93.2 million in cash and cash equivalents, of which $62.2 million is cash and $31.0 million is money market funds invested in U.S. Treasuries. We currently intend to continue investing a significant portion of our existing cash equivalents in interest bearing, investment grade securities, with maturities of less than three months. We do not believe that our investments, in the aggregate, have significant exposure to interest rate risk. However, we will continue to monitor the health of the financial institutions with which these investments and deposits have been made due to the current global financial environment.

 

Concentrations of Credit Risk and Other Risk

 

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. Cash and cash equivalents held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation on such deposits.

 

A majority of our trade receivables is derived from sales to large multinational OEMs who manufacture digital TVs, located throughout the world, with a majority located in Asia. Prior to May 14, 2009, the date of the acquisition of the Micronas business lines, sales to most of our customers were typically made on a prepaid or letter of credit basis while sales to a few customers were made on open accounts. We perform ongoing credit evaluations of its newly acquired customers’ financial condition and generally requires no collateral to secure accounts receivable. Historically, a relatively small number of customers have accounted for a significant portion of our revenues. Our products have been manufactured primarily by two foundries, United Microelectronics Corporation, or (UMC), based in Taiwan and Micronas, based in Germany. Effective with the February 8, 2010 closing of our acquisition of certain assets from NXP B.V., we also have products manufactured by Taiwan Semiconductor Manufacturing Company, or TSMC.

 

TRIDENT MICROSYSTEMS, INC.