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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A-1
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NO. 0-26660
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ESS TECHNOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2928582
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
46107 LANDING PARKWAY, FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code:
(510) 226-1088
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on
February 29, 1996 ($20.875) as reported on the Nasdaq National Market, was
approximately $251,146,000. Shares of Common Stock held by each officer and
director and by each person who owned 5% or more of the Registrant's outstanding
Common Stock on that date 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.
As of February 29, 1996, Registrant had outstanding 36,217,836 shares of
Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 1996 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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ESS TECHNOLOGY, INC.
1995 FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................................... 2
Item 2. Properties.................................................................. 9
Item 3. Legal Proceedings........................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders......................... 11
Item 4A. Executive Officers of the Registrant........................................ 11
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.... 14
Item 6. Selected Financial Data..................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................... 15
Item 8. Financial Statements and Supplementary Data................................. 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................................... 38
PART III
Item 10. Directors and Executive Officers of the Registrant.......................... 39
Item 11. Executive Compensation...................................................... 39
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 39
Item 13. Certain Relationships and Related Transactions.............................. 39
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............ 40
Signatures............................................................................... 43
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PART I
ITEM 1. BUSINESS
ESS Technology, Inc. ("ESS" or the "Company") designs, develops and markets
highly integrated mixed signal semiconductor multimedia solutions for sale to
desktop and notebook personal computer manufacturers and consumer product
companies. ESS is the leading supplier of mixed signal PC audio solutions that
integrate all essential audio components on a single chip. The Company's
AudioDRIVE products enable PC manufacturers to provide audio capabilities
directly on the motherboard of desktop and notebook computers, eliminating the
need for add-in sound cards.
ESS believes its AudioDRIVE single chip products provide comprehensive
solutions that offer higher performance and functionality, consume less power
and board space and cost less than other commercially available PC audio
solutions. The Company's AudioDrive products are based on its proprietary audio
technologies and design methodologies, as well as its software and firmware
expertise. The Company has developed a core library of audio semiconductor
designs, including a microcontroller, bus interface, CODEC, mixer, filter and FM
synthesizer, along with device drivers and application software. ESS utilizes
these technologies to implement ESFM, the Company's proprietary FM sound
synthesis technology, which enhances traditional FM synthesis techniques with
hardware, software and music database technology to produce superior sound
quality. The Company also utilizes its proprietary advanced analog and mixed
signal design methodologies, together with its library of audio semiconductor
designs, to produce highly integrated mixed signal audio chips. ESS' software
technology, bundled as part of its comprehensive solution, consists of its
AudioDRIVE device drivers for Microsoft Windows 3.1, Windows NT and Windows 95,
IBM OS/2 Warp, Intel's NSP and PC games, as well as audio applications,
including audio recorder, musical instrument digital interface ("MIDI") player
and mixer software. The Company's high performance audio products are currently
manufactured by leading semiconductor foundries utilizing an advanced mixed
signal 0.6 and 0.5 micron process technology.
PRODUCTS
The Company's products consist of AudioDRIVE single chip solutions,
wavetable synthesizers and multimedia system chipsets, all of which are designed
utilizing the Company's proprietary technologies. ESS' audio chips have evolved
from 12-bit to 16-bit and mono to stereo. Currently, most of the Company's major
customers are in the process of upgrading to ESS' more advanced 16-bit stereo
chips, which include ESFM technology. Sales of PC audio semiconductors accounted
for approximately 77.7% and 97.6% of the Company's net revenues in 1994 and
1995, respectively.
AudioDRIVE Single Chip PC Audio Products
ES488: a single mixed signal 12-bit mono audio chip. The ES488 integrates
digital logic and a microcontroller with audio CODEC and other analog functions
onto one chip and, when coupled with the Yamaha OPL2 FM synthesizer chip,
provides a low cost chip solution for multimedia PC audio. The ES488 is PC games
compatible in Sound Blaster ("SB") mode with the Yamaha OPL2 and is compatible
with Microsoft Windows and other operating systems. The ES488 provides power
management capability and is packaged in a small form factor 52 pin plastic quad
flatpack ("PQFP") package.
ES688: a single mixed signal 16-bit stereo audio chip. The ES688
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip and, when coupled with the Yamaha OPL3 FM synthesizer
chip, provides a low cost solution for high performance multimedia PC audio. The
ES688 is PC games compatible in SB Pro mode with the Yamaha OPL3 and is
compatible with Microsoft Windows and other operating systems. The ES688
provides power management capability and is packaged in a 100 pin PQFP package.
ES1488: a single mixed signal 16-bit mono audio chip with integrated ESFM
synthesizer. The ES1488 integrates digital logic and a microcontroller with
audio CODEC and other analog functions onto one chip, and includes ESFM
synthesis. The ES1488 is PC games compatible in SB mode and is compatible with
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Microsoft Windows and other operating systems. The ES1488 is socket compatible
with the ES488 and provides a single chip alternative for the combined solution
offered by the ES488 and the Yamaha OPL2 FM synthesis chip.
ES1688: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer. The ES1688 integrates digital logic and a microcontroller with
audio CODEC and other analog functions onto one chip, and includes ESFM
synthesis. The ES1688 is PC games compatible in SB and SB Pro modes and is
compatible with Microsoft Windows and other operating systems. The ES1688 is
socket compatible with the ES688 and provides a single chip alternative for the
combined solution offered by the ES688 and the Yamaha stereo OPL3 FM synthesis
chip.
ES1788: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer and game support. The ES1788 integrates digital logic and a
microcontroller with audio CODEC and other analog functions onto one chip, and
includes ESFM synthesis. The ES1788 is PC games compatible in SB and SB Pro
modes and is compatible with Microsoft Windows and other operating systems. The
ES1788 includes hardware volume control, 64 step volume control and dual
game/joystick port for game support.
ES1868: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation and game support. The ES1868
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip, and includes ESFM synthesis. The ES1868 is PC games
compatible in SB and SB Pro modes and is compatible with Microsoft Windows and
other operating systems. The ES1868 provides full ISA plug-and-play support and
includes hardware volume control, 64 step volume control and dual game/joystick
port for game support. The ES1868 also supports full-duplex operation with
simultaneous record and playback with two DMA channels. First customer shipment
of the ES1868 occurred in the first quarter of 1996.
ES1869: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation, and game support. The ES1869
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip, and includes ESFM synthesis. The ES1869 is PC games
compatible in SB and SB Pro modes and is compatible with Microsoft Windows and
other operating systems. The ES1869 provides full ISA plug-and -play support and
includes hardware volume control, 64 step volume control and dual game/joystick
port for game support. The ES1869 supports full-duplex operation with
simultaneous record and playback with two DMA channels, and also integrates
circuitry to produce a three-dimensional sound effect from two speakers. First
customer shipment of the ES1869 is expected to occur by the end of 1996.
ES1878: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, Zoom Video support, and game support. The
ES1878 integrates digital logic and a microcontroller with audio CODEC and other
analog functions onto one chip, and includes ESFM synthesis. The ES1878 is PC
games compatible in SB and SB Pro modes and is compatible with Microsoft Windows
and other operating systems. The ES1878 includes hardware volume control, 64
step volume control and dual game/joystick port for game support. The ES1878
provides full ISA plug-and-play support. The ES1889 also includes support for
full-duplex operation with simultaneous stereo record and playback with two DMA
channels, and it contains an I(2)S interface to support the PCMCIA Zoom Video
port specification for video input to PCs. First customer shipment of the ES1878
occured in the first quarter of 1996.
ES1888: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer which supports NSP full-duplex operation. The ES1888 integrates
digital logic and a microcontroller with audio CODEC and other analog functions
onto one chip, and includes ESFM synthesis. The ES1888 is PC games compatible in
SB and SB Pro modes and is compatible with Microsoft Windows and other operating
systems. The ES1888 includes hardware volume control, 64 step volume control and
dual game/joystick port for game support. The ES1888 also includes support for
NSP full-duplex operation with simultaneous stereo record and playback with two
DMA channels.
ES1889: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, and game support. The ES1889 integrates
digital logic and a microcontroller with audio CODEC
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and other analog functions onto one chip, and includes ESFM synthesis. The
ES1889 is PC games compatible in SB and SB Pro modes and is compatible with
Microsoft Windows and other operating systems. The ES1889 includes hardware
volume control, 64 step volume control and dual game/joystick port for game
support. The ES1889 also includes support for full-duplex operation with
simultaneous stereo record and playback with two DMA channels. The ES1889
supports plug-and-play through the PC's BIOS. First customer shipment of the
ES1889 is expected to occur by the end of 1996.
Wavetable Synthesizer Products
ES689: a wavetable music synthesizer chip. The ES689 is a high performance
wavetable music synthesizer chip that is General MIDI compatible and offers 32
note polyphony. It provides a serial interface to the ES1688 internal
digital-to-analog converter ("DAC") to provide an audio implementation that
includes both wavetable and ESFM synthesis, or external DAC for wavetable
synthesis. The ES689 interfaces to the ES981 or ES982 for one or two megabyte
sound sample sets, respectively.
ES690: a wavetable music synthesizer chip with chorus and reverb sound
effects. The ES690 is a high performance wavetable music synthesizer chip with
chorus and reverb sound effects for enriched sound. The ES690 is General MIDI
compatible and offers 32 note polyphony. It provides a serial interface to the
ES1688 internal DAC to provide an audio implementation that includes both
wavetable and ESFM synthesis, or external DAC for wavetable synthesis. The ES690
interfaces to the ES981 or ES982 for one or two megabyte sound sample sets,
respectively. First customer shipment of the ES690 occurred in the first quarter
of 1996.
ES981: a 512K x 16 wavetable ROM. The ES981 is a 512K x 16 read only
memory ("ROM") with a General MIDI sound sample set for use with the ES689 and
ES690. First customer shipment of the ES981 occurred in the first quarter of
1996.
ES982: a 1M x 16 wavetable ROM. The ES982 is a 1M x 16 ROM with a General
MIDI sound sample set for use with the ES689 and ES690.
Multimedia System Chipsets
ES978: a mixer expansion chip to support the ES1878 when building a PC
Notebook and Docking Station PC system. The ES978 is an analog mixer chip which
is placed in a docking station and interfaces directly with the ES1878 located
inside the notebook. This interface provides an efficient structure for notebook
and docking stations systems, requiring only six pins of the notebook to connect
with all communications paths to the docking station. First customer shipment of
the ES978 occurred in the first quarter of 1996.
ES938: a sound effects processor. The ES938 provides enhanced sound
effects by expanding monophonic and stereo sound to 3-D spatial soundfields. The
ES938 also integrates bass and treble control. First customer shipment of the
ES938 occurred in the first quarter of 1996.
ES968: a multi-function chip for multimedia add-in cards. The ES968
integrates plug-and-play support, MPU401 interface, dual game/joystick port and
CD-ROM interface for Sony, Panasonic, Mitsumi and IDE drives in one chip.
Software and Support
ESS provides comprehensive support for its AudioDRIVE chips. This includes
software that customers can bundle with their products that incorporate ESS
AudioDRIVE chips. This software includes device drivers for Microsoft Windows
3.1, Windows NT and Windows 95, IBM OS/2 Warp, Intel NSP and PC games. This
software also includes Audio Applications software and AudioRACK software. Other
support software that is available to customers includes localization software
and installation software that allows customers to tailor their products for
specific applications and needs.
Customer development support includes an Evaluation Kit that contains a
reference add-in card design with all the necessary information to incorporate
an AudioDRIVE chip in the customer's product. To assist
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customers in further reducing their time to market, ESS also provides a
Manufacturing Kit that contains manufacturing information, including
bill-of-materials, printed circuit board layout and production test software.
CUSTOMERS
ESS sells its product principally to manufacturers of PCs and add-in
boards. The following table shows representative customers worldwide:
UNITED STATES TAIWAN JAPAN(1) REST OF THE WORLD
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AST Acer Fujitsu ICL
Compaq ECS Matsushita JK Micro
Dell FIC NEC Natsteel
Digital Equipment GVC Seiko-Epson Olivetti
Hewlett Packard Mitac Sony Samsung
IBM Quanta Toshiba Trigem
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(1) Sales in Japan are made through a distributor.
A limited number of customers historically has accounted for a substantial
portion of the Company's net revenues. In 1993, 1994 and 1995, sales to the
Company's top five customers, including sales to the Company's international
distributor, accounted for approximately 77%, 51% and 48%, respectively, of the
Company's net revenues. In 1993, one customer, Western Publishing, accounted for
approximately 57% of the Company's net revenues. In 1994, two customers, Compaq
and Western Publishing, accounted for approximately 20% and 14%, respectively,
of the Company's net revenues. The decline in the percentage of net revenues
attributable to Western Publishing was a result of the Company's shift in
product mix from consumer products to PC audio products. In 1995, Compaq and
Universe Electron Corporation, the Company's Japanese distributor, each
accounted for approximately 17% of the Company's net revenues. The Company
expects that sales to a limited number of customers will continue to account for
a substantial portion of its net revenues for the foreseeable future. The
Company has experienced changes from year to year in the composition of its
major customer base and believes this will continue in the future. For example,
Compaq has only been a significant customer of the Company since 1994.
SALES AND MARKETING
The Company's sales and marketing strategy is to have its products designed
into PCs and PC-related products manufactured by leading OEMs worldwide. In the
United States, the Company markets its products exclusively through its direct
sales force located at its headquarters in Fremont, California.
In 1993, 1994 and 1995, international sales comprised approximately 87%,
72% and 73% of the Company's net revenues, respectively. The majority of the
Company's international revenues in 1993, 1994 and 1995 have been derived from
Asian manufacturers of PCs and PC-related add-in boards, as a large percentage
of the worldwide supply of these products is manufactured by suppliers in Asia.
ESS has direct sales personnel and technical staff located in Taipei, Taiwan. To
date, a significant portion of the Company's Asian sales have been to customers
located in Taiwan. See "Factors That May Affect Future Results -- International
Operations." The Company is continuing to expand its Taiwan sales force in an
effort to broaden its customer base and provide additional customer service and
technical support. The Company's products are also sold internationally through
a distributor located in Japan and manufacturers' representatives located in
Taiwan, Singapore, Korea, Hong Kong and Germany. To date, the Company has not
had substantial sales to customers located in Europe, and the Company is seeking
to expand its sales and distribution activities in Europe. The Company's
manufacturers' representatives and distributor are not subject to minimum
purchase requirements and can discontinue marketing any of the Company's
products at any time.
The Company believes that customer service and technical support are
important competitive factors in selling to major customers. The Company
provides technical support to its customers worldwide. Manufactur-
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ers' representatives and distributors supplement the Company's efforts by
providing additional customer service at the local level. The Company believes
that close contact with its customers not only improves the customers' level of
satisfaction, but also provides important insight into future market direction.
Sales of the Company's products are generally made pursuant to standard
purchase orders, which are frequently revised to reflect changes in the
customer's requirements. Product deliveries are scheduled upon the Company's
receipt of purchase orders. Generally, these purchase orders allow customers to
reschedule delivery dates and cancel purchase orders without significant
penalties. For these reasons, the Company believes that its backlog, while
useful for scheduling production, is not necessarily a reliable indicator of
future revenues.
RESEARCH AND DEVELOPMENT
In order to compete successfully, the Company believes that it must
continually design, develop and introduce new products that take advantage of
market opportunities and address emerging standards. The Company's strategy is
to leverage its substantial base of audio technology and design expertise,
analog, digital and mixed signal design and process technologies, and software
and systems expertise to develop new PC audio solutions as well as other new
products targeting opportunities in the multimedia PC market. The Company is
currently engaged in the development of new PC audio products that provide
advanced sound effects. ESS has also begun development of new multimedia
products that provide video applications, computer telephony capabilities, such
as fax/modem/voice, and graphics applications. The Company intends to continue
to provide comprehensive solutions for its customers by developing device
drivers, firmware and application software, in addition to the semiconductor
device for these new products.
ESS utilizes a design environment based on workstations, dedicated product
simulators, system simulation with hardware and software modeling, and a high
level design description language. The Company invests regularly in new advanced
equipment and software tools and intends to maintain and enhance its library of
core cells.
At December 31, 1995, ESS had a staff of 78 research and development
personnel, 50 of which were involved in semiconductor design and process
development and 28 of which were involved in software development. In addition,
ESS has, on occasion, engaged outside developers to develop certain technologies
to the Company's specifications and intends to increase it reliance on outside
developers in the future. During 1993, 1994 and 1995, the Company spent
approximately $2.9 million, $3.7 million and $8.7 million, respectively, on
research and development activities.
ESS has in the past and will continue to consider in the future acquiring
technology and product lines to enhance it own product offerings and to
accelerate its time-to-market. In January 1996, the Company completed its
acquisition of VideoCore Technology, Inc. ("VideoCore") pursuant to which the
Company acquired all of the outstanding capital stock of VideoCore in exchange
for approximately 525,000 shares of the Company's Common Stock and $5.4 million
in cash. VideoCore, now a wholly owned subsidiary of the Company, is developing
integrated circuits which, once completed, will incorporate advanced compression
technology for digital video products. In March 1996, the Company completed its
acquisition of OSEE Technology, Inc. ("OSEE") pursuant to which the Company
acquired all of the outstanding capital stock of OSEE in exchange for
approximately 217,000 shares of the Company's Common Stock and $3.6 million in
cash. OSEE, now a wholly owned subsidiary of the Company, is a developer of
advanced fax/modem V.34 and V.34bis algorithm technology which will enable the
Company to provide modem and computer telephony applications on the Company's
multimedia processor. The Company may continue to utilize cash and equity to
acquire or invest in complementary businesses or products or to obtain the right
to use complementary technologies. From time to time, in the ordinary course of
business, the Company may evaluate potential acquisitions of or investments in
such businesses, products or technologies owned by third parties.
MANUFACTURING
The Company contracts with independent foundries to manufacture all of its
products, enabling the Company to focus on its design strengths, minimize fixed
costs and capital expenditures and gain access to
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advanced manufacturing capabilities. The Company's products are currently
manufactured by four independent foundries, all of which utilize advanced
manufacturing technologies. A substantial majority of the Company's products are
manufactured by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC"), which
has manufactured certain of the Company's products since 1989. The Company also
has foundry arrangements with United Microelectronics Corporation ("UMC") in
Taiwan, Sharp Corporation ("Sharp") in Japan and IC Works ("ICW") in California.
Substantially all of the Company's devices are currently fabricated using a
mixed signal CMOS 0.6 and 0.5 micron process technology, and the Company is
currently developing products which will be manufactured utilizing a 0.35 micron
process technology.
The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs and to
produce products of acceptable quality and with acceptable manufacturing yields
in a timely manner. These foundries fabricate products for other companies and,
with the exception of TSMC, manufacture products of their own design. In
November 1995, the Company entered into long-term agreements with two of its
foundries, TSMC and UMC. The Company intends to continue to work with its other
foundries and to qualify new foundries, to obtain additional manufacturing
capacity. There can be no assurance, however, that the Company will be able to
obtain additional capacity when necessary.
Under the Company's agreement with TSMC, in exchange for TSMC's wafer
capacity commitments for the years 1996 through 1999, the Company is obligated
to pay approximately $32 million over the next two years. The Company also
obtained an option to expand the TSMC wafer capacity commitments further for
years 1997 through 2000. If the Company exercises its option, it would be
obligated to pay an additional $31 million in two installments in 1997 and 1998.
The Company is obligated to make payments whether or not it takes the wafers,
but certain provisions of the agreement allow for the possibility of sales of
unused capacity to third parties to help defray costs to the Company.
Under the Company's agreement with UMC, the Company entered into a joint
venture arrangement with UMC and other U.S. semiconductor companies to build a
separate semiconductor manufacturing facility to be located in Taiwan at an
estimated cost of $1 billion. The Company will invest approximately $30 million
in three installments over the projected eighteen month period required to build
the facility. Under the terms of the agreement, the Company will receive a 5%
equity ownership in the joint venture company and capacity rights. The new
fabrication facility is currently projected to commence production of 8-inch
wafers in 1997 with advanced technologies eventually leading to 0.25 microns.
All of the Company's semiconductor products are assembled and tested by
third-party vendors, primarily Amkor ANAM in Korea, Advanced Semiconductor
Engineering in Taiwan, Astra Microtronics in Indonesia and OSE in Taiwan. The
Company has internally designed and developed its own test software and certain
test equipment, which is provided to the Company's test vendors. Shortages of
raw materials or disruptions in the provision of services by the Company's
assembly vendors could lead to supply constraints or delays in the delivery of
the Company's products. Such constraints or delays might result in the loss of
customers, limitations or reductions in the Company's revenues or other material
adverse effects on the Company's business, financial condition and results of
operations. The Company's reliance on third-party assembly and testing vendors
involves a number of other risks, including reduced control over delivery
schedules, quality assurance and costs. The inability of such third parties to
deliver products of acceptable quality and in a timely manner could have a
material adverse effect on the Company's business, financial condition and
results of operations.
COMPETITION
The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, price declines and rapid product
obsolescence. The Company currently competes with add-in sound card suppliers
and semiconductor manufacturers offering multiple chip solutions. The Company
expects competition to increase in the future from existing competitors,
including Yamaha, and from other companies that may enter the Company's existing
or future markets with products that may be less costly or provide higher levels
of integration, higher performance or additional features. The Company is unable
to predict the timing and nature of any such competitive product offerings. The
announcement and commercial shipment of competitive products, such as
announcements by Yamaha, could adversely affect sales of the
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Company's products and may result in increased price competition that would
adversely affect the average selling prices ("ASPs") and margins of the
Company's products. In general, product prices in the semiconductor industry
have decreased over the life of a particular product. The markets for most of
the applications for the Company's products, particularly the PC market, are
characterized by intense price competition. The willingness of prospective
customers to design the Company's products into their products depends to a
significant extent upon the ability of the Company to sell its products at a
price that is cost-effective for such customers. As the markets for the
Company's products mature and competition increases, the Company anticipates
that prices for its products will continue to decline. If the Company is unable
to reduce its costs sufficiently to offset declines in product prices or is
unable to introduce more advanced products with higher product prices, the
Company's business, financial condition and results of operations would be
materially adversely affected.
The Company's existing and potential competitors consist principally of
large domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources, greater intellectual property rights, broader product lines and
longer-standing relationships with customers than the Company. The Company's
competitors also include a number of smaller and emerging companies. The
Company's principal audio competitors include Cirrus Logic, Creative Technology,
OPTi and Yamaha. Certain of the Company's current and potential competitors
maintain their own semiconductor foundries and may therefore benefit from
certain capacity, cost and technical advantages. The Company believes that its
ability to compete successfully depends on a number of factors, both within and
outside of its control, including the price, quality and performance of the
Company's and its competitors' products, the timing and success of new product
introductions by the Company, its customers and its competitors, the emergence
of new multimedia PC standards, the development of technical innovations, the
ability to obtain adequate foundry capacity and sources of raw materials, the
efficiency of production, the rate at which the Company's customers design the
Company's products into their products, the number and nature of the Company's
competitors in a given market, the assertion of intellectual property rights and
general market and economic conditions. There can be no assurance that the
Company will be able to compete successfully in the future.
Each successive generation of microprocessors has provided increased
performance, which could in the future result in a microprocessor capable of
performing audio functions. In this regard, Intel Corporation has developed
Native Signal Processing ("NSP") capability and an extended multimedia system
architecture ("MMX") for use in conjunction with its Pentium microprocessor, and
is promoting the processing power of the Pentium for data and signal intensive
functions such as graphics acceleration and other multimedia functions. There
can be no assurance that the increased capabilities of microprocessors will not
adversely affect demand for the Company's products.
PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trademarks, copyrights,
trade secret laws and confidentiality procedures to protect its intellectual
property rights. As of December 31, 1995, the Company had 10 patents granted in
the United States, which expire over time, commencing in 1996 and ending in
2011, and 9 corresponding foreign patents. In addition, the Company had 2
patents pending in the United States and intends to seek further United States
and international patents on its technology. There can be no assurance that
patents will be issued from any of the Company's pending applications or
applications in preparation or that any claims allowed from pending applications
or applications in preparation will be of sufficient scope or strength, or be
issued in all countries where the Company's products can be sold, to provide
meaningful protection or any commercial advantage to the Company. Also,
competitors of the Company may be able to design around the Company's patents.
The laws of certain foreign countries in which the Company's products are or may
be manufactured or sold, including various countries in Asia, may not protect
the Company's 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 the
Company's technology and products more likely. Although the Company is not aware
of the development, distribution or sales of any illegal copies of the Company's
hardware or software, any infringements of its patents, copyrights or
trademarks, or any violation of its trade secrets, confidentiality
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procedures or licensing agreements to date, there can be no assurance that the
steps taken by the Company to protect its proprietary information will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which have resulted in
significant and often protracted and expensive litigation. Except for the Yamaha
litigation (see "Item 3. Legal Proceedings"), there is no pending intellectual
property litigation against the Company. However, the Company or its foundries
may from time to time receive notice of claims that the Company has infringed
patents or other intellectual property rights owned by others. The Company may
seek licenses under such patents or other intellectual property rights. However,
there can be no assurance that licenses will be offered or that the terms of any
offered licenses will be acceptable to the Company. The failure to obtain a
license from a third party for technology used by the Company could cause the
Company to incur substantial liabilities and to suspend the manufacture of
products or the use by the Company's foundries of processes requiring the
technology. Furthermore, the Company may initiate claims or litigation against
third parties for infringement of the Company's proprietary rights or to
establish the validity of the Company's proprietary rights. Litigation by or
against the Company could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel, whether
or not such litigation results in a favorable determination for the Company. In
the event of an adverse result in any such litigation, the Company could be
required to pay substantial damages, cease the manufacture, use and sale of
infringing products, expend significant resources to develop non-infringing
technology, discontinue the use of certain processes or obtain licenses for the
infringing technology. There can be no assurance that the Company would be
successful in such development or that such licenses would be available on
reasonable terms, or at all, and any such development or license could require
expenditures by the Company of substantial time and other resources. Although
patent disputes in the semiconductor industry have often been settled through
cross-licensing arrangements, there can be no assurance that, in the event that
any third party makes a successful claim against the Company or its customers, a
cross-licensing arrangement could be reached. If a license is not made available
to the Company on commercially reasonable terms, the Company's business,
financial condition and results of operations could be materially adversely
affected.
The Company licenses certain of the technology utilized by the Company in
its products, and expects to continue to do so in the future. The Company has no
current plans to grant licenses with respect to its products or technology;
however, it may become necessary for the Company to enter into product licenses
in the future in order, among other things, to secure foundry capacity. Although
the Company has in the past granted licenses to certain of its technology, some
of which have expired, such licenses have been limited and the Company has not
derived material revenues from such licenses in recent periods.
EMPLOYEES
As of December 31, 1995, the Company had 158 full-time employees, including
78 in research and development, 35 in marketing, sales and support and 45 in
finance, administration and operations. The Company's future success will
depend, in part, on its ability to continue to attract, retain and motivate
highly qualified technical and management personnel, particularly highly skilled
semiconductor design personnel and software engineers involved in new product
development, for whom competition is intense. The Company's employees are not
represented by any collective bargaining unit, and the Company has never
experienced a work stoppage.
ITEM 2. PROPERTIES
The Company leases two facilities in Fremont, California. The leases for
such facilities expire in June 30, 1996 and October 31, 1996. The facilities
consist of two buildings comprising approximately 62,000 square feet, which are
used as the Company's headquarters. The Company recently executed an agreement
to purchase approximately 16 acres of land near its current Fremont
headquarters, on which the Company plans to construct a new, approximately
93,000 square foot headquarters facility, which is currently expected to be
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completed in late 1996. The Company anticipates that, after the completion of
its new headquarters, its facilities will be adequate to meet its needs for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
In March 1995, Yamaha filed a lawsuit against the Company alleging that the
Company's FM synthesis products infringe two of Yamaha's patents, U.S. Patent
No. 4,249,447 and U.S. Patent No. 4,813,326 (the "Yamaha Patents"). Yamaha
initiated suit with a motion for a temporary restraining order and a request for
a preliminary injunction. In addition, in its complaint, Yamaha seeks a
permanent injunction against future infringement, damages for past infringement,
attorneys' fees and costs. Yamaha's lawsuit alleges infringement by all of the
Company's FM synthesis chips, currently consisting of the ES1488, ES1688,
ES1788, ES1868 and ES1888. For 1995, the Company had revenues of approximately
$52.9 million attributable to sales of these products, constituting
approximately 50% of net revenues. Further, a substantial majority of the
Company's revenues for the foreseeable future is expected to be dependent upon
sales of these and future products incorporating FM synthesis. The lawsuit,
entitled Yamaha Corporation vs. ESS Technology, Inc., is pending in the U.S.
District Court for the Central District of California in Los Angeles,
California.
Yamaha's requests for a temporary restraining order and preliminary
injunction were denied on March 17, 1995 and May 1, 1995, respectively. In its
order denying the request for preliminary injunction, the District Court stated
that its decision was based on an assessment of the likelihood of Yamaha's
success on the merits, as well as a balance of the relative hardships that would
be suffered by ESS or Yamaha as a result of the granting or denial of the
preliminary injunction. Yamaha has appealed the District Court's denial of the
request for preliminary injunction to the U.S. Court of Appeals for the Federal
Circuit. The hearing at the Federal Circuit took place on January 8, 1996, and
on March 29, 1996 that Court confirmed the denial of the request for preliminary
injunction.
On August 18, 1995 the District Court granted in part and denied in part a
motion for summary judgment which had been filed by the Company. The District
Court held that the Company's FM synthesis products did not literally infringe
Yamaha's U.S. Patent No. 4,249,447, but held that there was a triable issue of
fact as to the infringement of such patent on another basis. The Court also
found triable issues of fact and, therefore, denied the Company's motion for
summary judgment with regard to U.S. Patent No. 4,813,326. Trial in the Yamaha
litigation is expected to begin in early 1997.
The Company does not believe that its products infringe the Yamaha Patents
and, as a result, the Company believes it will ultimately prevail in its
litigation with Yamaha. ESS was aware of the Yamaha Patents during the period it
was designing its FM synthesis products in 1993 and 1994 and received opinions
from its patent counsel, the Law Offices of Thomas E. Schatzel, regarding
non-infringement in connection with the design of such products before the
products were sold. ESS is vigorously contesting all of Yamaha's claims.
However, the Company cannot predict the ultimate outcome of the appeal of the
denial of the preliminary injunction or the final resolution of the lawsuit. In
the event a preliminary or permanent injunction were to be granted, the Company
would be unable to sell the ES1488, ES1688, ES1788, ES1868 and ES1888 and any
other products incorporating the Company's current technique for providing FM
synthesis capability. The grant of a preliminary or permanent injunction would
result in a material adverse effect on the Company's business, financial
condition and results of operations, including a substantial reduction in the
Company's revenues and income, losses for an extended period of time and a
substantial depletion in the Company's financial resources. In addition, the
Company could be required to pay significant monetary damages to Yamaha, which
are subject to trebling in the event of a finding of willful infringement.
Further, the Company has agreed to indemnify customers from liability with
respect to claimed infringements of the Yamaha Patents and, in the event of a
determination of infringement and the grant of an injunction, the Company has
agreed to either secure a license for its customers to continue using the
enjoined chips, replace the chips with noninfringing chips or remove the chips
and refund the purchase price of such chips. Such indemnification increases the
Company's exposure to, and amount of, potential costs and liability in such
event, and could have a material adverse effect on the Company's business,
financial condition and results of operations. In the event of an injunction,
the Company could attempt to obtain a license from Yamaha to enable the Company
to continue to sell products incorporating the Company's current technique for
implementing FM synthesis. The
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Company could also attempt to develop a different technique for implementing FM
synthesis and modify the design of its products in an effort to avoid
infringement of the Yamaha Patents. Even if successful, any such efforts would
require a substantial period of time to complete and there can be no assurance
that such efforts would result in competitive products. During such period, the
Company could continue to sell the ES488, ES688 and other products that do not
incorporate FM synthesis capability. However, there can be no assurance as to
the amount of revenues that the Company would receive from the sale of such
products.
In connection with the Yamaha litigation, the Company has incurred and
expects to continue to incur substantial legal and other expenses. In addition,
the Yamaha litigation has diverted and is expected to continue to divert the
efforts and attention of the Company's management and technical personnel.
Patent litigation is highly complex and can extend for a protracted period of
time, which can substantially increase the cost of such litigation. Accordingly,
the expenses and diversion of resources associated with the Yamaha litigation
could have a material adverse effect on the Company's business, financial
condition and results of operations. If the Yamaha lawsuit were to be resolved
by a settlement, ESS might be required to make substantial payments to Yamaha or
to grant a license to Yamaha to utilize certain of the Company's technology,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Yamaha is the holder of a number of patents relating to the use of music
synthesis technology. In addition, new patent applications may be currently
pending or be filed in the future by Yamaha. Pending U.S. patent applications
are confidential until patents are issued, and thus it is impossible to
ascertain all possible patent infringement issues. The Company believes that
Yamaha may have a strategy of protecting their market share by filing
intellectual property claims against certain competitors and may assert
additional claims against the Company in the future regardless of the outcome of
the present litigation. Potential additional litigation would likely involve
different patents or other claims. In addition, new patent applications may be
currently pending or be filed in the future by Yamaha. The legal and other
expenses and diversion of resources associated with any such litigation could
materially and adversely affect the Company's business, financial condition and
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1995.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the Company's
current executive officers:
NAME AGE POSITION
- - ------------------------------------------- --- -------------------------------------------
Fred S.L. Chan............................. 49 President, Chief Executive Officer and
Chairman of the Board of Directors
Ralph J. Harms............................. 46 Vice President, Chief Financial Officer and
Secretary
Chi-Shin Wang.............................. 49 Chief Technical Officer
Robert S. Plachno.......................... 40 Vice President, Research and Development
Robert L. Blair............................ 48 Vice President, Operations
Nicholas A. Aretakis....................... 34 Vice President, Sales
Hoover J. Chen............................. 47 Vice President, Engineering
Roger K. Shum.............................. 45 Vice President, Manufacturing
Jan Fandrianto............................. 35 Vice President, Video Group
Mr. Chan joined the Company in November 1985 as President and has been a
director since January 1986. He was appointed Chairman of the Board of Directors
in October 1992 and Chief Executive Officer in June 1994. Mr. Chan served as
Secretary from October 1992 to August 1995 and Chief Financial Officer from
October 1992 to May 1995. Mr. Chan also held the positions of President and
director of Niche Tech, Inc. ("Niche Tech"), an integrated circuit design
company previously affiliated with the Company, from October
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1991 to May 1993. From 1984 to 1985, Mr. Chan was founder, President and Chief
Executive Officer of AC Design Inc., a VLSI chip design center providing CAD,
engineering and design services. From 1982 to 1984, he was co-founder, President
and Chief Executive Officer of CADCAM Technology, Inc., a company in the
business of CAE systems development. Mr. Chan holds B.S.E.E. and M.S.C. degrees
from the University of Hawaii. Mr. Chan is the husband of Annie M. H. Chan, a
director of the Company.
Mr. Harms has been Vice President and Chief Financial Officer of the
Company since May 1995 and Secretary of the Company since August 1995. He
previously held financial and general management positions at various
semiconductor companies, including Intel and Philips Semiconductors and, most
recently, Vice President, Chief Financial Officer and Secretary at SEEQ
Technology Incorporated ("SEEQ"), a semiconductor company, from December 1990 to
May 1995 and Vice President/General Manager, Logic Division, at SEEQ from 1988
to December 1990. Mr. Harms holds an M.B.A. degree in Finance and Accounting
from the University of Michigan. In addition, Mr. Harms holds a B.S.E.E. degree
from Michigan State University.
Dr. Wang has been Chief Technical Officer of the Company since December
1995. Prior to joining the Company he was a co-founder of Integrated Information
Technology, a semiconductor company, and served as President and Chief Executive
Officer from 1987 to December 1995. From 1981 to 1986, he was a co-founder of
Weitek Corporation and served as Vice President of Engineering. Dr. Wang was a
member of the technical staff of Hughes Aircraft Company from 1973 to 1976 and a
project manager of Hewlett Packard from 1976 to 1981. He holds a M.S. degree in
Physics from the California Institute of Technology and a Ph.D.E.E. from
Stanford University.
Mr. Plachno has been Vice President, Research and Development of the
Company since March 1993. Prior to joining the Company, he held research and
development positions in various semiconductor companies, including, from 1986
to February 1993, Vice President of Research and Development at NARA, an
integrated circuit design consulting company, and from 1984 to 1986, private
consultant to American Information Technology, a managed circuit design group.
From 1981 to 1984, Mr. Plachno was Vice President of Engineering at Zytrex, a
semiconductor company. Mr. Plachno holds a B.S. degree in Computer Engineering
from the University of Illinois.
Mr. Blair has been Vice President, Operations of the Company since December
1994. From December 1991 to November 1994, he was Senior Vice President
Operations (Software Packaging & Printing Division) of Logistix Corporation, a
software turnkey company, and, from 1989 to November 1991, he was Vice President
and co-owner of Rock Canyon Investments, a real estate development planning firm
in California. From 1986 to 1989, he held various positions at Xidex
Corporation, a computer diskette manufacturer, including President/General
Manager, at XEMAG, a division of Xidex Corporation. From 1973 to 1986 he was
Vice President, High Reliability Operations at Precision Monolithics, Inc.
Mr. Aretakis has been Vice President, Sales of the Company since August
1994. Prior to joining the Company, he held sales positions in various
semiconductor companies, including Director of OEM Sales at Media Vision, a
computer peripherals manufacturer, from March 1993 to July 1994 and Director of
Sales at SEEQ from 1988 to January 1993. From 1984 through 1988, Mr. Aretakis
held various marketing positions at Microchip Technology Inc. Mr. Aretakis holds
a B.S.E.E. degree from Columbia University and a B.A. degree in Mathematics from
Hobart College.
Mr. Chen has been Vice President, Engineering of the Company since April
1995. From June 1993 to April 1995, he held various engineering positions with
Samsung Electronics Co., first as Director, Multimedia IC Products, Micro
Devices Division, Los Angeles Design Center, and, most recently, as Director,
Micro Devices Division, San Jose Design Center. From December 1992 to June 1993,
he was Vice President of Technology with Mitac Research Corp., a division of
Mitac International Corp., a personal computer manufacturer. From 1989 to
December 1992, he was President and Chief Executive Officer of Micro Integrated
Communications Corp., a manufacturer of modem/fax products. He holds a B.S.E.E.
degree from National Taiwan University and M.S.E.E. and Ph.D.E.E. degrees from
Ohio State University.
Mr. Shum has been Vice President, Manufacturing of the Company since
January 1995, and, from June 1993 to December 1994, he was the Company's Vice
President, Operations. Mr. Shum was Plant Manager,
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Backend Operations at Macronix International Company Ltd., a semiconductor
company, from March 1990 to May 1993. From 1986 to March 1990, Mr. Shum was Vice
President, Operations with Dynasty Technology, Inc., a design service and
supplier to the semiconductor industry. Mr. Shum holds B.S.E.E and M.S.E.E.
degrees from the University of Michigan.
Mr. Fandrianto has been Vice President of the Video Group since January
1996. Prior to joining the Company, he was president of VideoCore Technology,
Inc. from August 1995 to December 1995. From April 1982 to July 1995, Mr.
Fandrianto held various engineering management positions at several high
technology companies including Weitek, a semiconductor company, Hewlett Packard
and served as Chief Technical Officer at Integrated Information Technology, a
semiconductor company. He holds a B.S.E.E. degree from the University of
California at Berkeley and a M.S.E.E. degree from Stanford University.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock has been trading on the Nasdaq National Market
under the symbol "ESST" since October 6, 1995. The following table sets forth
the high and low last reported sales prices for the Common Stock as reported by
the Nasdaq National Market durirg the quarter indicated.
FISCAL 1995: HIGH LOW
------------------------------------------------------------- ---- -----
Fourth Quarter (commencing October 6, 1995).................. $39 $14 1/16
As of February 29, 1996, there were approximately 95 record holders of the
Company's Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1991 1992 1993 1994 1995
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues............................ $22,624 $23,675 $15,218 $33,435 $105,744
Cost of revenues........................ 8,441 9,588 6,733 12,047 39,584
------- ------- ------- ------- --------
Gross profit.......................... 14,183 14,087 8,485 21,388 66,160
Operating expenses:
Research and development.............. 1,959 3,529 2,915 3,711 8,665
Selling, general and administrative... 1,950 2,799 3,005 3,233 9,758
------- ------- ------- ------- --------
Operating income........................ 10,274 7,759 2,565 14,444 47,737
Nonoperating income (expense), net...... 53 (266) 598 283 2,694
------- ------- ------- ------- --------
Income before income taxes.............. 10,327 7,493 3,163 14,727 50,431
Provision for income taxes.............. (4,805) (2,654) (2,880) (6,346) (20,545)
------- ------- ------- ------- --------
Net income.............................. $ 5,522 $ 4,839 $ 283 $ 8,381 $ 29,886
======= ======= ======= ======= ========
Net income per share.................... $ 0.09 $ 0.08 $ 0.01 $ 0.22 $ 0.79
======= ======= ======= ======= ========
Weighted average common and common
equivalent shares(1).................. 58,649 57,220 35,849 37,413 37,775
======= ======= ======= ======= ========
DECEMBER 31,
--------------------------------------------------------
1991 1992 1993 1994 1995
------- ------- ------- ------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments........................... $ 5,913 $10,964 $ 8,114 $10,860 $ 78,124
Working capital......................... 8,988 3,924 2,940 11,135 70,602
Total assets............................ 21,448 19,949 15,108 24,014 162,703
Long-term debt, less current portion.... 653 3,220 -- -- 15,960
Total shareholders' equity.............. 9,589 517 5,889 14,458 105,208
- - ---------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of weighted average common and common equivalent shares used to compute net
income per share.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
ESS designs, develops and markets highly integrated mixed signal
semiconductor multimedia solutions for sale to desktop and notebook personal
computer manufacturers and consumer product companies. Through 1992, the Company
was primarily engaged in the design, development and sale of speech/sound
semiconductors for the consumer and educational markets. These products were
incorporated in toys, games and other consumer products. During such period, the
Company expanded its product offerings and granted licenses to companies for the
development of toy and other consumer products. Through 1993, most of the
Company's sales were derived from sales of consumer speech/sound semiconductors.
In late 1992, due to an increasingly competitive market environment for
speech/sound semiconductors used in toys and other consumer products and the
emerging opportunities in the multimedia PC market, ESS made a strategic
decision to focus on the rapidly growing multimedia PC audio market.
Consequently, the Company began investing substantial resources in the
development of its PC audio technology. In 1993, the Company commenced volume
shipments of its first PC audio semiconductor product, the ES488, a 12-bit mono
audio semiconductor. As a result of the continuing difficult market conditions
for the Company's consumer speech/sound semiconductors and the effects of the
Company's change in product strategy, the Company experienced a substantial
decline in net revenues and net income in 1993. In the first half of 1994, the
Company commenced volume shipments of its ES688 product, a single chip 16-bit
stereo audio semiconductor, which accounted for a substantial majority of the
Company's revenues during 1994 and 1995. In the third quarter of 1994 and the
first quarter and third quarter of 1995, the Company commenced volume shipments
of the ES1488, ES1688, and ES1788, respectively, all of which are single chip PC
audio solutions with integrated ESFM synthesis. As a result of the introduction
of the Company's PC audio semiconductor products, the Company's net revenues
increased from $3.7 million in the first quarter of 1994 to $36.9 million in the
fourth quarter of 1995.
In 1993, 1994 and 1995, the Company's PC audio semiconductor products
accounted for 10.1%, 77.7% and 97.6%, respectively, of net revenues. The Company
expects that, for the foreseeable future, its PC audio products will account for
substantially all of its net revenues. The Company's consumer speech/sound
semiconductors accounted for 16.9% and 1.9% of net revenues in 1994 and 1995,
respectively. The Company also received minimal revenues from licensing fees in
1994 and 1995.
In January 1996, the Company completed its acquisition of VideoCore
pursuant to which the Company acquired all of the outstanding capital stock of
VideoCore in exchange for approximately 525,000 shares of the Company's Common
Stock and $5.4 million in cash. VideoCore, now a wholly owned subsidiary of the
Company, is developing integrated circuits which once completed, will
incorporate advanced compression technology for digital video products. In March
1996, the Company completed its acquisition of OSEE pursuant to which the
Company acquired all of the outstanding capital stock of OSEE in exchange for
approximately 217,000 shares of the Company's Common Stock and $3.6 million in
cash. OSEE, now a wholly owned subsidiary of the Company, is a developer of
advanced fax/modem V.34 and V.34bis algorithm technology which will enable the
Company to provide modem and computer telephony applications on the Company's
multimedia processor. Both acquisitions will be accounted for as a purchase, and
a substantial majority of the purchase prices is attributable to research and
development in process, which will be expensed in the first quarter of 1996.
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RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated statement of operations as a percentage of net revenues for the
periods indicated.
YEARS ENDED DECEMBER 31,
-------------------------
1993 1994 1995
----- ----- -----
Net revenues................................................ 100.0% 100.0% 100.0%
Cost of revenues............................................ 44.2 36.0 37.4
------ ------ ------
Gross margin.............................................. 55.8 64.0 62.6
Operating expenses:
Research and development.................................. 19.2 11.1 8.2
Selling, general and administrative....................... 19.7 9.7 9.2
------ ------ ------
Operating income............................................ 16.9 43.2 45.2
Nonoperating income (expense), net.......................... 3.9 0.8 2.5
------ ------ ------
Income before income taxes.................................. 20.8 44.0 47.7
Income taxes................................................ (18.9) (19.0) (19.4)
------ ------ ------
Net income.................................................. 1.9% 25.0% 28.3%
====== ====== ======
Net Revenues. Net revenues were $15.2 million, $33.4 million and $105.7
million in 1993, 1994 and 1995, respectively. Net revenues for 1995 increased
216% from 1994 primarily as a result of the continued rapid sales growth of the
Company's existing PC audio products as well as from the introduction of new PC
audio products. Net revenues for 1994 increased 120% from 1993 primarily as a
result of the rapid sales growth of the Company's higher priced PC audio
semiconductor products. The Company's PC audio semiconductor products accounted
for 97.6% of the Company's net revenues for 1995. The rapid increase in PC audio
semiconductor product sales was partially offset by a continued decrease in
sales of the Company's consumer speech/sound semiconductors. International
revenues accounted for approximately 87% ,72% and 73% of net revenues for 1993,
1994 and 1995, respectively. The decrease in international sales as a percentage
of net revenues between 1993 and 1994 primarily reflects the transition from
consumer speech/sound semiconductors to PC audio semiconductor products.
Gross Margin. Gross profit was $8.5 million, $21.4 million and $66.2
million in 1993, 1994 and 1995, respectively, representing 55.8%, 64.0% and
62.6% of net revenues for such years, respectively. Gross margins declined from
1994 to 1995 as a result of a decrease in ASPs of the Company's existing PC
audio products and manufacturing startup costs associated with the Company's new
PC audio product introductions which were partially offset by higher ASPs
associated with the introduction of new PC audio products. Gross margin improved
from 1993 to 1994 primarily as a result of increased unit shipments of the
Company's PC audio products, which generally have higher margins than its
consumer speech/sound products. The Company expects that ASPs for its existing
products will continue to decline over time and that ASPs for each new product
will decline significantly over the life of the product. A decline in ASPs that
is not offset by a reduction in production costs or by sales of new products
with higher gross margins would decrease the Company's overall gross margin and
could materially adversely affect the Company's operating results. As a result,
the Company believes that its gross margin may continue to decline in the
future.
Research and Development Expenses. Research and development expenses were
$2.9 million, $3.7 million and $8.7 million, or 19.2%, 11.1% and 8.2% of net
revenues, in 1993, 1994 and 1995, respectively. The increase in absolute dollars
in research and development expenses from 1994 to 1995 primarily reflected
increases in the Company's engineering staff and internal and outside consulting
expenses associated with increased research and development efforts to support
the introduction of new PC audio products and multimedia products. The increase
in absolute dollars in research and development expenses from 1993 to 1994
primarily reflected increased materials expenses and additional personnel to
support the development of the ES1488 and ES1688 PC audio products. The Company
expects to incur higher absolute research and development expenses in 1996,
although these expenses are expected to remain relatively constant as a
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percentage of net revenues. There can be no assurance, however, that revenues
will grow at the same rate as the anticipated research and development expenses.
Selling, General and Administration Expenses. Selling, general and
administrative expenses were $3.0 million, $3.2 million and $9.8 million, or
19.7%, 9.7% and 9.2% of net revenues, in 1993, 1994 and 1995, respectively. The
increase in absolute dollars in selling, general and administrative expenses
from 1994 to 1995 was primarily due to legal expenses associated with the
Company's ongoing litigation with Yamaha. See "Item 3. Legal Proceedings" and
Notes 2 and 8 to Notes to Consolidated Financial Statements. The increase in
these expenses was also due to commissions on higher sales levels, added
personnel and related expenses and, to a lesser extent, promotional expenses and
costs associated with the expansion of the Company's sales activities. The
increase in absolute dollars in selling, general and administrative expenses
from 1993 to 1994 was primarily due to added personnel and related expenses,
commissions on higher sales levels and, to a lesser extent, promotional expenses
and costs associated with the expansion of the Company's sales activities. The
Company expects to incur higher selling, general and administrative expenses due
to increased selling activities on higher sales and reporting and other
requirements of a public company, although these expenses are expected to remain
relatively constant as a percentage of net revenues. There can be no assurance,
however, that revenues will grow at the same rate as the anticipated selling,
general and administrative expenses.
Non-Operating Income (Expense), Net. Non-operating income (expense), net
was $598,000, $283,000 and $2,694,000 in 1993, 1994 and 1995, respectively. In
1993, non-operating income (expense), net consisted of a gain on securities,
and, to a lesser extent, interest income net of interest expense. In 1994,
non-operating income (expense), net consisted of interest income net of interest
expense and a gain on securities. In 1995, non-operating income (expense), net
consisted of interest income and a gain on securities.
Provision for Income Taxes. The Company's effective tax rate was 91%, 43%
and 41% for 1993, 1994 and 1995, respectively. The higher tax rate in 1993 was
due to federal taxes on the repatriation of profits from the Company's Hong Kong
subsidiary that were previously considered to be permanently invested and to
non-deductible compensation expenses. The Company's tax rate for 1994 was higher
than the combined federal and state statutory rate of 41% as a result of federal
taxes provided on foreign earnings. The Company's tax rate for 1995 was at the
combined federal and state statutory rate of 41%. See Note 4 of Notes to
Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements from
cash generated from operations, the sale of equity securities, bank lines of
credit and long-term and short-term debt. At December 31, 1995, ESS had cash and
cash equivalents and short-term investments of $78.1 million and working capital
of $70.6 million which includes $60.7 million in net proceeds generated from the
Company's initial public offering in October 1995. As of December 31, 1995, the
Company had a line of credit for $10 million expiring on March 31, 1997. The
line of credit requires the Company to achieve certain financial ratios and
operating results. There were no borrowings under the line of credit as of
December 31, 1995.
In 1995, the Company's operating activities generated cash of approximately
$13.5 million. This resulted primarily from net income of approximately $29.9
million. In 1995, approximately $16.0 million was used to finance working
capital, primarily due to increases in accounts receivable and inventories,
reflecting growth in sales of the Company's PC audio products, which were offset
in part by an increase in accounts payable. In 1995, the purchase of short-term
investments and property and equipment used approximately $26.2 million, and
$8.4 million, respectively.
In 1994, the Company's operating activities generated net cash of
approximately $5.1 million. This resulted primarily from net income of
approximately $8.4 million and depreciation and amortization of $656,000. In
1994, approximately $3.8 million was used to finance working capital, primarily
due to increases in accounts receivable and inventories, reflecting growth in
sales of the Company's PC audio products, which
17
19
were offset in part by an increase in accounts payable. In 1994, the sale of
marketable equity securities provided approximately $1.3 million, offset in part
by $1.1 million used to acquire additional property and equipment. Cash used to
pay short-term debt was approximately $2.7 million.
In 1993, the Company's operating activities used net cash of approximately
$1.1 million. This resulted primarily from approximately $2.4 million used to
finance working capital, consisting primarily of decreases in accounts payable
and income taxes, offset in part by net income of $283,000, depreciation and
amortization of $663,000, non-cash compensation of $905,000 and a $578,000 gain
on sales of marketable equity securities. Sales of marketable equity securities
and short-term investments provided approximately $2.5 million, of which
$609,000 was used to acquire property and equipment. Cash used to repay
short-term and long-term debt, net of proceeds from short-term debt, was
approximately $5.0 million. In addition, the issuance of Common Stock provided
approximately $1.3 million.
The Company believes that its existing cash and cash equivalents, together
with the cash generated from operations and available borrowings under its line
of credit, will be sufficient to fund acquisitions of property and equipment and
provide adequate working capital through at least the next twelve months.
Capital expenditures for the next twelve months are anticipated to be
approximately $15 million, of which approximately $10 million will be used to
fund the construction of a new headquarters facility and approximately $5
million will be used to acquire capital equipment. The Company may also utilize
cash to acquire or invest in complementary businesses or products or to obtain
the right to use complementary technologies. From time to time, in the ordinary
course of business, the Company may evaluate potential acquisitions of or
investments in such businesses, products or technologies owned by third parties.
However, the Company has no present understandings, commitments or agreements
with respect to any material acquisition of or investment in other businesses,
products or technologies. The Company also has a bank line of credit which may
be utilized to provide additional working capital.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for the historical information contained in this Annual Report on
Form 10-K, the matters discussed in this report are forward looking statements.
These forward looking statements concern matters that involve risks and
uncertainties, including but not limited to those set forth below, that could
cause actual results to differ materially from those in the forward looking
statements. In any event, the matters set forth below should be carefully
considered when evaluating the Company's business and prospects.
Potential Fluctuations in Operating Results. The Company's operating
results are subject to quarterly and other fluctuations due to a variety of
factors, including the gain or loss of significant customers, increased
competitive pressures, changes in pricing policies by the Company, its
competitors or its suppliers, including decreases in unit ASPs of the Company's
products, the timing of new product announcements and introductions by the
Company or its competitors and market acceptance of new or enhanced versions of
the Company's and its customers' products. Other factors include the
availability of foundry capacity, fluctuations in manufacturing yields,
availability and cost of raw materials, changes in the mix of products sold, the
cyclical nature of both the semiconductor industry and the market for PCs,
seasonal customer demand, the timing of significant orders and significant
increases in expenses associated with the expansion of operations. In addition,
the Company's quarterly operating results could be materially adversely affected
by legal expenses incurred in connection with, or any adverse judgment in, the
patent litigation with Yamaha Corporation. The Company's operating results could
also be adversely affected by economic conditions generally in various
geographic areas where the Company or its customers do business, or order
cancellations or rescheduling. These factors are difficult to forecast, and
these or other factors could materially affect the Company's quarterly or annual
operating results. There can be no assurance as to the level of sales or
earnings that may be attained by the Company in any given period in the future.
See "Management Discussion and Analysis of Financial Condition and Results of
Operations."
Patent Litigation with Yamaha Corporation. In March 1995, Yamaha files a
lawsuit against the Company alleging that the Company's FM synthesis products
infringe two of Yamaha's patents. See "Item 3. Legal Proceedings."
18
20
Competition; Pricing Pressures. The markets in which the Company competes
are intensely competitive and are characterized by rapid technological change,
price declines and rapid product obsolescence. See "Item 1.
Business -- Competition."
Dependence on Single Product Line and PC Industry. In 1994 and 1995, sales
of PC audio semiconductors accounted for approximately 77.7% and 97.6%,
respectively, of the Company's net revenues, and the Company expects that sales
of audio semiconductors will continue to account for a significant majority of
its net revenues for the foreseeable future. Any reduction in demand for the
Company's audio semiconductors, whether because of a reduction in demand for PCs
in general or PC audio, increased competition or otherwise, would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Most of the Company's products are sold for incorporation into multimedia
desktop and notebook computers. ESS audio semiconductors are incorporated into
motherboards by multimedia PC original equipment manufacturers ("OEMs") or in
add-in sound cards. Therefore, the Company is heavily dependent on the continued
growth of the markets for multimedia desktop and notebook computers and
multimedia applications utilizing high quality audio. Currently, the market for
PCs, including multimedia PCs is undergoing a slower rate of growth than in
previous years and the overall PC industry has historically been cyclical. There
can be no assurance that the high levels of growth previously experienced by the
PC industry will return in future periods. A decline in demand in the PC
industry could result in a corresponding decline in demand for the Company's
products, which would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Item 1.
Business -- Products."
Importance of New Products and Technological Change. The markets for the
Company's products are characterized by evolving industry standards, rapid
technological change and product obsolescence. The Company's success is highly
dependent upon the successful development and timely introduction of new
products at competitive price and performance levels. The success of new
products depends on a number of factors, including timely completion of product
development, market acceptance of the Company's and its customers' new products,
securing sufficient foundry capacity for volume manufacturing of wafers,
achievement of acceptable wafer fabrication yields by the Company's independent
foundries and the Company's ability to offer new products at competitive prices.
In order to succeed in having the Company's products incorporated into new
products being designed by desktop and notebook computer manufacturers, the
Company must anticipate market trends and performance and functionality
requirements of such manufacturers and must successfully develop and manufacture
products that meet these requirements. In addition, the Company must meet the
timing and price requirements of such manufacturers and must make such products
available in sufficient quantities. Accordingly, in selling to OEMs, the Company
can often incur significant expenditures prior to volume sales of new products,
if any. In order to help accomplish these goals, the Company has in the past and
will continue to consider in the future the acquisition of other companies or
the products and technologies of other companies. Such acquisitions carry
additional risks such as a lack of integration with existing products and
corporate culture, the potential for large write-offs and the diversion of
management attention. The Company is currently engaged in the development of new
PC audio products as well as new multimedia products that provide telephony
capabilities such as fax/modem/voice, and graphics and video applications. There
can be no assurance that the Company will be able to identify market trends or
new product opportunities, develop and market new products, achieve design wins
or respond effectively to new technological changes or product announcements by
others. A failure in any of these areas would have a material adverse effect on
the Company's business, financial condition and results of operations. See "Item
I. Business -- Research and Development."
Dependence on TSMC and Other Third Parties. The Company relies on
independent foundries to manufacture all of its products. A substantial majority
of the Company's products are currently manufactured by TSMC, which has
manufactured certain of the Company's products since 1989. The Company also has
foundry arrangements with Sharp, ICW, and UMC, which have been manufacturing
certain of the Company's products since 1986, 1991 and 1995, respectively. TSMC,
in particular, provides the Company with access to advanced process technology
necessary for the manufacture of the Company's products. These foundries
fabricate products for other companies and, with the exception of TSMC,
manufacture products of their own design. In November 1995, the Company entered
into long-term agreements with TSMC and UMC
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21
in which the Company has secured access to additional capacity and to leading
edge technology. See "Item I. Business -- Manufacturing."
While the Company has entered into long-term agreements with two of its
foundries, the Company's reliance on these and other independent foundries
involves a number of risks, including the absence of adequate capacity, the
unavailability of, or interruption in access to, certain process technologies
and reduced control over delivery schedules, manufacturing yields and costs, and
the international risks more fully described below. The Company expects to rely
upon TSMC and UMC to manufacture a substantial majority of the Company's
products for the foreseeable future. In the event that TSMC and UMC are unable
to continue to manufacture the Company's key products in required volumes, the
Company will have to identify and secure additional foundry capacity. In such an
event, the Company may be unable to identify or secure additional foundry
capacity from another manufacturer, particularly at the levels that the Company
currently expects TSMC and UMC to provide. Even if such capacity is available
from another manufacturer, the qualification process could take six months or
longer. The loss of any of its foundries as a supplier, the inability of the
Company to acquire additional capacity at its current suppliers or qualify other
wafer manufacturers for additional foundry capacity should additional capacity
be necessary, or any other circumstances causing a significant interruption in
the supply of semiconductors to the Company would have a material adverse effect
on the Company's business, financial condition and results of operations.
To address potential foundry capacity constraints in the future, ESS will
continue to consider and may be required to enter into additional arrangements,
including equity investments in or loans to independent wafer manufacturers in
exchange for guaranteed production capacity, joint ventures to own and operate
foundries, or "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods. Any such arrangements
could require the Company to commit substantial capital and grant licenses to
its technology. The need to commit substantial capital may require the Company
to obtain additional debt or equity financing, which could result in dilution to
the Company's shareholders. There can be no assurance that such additional
financing, if required, will be available when needed or, if available, will be
obtained on terms acceptable to the Company.
Customer Concentration. A limited number of customers have accounted for a
substantial portion of the Company's net revenues. In 1993, 1994 and 1995, sales
to the Company's top five customers, including sales to the Company's
international distributor, accounted for approximately 77%, 51% and 48%
respectively, of the Company's net revenues. In 1993, one customer, Western
Publishing, accounted for 57% of the Company's net revenues. In 1994, two
customers, Compaq and Western Publishing, accounted for approximately 20% and
14%, respectively, of the Company's net revenues. The decline in the percentage
of sales attributable to Western Publishing reflects the Company's shift in
product mix to PC audio products. In 1995, Compaq and Universe Electron
Corporation, the Company's Japanese distributor, each accounted for
approximately 17% of the Company's net revenues. The Company expects that sales
to a limited number of customers will continue to account for a substantial
portion of its net revenues for the foreseeable future. The Company has
experienced changes from year to year in the composition of its major customer
base and believes this pattern may continue. For example, Compaq has only been a
significant customer of the Company since 1994. The Company does not have
long-term purchase agreements with any of its customers. The reduction, delay or
cancellation of orders from one or more major customers for any reason or the
loss of one or more of such major customers could materially and adversely
affect the Company's business, financial condition and results of operations. In
addition, since the Company's products are often sole sourced to its customers,
the Company's operating results could be materially and adversely affected if
one or more of its major customers were to develop other sources of supply.
There can be no assurance that the Company's current customers will continue to
place orders with the Company, that orders by existing customers will not be
canceled or will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers. The Company currently places
noncancelable orders to purchase its products from independent foundries on an
approximately three month rolling basis, while its customers generally place
purchase orders with the Company less than four weeks prior to delivery that may
be canceled without significant penalty. Consequently, if anticipated sales and
shipments in any quarter are canceled or do not
20
22
occur as quickly as expected, expense and inventory levels could be
disproportionately high and the Company's business, financial condition and
results of operations could be materially adversely affected.
Management of Growth. The Company has recently experienced significant
growth that has placed, and could continue to place, significant strain on the
Company's limited personnel, management systems and other resources. The Company
has hired several new executive officers since the beginning of 1994, including
its Vice President of Engineering, Vice President of Operations, Vice President
of Sales, Chief Financial Officer and Chief Technical Officer. Furthermore, the
Company anticipates expanding its facilities by building a new headquarters in
1996. To manage its operations and growth effectively, the Company will need to
continue to improve its operational, financial and management information
systems, implement additional systems and controls, and hire, train, motivate,
manage and retain its employees. There can be no assurance that the Company will
be able to manage such growth effectively, and the failure to do so could have a
material adverse effect on the Company's business, financial condition and
results of operations.
International Operations. During 1993, 1994 and 1995, international sales,
accounted for approximately 87%, 72% and 73% of the Company's net revenues,
respectively. Substantially all of the Company's international sales were to
customers in Taiwan, Japan, Singapore and Hong Kong. The Company expects that
international sales will continue to represent a significant portion of its net
revenues for the foreseeable future. In addition, substantially all of the
Company's products are manufactured, assembled and tested by independent third
parties in Asia. Due to its reliance on international sales and foreign
third-party manufacturing, assembly and testing operations, the Company is
subject to the risks of conducting business outside of the United States. These
risks include unexpected changes in, or impositions of legislative or regulatory
requirements, delays resulting from difficulty in obtaining export licenses for
certain technology, tariffs, quotas and other trade barriers and restrictions,
longer payment cycles, greater difficulty in accounts receivable collection,
potentially adverse taxes, the burdens of complying with a variety of foreign
laws and other factors beyond the Company's control. The Company is also subject
to general geopolitical risks in connection with its international trade
relationships. In particular, Taiwan, which represents 40% of the Company's
sales and is the location of its major foundries and one test facility, is
currently experiencing military threats from mainland China. If the highly
publicized tensions escalate, it is possible that purchases by Taiwanese
customers will decline significantly and semiconductor manufacturing in Taiwan
will be seriously impeded, cutting off the Company's main supply of guaranteed
wafer production. This could also lead to capacity constraints at non-Taiwanese
foundries. Although the Company has not to date experienced any material adverse
effect on its business, financial condition or results of operations as a result
of such regulatory, geopolitical and other factors, there can be no assurance
that such factors will not have a material adverse effect on the Company's
business, financial condition and results of operations in the future or require
the Company to modify its current business practices.
In addition, the laws of certain foreign countries in which the Company's
products are or may be manufactured or sold, including various countries in
Asia, may not protect the Company's 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 the Company's technology and products more likely.
Currently, all of the Company's product sales and all of its arrangements with
foundries and assembly and test vendors, other than its foundry arrangement with
Sharp Corporation, provide for pricing and payment in U.S. dollars. To date,
although the effect of currency fluctuations have been insignificant, there can
be no assurance that fluctuations in currency exchange rates will not have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, to date the Company has not engaged in any
currency hedging activities, although the Company may do so in the future.
Further, there can be no assurance that one or more of the foregoing factors
will not have a material adverse effect on the Company's business, financial
condition and results of operations or require the Company to modify its current
business practices.
Semiconductor Industry. The semiconductor industry has historically been
characterized by rapid technological change, cyclical market patterns,
significant price erosion, periods of over-capacity and production shortages,
variations in manufacturing costs and yields and significant expenditures for
capital equipment and product development. In addition, the industry has
experienced significant economic downturns at various times, characterized by
diminished product demand and accelerated erosion of product prices.
21
23
Although the semiconductor industry in recent periods has experienced increased
demand, it is uncertain how long these conditions will continue. The Company may
experience substantial period-to-period fluctuations in operating results due to
general semiconductor industry conditions.
Patents and Proprietary Rights. The Company relies on a combination of
patents, trademarks, copyrights, trade secret laws and confidentiality
procedures to protect its intellectual property rights. See "Item 1.
Business -- Patents and Proprietary Rights."
Dependence on Key Personnel. The Company's success depends to a
significant degree upon the continued contributions of members of its senior
management, particularly Fred S.L. Chan, the Company's President, Chief
Executive Officer and Chairman of the Board of Directors, as well as other
officers and key technical, marketing and sales personnel, many of whom would be
difficult to replace. The future success of the Company depends on its ability
to continue to attract, retain and motivate qualified technical and management
personnel, particularly highly skilled semiconductor design personnel and
software engineers, for whom competition is intense. Recently, the Company has
hired a number of executives and management personnel.
Internal Revenue Service Audit. ESS is currently being audited by the
Internal Revenue Service for the years 1992, 1992 and 1993. The audits are
primarily focused on the methods used by the Company for allocating revenues and
expenses between the Company and its wholly-owned Hong Kong subsidiary. The
Company believes it has established an adequate reserve for taxes. However, no
assurance can be given that the actual amounts of taxes payable upon resolution
of the matters covered by the audits will not exceed the amount of this reserve.
If this reserve is inadequate, the Company's financial condition could be
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and Note 4 of Notes to Consolidated
Financial Statements.
Control by Existing Shareholders. As of February 29, 1996, Fred S.L. Chan,
the Company's President, Chief Executive Officer and Chairman of the Board of
Directors, together with his spouse, Annie M. H. Chan, a director of the
Company, and certain other shareholders related to Mr. and Mrs. Chan owned, in
the aggregate, 52% of the Company's outstanding Common Stock. As a result, these
shareholders, acting together, possess voting control over the Company, giving
them the ability among other things to elect at least a majority of the
Company's Board of Directors (and the entire Board of Directors when cumulative
voting is eliminated) and approve significant corporate transactions. Such
control could delay, defer or prevent a change in control of the Company, impede
a merger, consolidation, takeover or other business combination involving the
Company, or discourage a potential acquiror from making a tender offer or
otherwise attempting to obtain control of the Company.
Shares Eligible for Future Sale. As of February 29, 1996, the Company had
approximately 36,217,836 shares of Common Stock outstanding. Of such shares,
8,110,000 shares are freely tradable and the remaining 28,107,836 shares are
restricted shares ("Restricted Shares") under the Securities Act of 1933, as
amended (the "Securities Act"). Beginning April 3, 1996 and October 6, 1996,
approximately 17,515,509 and 6,782,677 Restricted Shares, respectively, will
first become eligible for sale in the public market pursuant to Rules 144 and
701 promulgated under the Securities Act, the expiration of certain lock-up
agreements with the Company or the underwriters of its initial public offering,
or a combination of the foregoing, subject to certain volume and other resale
restrictions. In addition, at various times after December 1996, approximately
3,809,650 additional Restricted Shares will become eligible for sale in the
public market, subject to certain volume and resale restrictions pursuant to
Rule 144.
Possible Volatility of Stock Price. The price of the Company's Common
Stock has in the past and may continue in the future to fluctuate widely. Future
announcements concerning the Company, its competitors or its principal
customers, including quarterly operating results, changes in earnings estimates
by analysts, technological innovations, new product introductions, governmental
regulations or litigation may cause the market price of the Common Stock to
continue to fluctuate substantially. Further, in recent years the stock market
has experienced extreme price and volume fluctuations that have particularly
affected the market prices of equity securities of many high technology
companies and that often have been unrelated or disproportionate to the
operating performance of such companies. These fluctuations, as well as general
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economic, political and market conditions such as recessions or international
currency fluctuations, may materially adversely affect the market price of the
Common Stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1995 and 1994
Consolidated Statements of Operations for the years ended December 31,
1995, 1994 and 1993
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1995, 1994 and 1993
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1994 and 1993
Notes to Consolidated Financial Statements
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
ESS Technology, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity and cash
flows present fairly, in all material respects, the financial position of ESS
Technology, Inc. and its subsidiaries at December 31, 1994 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1995, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Price Waterhouse LLP
San Jose, California
January 19, 1996, except as to Note 10,
which is as of March 29, 1996
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ESS TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1994 AND 1995
(AMOUNTS IN THOUSANDS)
DECEMBER 31,
------------------------
1994 1995
------- --------
ASSETS
Current assets:
Cash and cash equivalents....................................... $10,860 $ 51,881
Short-term investments.......................................... -- 26,243
Accounts receivable, net........................................ 4,301 10,236
Inventories..................................................... 4,029 19,169
Deferred income taxes........................................... 1,276 2,337
Prepaid expenses and other assets............................... 225 2,271
------- -------
Total current assets.................................... 20,691 112,137
Property and equipment, net....................................... 2,919 10,371
Other assets...................................................... 404 40,195
------- -------
$24,014 $162,703
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses........................... $ 2,671 $ 33,744
Income taxes payable............................................ 2,816 3,722
Deferred income taxes........................................... 4,069 4,069
------- -------
Total current liabilities............................... 9,556 41,535
------- -------
Long-term advances payable to vendors............................. -- 15,960
------- -------
Total liabilities....................................... 9,556 57,495
------- -------
Commitments and contingencies
(Notes 7, 8, 9 and 10)
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding.................................. -- --
Common stock, no par value, 100,000 shares authorized;
30,248 and 35,473 shares issued and outstanding at
December 31, 1994 and 1995, respectively..................... 6,087 66,891
Deferred compensation related to stock options.................. (120) (60)
Retained earnings............................................... 8,491 38,377
------- -------
Total shareholders' equity.............................. 14,458 105,208
------- -------
Total liabilities and shareholders' equity........................ $24,014 $162,703
======= =======
The accompanying notes are an integral part of these financial statements.
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27
ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
--------------------------------
1993 1994 1995
------- ------- --------
Net revenues................................................. $15,218 $33,435 $105,744
Cost of revenues............................................. 6,733 12,047 39,584
------- ------- --------
Gross profit............................................... 8,485 21,388 66,160
Operating expenses:
Research and development................................... 2,915 3,711 8,665
Selling, general and administrative........................ 3,005 3,233 9,758
------- ------- --------
Operating income............................................. 2,565 14,444 47,737
Interest expense............................................. (485) (164) --
Interest income.............................................. 505 305 1,348
Gain on short-term investments............................... 578 142 1,346
------- ------- --------
Income before provision for income taxes..................... 3,163 14,727 50,431
Provision for income taxes................................... (2,880) (6,346) (20,545)
------- ------- --------
Net income................................................... $ 283 $ 8,381 $ 29,886
======= ======= ========
Net income per share......................................... $ 0.01 $ 0.22 $ 0.79
======= ======= ========
Weighted average common and common equivalent shares......... 35,849 37,413 37,775
======= ======= ========
The accompanying notes are an integral part of these financial statements.
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ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
(AMOUNTS IN THOUSANDS)
COMMON STOCK
------------------- DEFERRED RETAINED
SHARES AMOUNT COMPENSATION EARNINGS TOTAL
------- ------- ------------ -------- --------
Balance at December 31, 1992......... 19,567 $ 930 $ (240) $ (173) $ 517
Issuance of common stock upon
exercise of options............. 2,328 254 -- -- 254
Issuance of common stock to
officers and directors.......... 6,481 2,880 -- -- 2,880
Issuance of common stock for
cash............................ 750 1,050 -- -- 1,050
Capital related to deemed
compensation (Note 5)........... -- 845 -- -- 845
Amortization of deferred
compensation.................... -- -- 60 -- 60
Net income......................... -- -- -- 283 283
-------- -------- ------ -------- --------
Balance at December 31, 1993......... 29,126 5,959 (180) 110 5,889
Issuance of common stock upon
exercise of options............. 1,122 128 -- -- 128
Amortization of deferred
compensation.................... -- -- 60 -- 60
Net income......................... -- -- -- 8,381 8,381
-------- -------- ------ -------- --------
Balance at December 31, 1994......... 30,248 6,087 (120) 8,491 14,458
Issuance of common stock, net of
issuance costs of $1,081........ 4,428 60,682 -- -- 60,682
Issuance of common stock upon
exercise of options............. 797 122 -- -- 122
Amortization of deferred
compensation.................... -- -- 60 -- 60
Net income......................... -- -- -- 29,886 29,886
-------- -------- ------ -------- --------
Balance at December 31, 1995......... 35,473 $66,891 $ (60) $ 38,377 $105,208
======== ======== ====== ======== ========
The accompanying notes are an integral part of these financial statements.
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ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1993 1994 1995
-------- ------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 283 $ 8,381 $ 29,886
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 663 656 934
Gain on sale of short-term investments................. (578) (142) (1,346)
Deemed compensation expense and compensation related
to stock options..................................... 905 60 60
Change in assets and liabilities:
Accounts receivable.................................. 273 (2,889) (5,935)
Inventories.......................................... (667) (2,970) (15,140)
Deferred income taxes................................ 982 (654) (1,061)
Prepaid expenses and other assets ................... (99) (45) (41,837)
Accounts payable and accrued expenses................ (1,953) 1,558 31,073
Long-term advances payable to vendors................ -- -- 15,960
Income taxes payable................................. (898) 1,199 906
--------
-
--------- ----------
Net cash provided by (used in) operating
activities...................................... (1,089) 5,154 13,500
--------
-
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment..................... (609) (1,067) (8,386)
Sale of marketable equity securities...................... 2,546 1,261 1,346
Purchase of short-term investments........................ -- -- (26,243)
--------
-
--------- ----------
Net cash provided by (used in) investing
activities...................................... 1,937 194 (33,283)
--------
-
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt............................. 9,223 -- --
Repayment of short-term debt.............................. (11,005) (2,730) --
Repayment of long-term debt............................... (3,220) -- --
Issuance of common stock.................................. 1,304 128 60,804
--------
-
--------- ----------
Net cash provided by (used in) financing
activities...................................... (3,698) (2,602) 60,804
--------
-
--------- ----------
Net increase (decrease) in cash and cash equivalents........ (2,850) 2,746 41,021
Cash and cash equivalents at beginning of period............ 10,964 8,114 10,860
--------
-
--------- ----------
Cash and cash equivalents at end of period.................. $ 8,114 $10,860 $ 51,881
========= ========= ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest............................................... $ 254 $ 307 $ --
========= ========= ==========
Income taxes........................................... $ 2,791 $ 5,887 $ 20,702
========= ========= ==========
During 1993, the Company issued common stock totaling $2,880 to certain
officers of the Company in exchange for promissory notes receivable. Such notes
were offset against notes payable by the Company to those officers.
The accompanying notes are an integral part of these financial statements.
28
30
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
ESS Technology, Inc. (the "Company") was incorporated in California in
February 1984. The Company and its wholly-owned subsidiaries design, develop and
market sound-emitting semiconductors offering multimedia solutions for sale to
desktop and notebook personal computer manufacturers.
In October 1995, the Company completed its initial public offering of
8,050,000 shares of common stock including the shares from an over-allotment
option. Of the total shares offered, 4,427,500 were sold by the Company and
3,622,500 shares were sold by shareholders. Net proceeds to the Company were
$61,763,000 before deducting offering expenses of $1,081,000.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Use of Estimates and Assumptions
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Cash and Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an initial
maturity of 90 days or less to be cash equivalents and investments with original
maturity dates of greater than 90 days to be short-term investments. The Company
accounts for its short-term investments under Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt or Equity Securities" (SFAS
115), which requires investment securities to be classified as either held to
maturity, trading or available for sale.
All of the Company's short-term investments, comprising primarily debt
instruments with contractual maturities of less than two years have been
classified as available for sale. Interest income is accrued as earned. At
December 31, 1995, the fair value of the Company's investments approximated
cost.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined by the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is provided using the straight-line method over estimated useful lives
that range from 3 to 5 years for machinery and equipment and furniture and
fixtures and 4 to 33 years for buildings and building improvements.
Revenue Recognition
Revenue from product sales is recognized at the time of shipment. Sales to
distributors are generally subject to agreements allowing limited rights of
return and price protection with respect to unsold products held by the
distributor. Reserves for estimated returns and price adjustments are provided
at the time revenue is recognized. Such reserves are calculated based on
historical rates of returns and allowances, distributor inventory levels and
other factors.
29
31
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Research and Development
Research and development costs are expensed as incurred.
Income Taxes
The Company accounts for income taxes under an asset and liability approach
that requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax bases of assets and liabilities. U.S. deferred income taxes
are provided on unremitted earnings of the Company's foreign subsidiary to the
extent that such earnings are not considered permanently invested.
Net Income per share
Net income per share is computed using the weighted average number of
common and common equivalent shares ("weighted average shares") outstanding
during the period. Common equivalent shares consist of the Company's common
stock issuable upon exercise of stock options (using the treasury stock method),
except when antidilutive. Common stock issued and stock options granted
subsequent to July 31, 1994 through the date of the initial public offering
(using the treasury stock method and the initial public offering price of $15.00
per share) have been included in the calculation of weighted average shares
outstanding as if they were outstanding for all applicable periods.
Reclassifications
Certain information in the 1993 and 1994 financial statements has been
reclassified to conform with the 1995 financial statement presentation.
Stock Split
On August 2, 1995, the Company effected a three-for-two stock split. Share
and option data for all periods presented have been restated accordingly.
30
32
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
DECEMBER 31,
--------------------
1994 1995
-------- -------
Cash and cash equivalents:
Cash and money market accounts........................................ $ 10,860 $15,693
Municipal notes and bonds............................................. -- 36,088
Certificates of deposit............................................... -- 100
------- -------
$ 10,860 $51,881
======= =======
Short-term investments:
Municipal notes and bonds............................................. $ -- $26,243
======= =======
Accounts receivable:
Accounts receivable................................................... $ 4,390 $10,339
Less: allowance for doubtful accounts................................. (89) (103)
------- -------
$ 4,301 $10,236
======= =======
Inventories:
Raw materials......................................................... $ 217 $ 2,773
Work-in-process....................................................... 2,121 9,224
Finished goods........................................................ 1,691 7,172
------- -------
$ 4,029 $19,169
======= =======
Property and equipment:
Land.................................................................. $ 676 $ 4,128
Buildings and building improvements................................... 926 2,144
Machinery and equipment............................................... 2,898 6,451
Furniture and fixtures................................................ 135 298
------- -------
Cost of property and equipment........................................ 4,635 13,021
Less: accumulated depreciation and amortization....................... (1,716) (2,650)
------- -------
$ 2,919 $10,371
======= =======
Other assets:
Foundry prepayments................................................... $ -- $37,184
Prepaid license fees.................................................. -- 2,773
Other................................................................. 404 238
------- -------
$ 404 $40,195
======= =======
Accounts payable and accrued expenses:
Accounts payable...................................................... $ 1,861 $ 7,588
Accrued compensation costs............................................ 318 1,051
Accrued legal fees.................................................... -- 945
Advances payable to vendors........................................... -- 22,904
Other accrued liabilities............................................. 492 1,256
------- -------
$ 2,671 $33,744
======= =======
31
33
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. DEBT
On November 16, 1995, the Company entered into an unsecured short-term line
of credit agreement totaling $10 million with a foreign bank. Under the terms of
the agreement, the Company may borrow at a fixed rate of LIBOR plus 1% or a
variable rate at the foreign bank's reference rate minus 1%. The line of credit
requires the Company to achieve certain financial ratios and operating results.
There were no borrowings under the line of credit as of December 31, 1995.
4. INCOME TAXES
Income before provision for income taxes consisted of the following:
YEAR ENDED DECEMBER 31,
------------------------------
1993 1994 1995
------ ------- -------
(IN THOUSANDS)
Domestic............................................... $ (295) $13,385 $50,363
Foreign................................................ 3,458 1,342 68
------ ------- -------
$3,163 $14,727 $50,431
====== ======= =======
Provision for income taxes consisted of the following:
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1994 1995
------ ------ -------
(IN THOUSANDS)
Current:
Federal............................................... $ 833 $5,358 $18,382
State................................................. 477 1,415 3,200
Foreign............................................... 588 228 24
------ ------ -------
1,898 7,001 21,606
------ ------ -------
Deferred:
Federal............................................... 763 (663) (1,056)
State................................................. 219 8 (5)
------ ------ -------
982 (655) (1,061)
------ ------ -------
Total......................................... $2,880 $6,346 $20,545
====== ====== =======
A reconciliation between the provision for income taxes computed at the
federal statutory rate of 34% for the year ended December 31, 1993 and 35% for
the years ended December 31, 1994 and 1995 and the provision for income taxes is
as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1994 1995
------ ------ -------
(IN THOUSANDS)
Provision at statutory rate............................. $1,076 $5,154 $17,651
Lower rates on earnings of foreign subsidiary........... (795) (310) --
Unremitted earnings of foreign subsidiary............... 1,624 310 --
State income taxes, net of federal tax benefit.......... 246 904 3,048
Nondeductible compensation expense...................... 287 -- --
Other................................................... 442 288 (154)
------ ------ -------
Provision for income taxes.............................. $2,880 $6,346 $20,545
====== ====== =======
32
34
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets (liabilities) are comprised of the following:
YEAR ENDED DECEMBER
31,
-------------------
1994 1995
------- -------
(IN THOUSANDS)
State income taxes............................................... $ 398 $ 1,000
Accounts receivable and inventory reserves....................... 309 374
Accrued expenses................................................. 83 195
Capital loss..................................................... 381 --
Legal reserves and other......................................... 105 768
------- -------
Total deferred tax assets.............................. 1,276 2,337
Unremitted earnings of foreign subsidiary........................ (4,069) (4,069)
------- -------
Net deferred tax liability....................................... $(2,793) $(1,732)
======= =======
The Internal Revenue Service is currently examining the Company's federal
income tax returns for 1991 to 1993. Management believes sufficient taxes have
been provided and that the ultimate outcome of these examinations will not have
a material adverse impact on the Company's financial position or results of
operations.
In 1992, the Company considered approximately half of the earnings of its
Hong Kong subsidiary to be permanently invested, resulting in a lower effective
tax rate for that year. Due to changes in circumstances, in 1993 the Company
determined that the earnings of the Hong Kong subsidiary were no longer viewed
as reinvested indefinitely. Because repatriated earnings are subject to federal
income taxes, the benefit of lower Hong Kong tax rates recognized in 1992 was
reversed in 1993. For years subsequent to 1992, the Company provided for federal
income taxes on all earnings of its Hong Kong subsidiary because such earnings
are not intended to be reinvested indefinitely.
5. SHAREHOLDERS' EQUITY
Common Stock
During the fourth quarter of 1992, the Company entered into Stock
Repurchase Agreements (the "Agreements") with a founder, members of his family,
certain employees, and other shareholders of the Company (the "Sellers"). Under
the Agreements, the Company repurchased 33,552,000 shares of the Company's
outstanding common stock and vested options for 1,591,000 shares of common stock
for cash of $11,910,000 and notes payable of $2,990,000 bearing interest of 6%.
In connection with the purchase of vested stock options, the Company recorded
compensation expense of $800,000 in 1992 because, in effect, cash was paid to
settle a stock option grant. Of the notes payable, $1,454,000 was paid in 1993.
The remaining note of $1,536,000 was purchased from the founder by the chief
executive officer in 1993 at a discount of $845,000. The $845,000 discount was
deemed to be compensation from the Company to the chief executive officer and
was charged as compensation expense in 1993 with the corresponding credit to
common stock.
1986 Stock Option Plan
In February 1986, the Company adopted the 1986 Stock Option Plan (the "1986
Plan"). Under the 1986 Plan, 3,600,000 shares of common stock have been reserved
for issuance to employees, consultants and investors as approved by the Board of
Directors. The 1986 Plan provides for incentive stock options and the Board may
terminate the 1986 Plan at any time. Options under the Plan are granted, subject
to certain conditions, at estimated fair value as determined by the Board of
Directors. Options granted under the 1986 Plan generally vest 25% each year
after the date of grant. Options are adjusted on a pro rata basis for certain
changes in the capitalization of the Company, such as stock splits and stock
dividends. In addition, the
33
35
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding options issued under the 1986 Plan terminate within 90 days after
termination of an option holder's employment with the Company. As of December
31, 1995, there were 490,000 shares available for grant and 657,000 shares
vested and outstanding at a price per share ranging from $0.073 to $0.083.
1992 Stock Option Plan
In January 1992, the Company adopted the 1992 Stock Option Plan (the "1992
Plan"). The 1992 Plan authorized 6,966,000 shares to be reserved for issuance.
The terms of the 1992 Plan are generally similar to those of the 1986 Plan
outlined above.
Stock option activity under the 1992 Plan was as follows:
OUTSTANDING OPTIONS
SHARES ---------------------------
AVAILABLE NUMBER OF PRICE
FOR GRANT SHARES PER SHARE
---------- --------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Balance at December 31, 1992.................... 4,851 2,025 $0.083-$0.140
Options granted................................. (3,896) 3,896 $0.447-$1.400
Options exercised............................... -- (506) $0.083-$0.447
Options canceled................................ 1,907 (1,907) $0.083-$0.447
--- ------ -------------
Balance at December 31, 1993.................... 2,862 3,508 $0.083-$1.400
Options granted................................. (2,051) 2,051 $1.400
Options exercised............................... -- (96) $0.083-$0.447
Options canceled................................ 1,023 (1,023) $0.083-$0.447
--- ------ -------------
Balance at December 31, 1994.................... 1,834 4,440 $0.083-$1.400
Options granted................................. (1,981) 1,981 $1.400-$10.80
Options exercised............................... -- (83) $0.625-$1.400
Options canceled................................ 295 (295) $10.80-$1.400
--- ------ -------------
Balance at December 31, 1995.................... 148 6,043 $0.083-$10.80
=== ====== =============
As of December 31, 1995, 2,224,000 options were vested under the 1992 Plan.
Executive Plan
In January 1990 and March 1991, the Company granted 5,400,000 and 1,080,000
options, respectively, outside of the 1986 Plan to officers of the Company under
the Executive Plan. The options were granted at the then fair value of $0.083
per share, as determined by the Board of Directors. The options generally vested
over periods of one to four years. A total of 1,350,000, 810,000 and 675,000
options were exercised during the years ended December 31, 1993, 1994 and 1995,
respectively. As of December 31, 1995, no options were outstanding under the
Executive Plan.
Equity Incentive Plan
In August 1995, the Company adopted the 1995 Equity Incentive Plan (the
"Incentive Plan"), which provides for the grant of stock options and stock
bonuses and the issuance of restricted stock by the Company to its employees,
directors and others. The Company has reserved 3,000,000 shares of the Company's
Common Stock for issuance under the Incentive Plan. At December 31, 1995, there
were 2,966,000 shares available for grant and 34,000 options had been granted at
a price per share of $34.00.
34
36
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Employee Stock Purchase Plan
In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan
(the "Purchase Plan") and reserved a total of 225,000 shares of the Company's
Common Stock for issuance thereunder. The Purchase Plan permits eligible
employees to acquire shares of the Company's Common Stock through payroll
deductions. As of December 31, 1995, no shares have been issued under the
Purchase Plan.
Directors Plan
In August 1995, the Company adopted the Directors Plan and reserved a total
of 300,000 shares of the Company's Common Stock for issuance thereunder. The
Directors Plan allows for granting of stock options to members of the Board of
Directors who are not employees of the Company. As of December 31, 1995, no
shares have been granted under the Directors Plan.
6. INDUSTRY SEGMENT AND FOREIGN OPERATIONS
The Company operates in one industry segment, comprised of desktop and
notebook personal computer manufacturers and consumer product companies, and is
engaged to design, manufacture and market speech software, semiconductor chip
products and speech-related products. Sales and purchase transactions are
generally denominated in U.S. dollars.
The following is a summary of the Company's geographic operations:
ESS (U.S.)
--------------------------------- INTERCOMPANY
DOMESTIC FOREIGN TOTAL ESS (FAR EAST) ELIMINATIONS CONSOLIDATED
-------- ------- -------- -------------- ------------ ------------
(AMOUNTS IN THOUSANDS)
Year ended December 31, 1993:
Net revenues.................... $ 1,922 $ 1,531 $ 3,453 $ 13,296 $ (1,531) $ 15,218
Income from operations.......... -- -- 132 2,433 -- 2,565
Identifiable assets............. -- -- 614 14,913 (419) 15,108
Year ended December 31, 1994:
Net revenues.................... $ 9,311 $19,001 $ 28,312 $ 5,300 $ (177) $ 33,435
Income from operations.......... -- -- 13,446 998 -- 14,444
Identifiable assets............. -- -- 18,621 5,412 (19) 24,014
Year ended December 31, 1995:
Net revenues.................... $29,024 $76,720 $105,744 -- -- $105,744
Income from operations.......... -- -- 47,737 -- -- 47,737
Identifiable assets............. -- -- 157,181 $ 5,522 -- 162,703
Sales by ESS (Far East) and foreign sales by ESS (U.S.) are primarily to
customers in the Pacific Rim, and to a lesser extent to customers in Europe.
7. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash equivalents, short-term investments and
trade accounts receivable. Cash equivalents and short-term investments which
primarily comprised of investments in money market funds and municipal debt
instruments, are maintained with high quality institutions and the composition
and maturities are regularly monitored by management.
35
37
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the percentage of net revenues accounted for
by the Company's significant customers.
YEAR ENDED DECEMBER
31,
----------------------
1993 1994 1995
---- ---- ----
Compaq Computer...................................... -- 20% 17%
Western Publishing................................... 57% 14% --
Universe Electron.................................... -- 8% 17%
A majority of the Company's trade receivables are derived from sales to
manufacturers of computer systems. The Company generally extends 30-day credit
terms to its customers, which is consistent with industry business practices.
The Company performs ongoing credit evaluations of its customers' financial
condition and generally, requires letters of credit from international
customers. The Company maintains an allowance for doubtful accounts on its
receivables based upon the expected collectibility of all accounts receivable.
To date, the Company has not incurred any significant losses due to
uncollectible accounts receivable. At December 31, 1995 and 1994, approximately
35% and 69%, respectively, of trade accounts receivable represent amounts due
from three customers.
8. LITIGATION
In March 1995, the Company was served with a patent infringement claim in
which Yamaha Corporation ("Yamaha") claimed that the Company's ESFM products
infringe upon patents held by Yamaha. The complaint seeks an injunction against
future infringement, damages for past infringement, fees and costs. If the
Company were found to be infringing a valid Yamaha patent, then the Company
could be required to cease the sale of ESFM products, which represent a
significant portion of the Company's revenues.
Management has investigated Yamaha's claims and discussed them with its
patent counsel, who was consulted early during the design and development of the
allegedly infringing ESFM products. On May 1, 1995, the U.S. District Court in
Los Angeles denied the plaintiff's request for a preliminary injunction. Yamaha
has appealed the District Court's denial of the request for preliminary
injunction to the U.S. Court of Appeals for the Federal Circuit. The hearing at
the Federal Circuit took place on January 8, 1996.
On August 18, 1995 the District Court granted in part and denied in part a
motion for summary judgment which had been filed by the Company. The District
Court held that the Company's FM synthesis products did not literally infringe
Yamaha's U.S. Patent No. 4,249,447, but held that there was a triable issue of
fact as to the infringement of such patent on another basis. The Court also
found triable issues of fact and, therefore, denied the Company's motion for
summary judgment with regard to U.S. Patent No. 4,813,326. Trial in the Yamaha
litigation is expected to begin in early 1997.
The Company is rigorously contesting all of Yamaha's claims. In connection
with the Yamaha litigation, the Company has incurred and will continue to incur
substantial legal and other expenses. While the outcome of such lawsuits cannot
be accurately predicted, based on the facts currently known, management does not
believe that the ultimate resolution of this matter will have a material adverse
impact on the Company's financial position or results of operations.
9. WAFER CAPACITY COMMITMENTS
In November of 1995, the Company entered into agreements with two wafer
foundries, TSMC and UMC, in which the Company secured access to additional
manufacturing capacity and to certain technology.
Under the TSMC agreement, in exchange for TSMC's increased wafer capacity
commitments, the Company committed to pay approximately $32 million over the
next two years as deposits for wafers through 1999. The cash requirements
associated with this agreement are two $16 million payments due on June 30,
36
38
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996 and 1997. The Company issued two promissory notes in the sum of $32 million
securing these payments. The Company also obtained an option to expand the TSMC
wafer capacity commitments further for years 1997 through 2000. If the Company
exercises its option to commit TSMC to additional wafer capacity, the Company
would be committed to an additional $30.8 million in deposits to be paid in two
$15.4 million payments due on June 30, 1997 and 1998. If the Company is not able
to use, assign, or sell the additional wafer quantities, a portion of the
deposits may be forfeited.
Under the UMC agreement, the Company entered into a joint venture
arrangement with UMC, together with other US semiconductor companies, to build a
separate semiconductor manufacturing facility located in Taiwan at an estimated
cost of $1 billion. The Company will invest approximately $30 million in three
installments over the projected eighteen-month period required to build the
facility. The Company accrued for the first installment payment of $6.9 million
in 1995. Under the terms of the agreement, the Company will receive a 5% equity
ownership in the joint venture company and certain capacity rights. The new
fabrication facility is currently projected to commence production in 1997.
10. SUBSEQUENT EVENTS:
In January 1996, the Company completed its acquisition of VideoCore
Technology, Inc. ("VideoCore") pursuant to which the Company acquired all of the
outstanding capital stock of VideoCore in exchange for approximately 525,000
shares of the Company's common stock and $5.4 million in cash. VideoCore, now a
wholly owned subsidiary of the Company, is developing integrated circuits which
once completed, will incorporate advanced compression technology for digital
video products. In March 1996, the Company completed its acquisition of OSEE
Technology, Inc. ("OSEE") pursuant to which the Company acquired all of the
outstanding capital stock of OSEE in exchange for approximately 217,000 shares
of the Company's common stock and $3.6 million in cash. OSEE, now a wholly owned
subsidiary of the Company, is a developer of advanced fax/modem V.34 and V.34bis
algorithm technology which will enable the Company to provide modem and computer
telephony applications on the Company's multimedia processor. Both acquisitions
will be accounted for as a purchase, and a substantial majority of the purchase
prices is attributable to research and development in process, which will be
expensed in the first quarter of 1996.
On March 29, 1996, the U.S. Court of Appeals for the Federal Circuit
confirmed the denial of Yamaha's request for a preliminary injunction, as
discussed in Note 8.
37
39
SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)
The following table presents unaudited quarterly financial information for
each of the Company's last eight quarters. This information has been derived
from the Company's unaudited financial statements and has been prepared on the
same basis as the audited Consolidated Financial Statements appearing elsewhere
in this Form 10-K. In the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, have been included to present
fairly the quarterly results.
1994 1995
---------------------------------------- ----------------------------------------
SEPT. SEPT.
MAR. 31 JUNE 30 30 DEC. 31 MAR. 31 JUNE 30 30 DEC. 31
------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues.............. $ 3,685 $ 6,709 $10,433 $12,608 $16,141 $21,363 $31,389 $36,851
Cost of revenues.......... 1,662 2,419 3,790 4,176 5,168 8,115 11,431 14,871
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 2,023 4,290 6,643 8,432 10,973 13,248 19,958 21,980
Operating expenses:
Research and
development........... 787 817 959 1,148 1,229 2,110 2,666 2,659
Selling, general and
administrative........ 464 613 736 1,420 3,040 1,949 1,920 2,849
------- ------- ------- ------- ------- ------- ------- -------
Operating income.......... 772 2,860 4,948 5,864 6,704 9,189 15,372 16,472
Nonoperating income
(expense), net.......... (31) 18 223 73 359 439 602 1,295
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes................... 741 2,878 5,171 5,937 7,063 9,628 15,974 17,767
Provision for income
taxes................... (319) (1,240) (2,229) (2,558) (2,896) (3,952) (6,530) (7,167)
------- ------- ------- ------- ------- ------- ------- -------
Net income................ $ 422 $ 1,638 $ 2,942 $ 3,379 $ 4,167 $ 5,676 $ 9,444 $10,600
======== ======== ======== ======== ======== ======== ======== ========
Net income per share...... $ 0.01 $ 0.04 $ 0.08 $ 0.09 $ 0.11 $ 0.15 $ 0.26 $ 0.26
======== ======== ======== ======== ======== ======== ======== ========
Weighted average common
and common equivalent
shares.................. 37,478 37,295 37,339 37,541 36,775 37,323 36,940 41,544
======== ======== ======== ======== ======== ======== ======== ========
The following table sets forth the above quarterly financial information as
a percentage of net revenues:
1994 1995
---------------------------------------- ----------------------------------------
SEPT. SEPT.
MAR. 31 JUNE 30 30 DEC. 31 MAR. 31 JUNE 30 30 DEC. 31
------- ------- ------- ------- ------- ------- ------- -------
Net revenues.............. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues.......... 45.1 36.1 36.3 33.1 32.0 38.0 36.4 40.4
------- ------- ------- ------- ------- ------- ------- -------
Gross margin............ 54.9 63.9 63.7 66.9 68.0 62.0 63.6 59.6
Operating expenses:
Research and
development........... 21.4 12.2 9.2 9.1 7.6 9.9 8.5 7.2
Selling, general and
administrative........ 12.6 9.1 7.1 11.3 18.9 9.1 6.1 7.7
------- ------- ------- ------- ------- ------- ------- -------
Operating income.......... 20.9 42.6 47.4 46.5 41.5 43.0 49.0 44.7
Nonoperating income
(expense), net.......... (0.8) 0.3 2.1 0.6 2.2 2.0 1.9 3.5
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes................... 20.1 42.9 49.5 47.1 43.7 45.0 50.9 48.2
Provision for income
taxes................... (8.7) (18.5) (21.4) (20.3) (17.9) (18.0) (20.8) (19.4)
------- ------- ------- ------- ------- ------- ------- -------
Net income................ 11.4% 24.4% 28.1% 26.8% 25.8% 27.0% 30.1% 28.8%
======== ======== ======== ======== ======== ======== ======== ========
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
38
40
PART III
Certain information required by Part III is omitted from this Report since
the Company plans to file with the Securities and Exchange Commission the
definitive proxy statement for its 1996 Annual Meeting of Shareholders (the
"Proxy Statement") not later than 120 days after the end of the fiscal year
covered by this Report, and certain information included therein is incorporated
herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors required by this Item is
incorporated by reference to the section in the Company's Proxy Statement
entitled "Proposal No. 1 -- Election of Directors -- Directors/Nominees."
The information concerning the Company's executive officers required by
this Item is incorporated by reference herein to Part I, Item 4A, entitled
"Executives Officers of the Registrant" on page 11 of this Report.
The information concerning compliance with Section 16 of the Securities
Exchange Act of 1934 is incorporated by reference to the section in the
Company's proxy statement entitled "Compliance under Section 16(a) of the
Securities Exchange Act of 1934."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
sections in the Company's Proxy Statement entitled "Executive Compensation,"
"Compensation of Directors and "Compensation Committee Interlocks and Insider
Participation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
section in the Company's Proxy Statement entitled "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
section in the Company's Proxy Statement entitled "Certain Transactions."
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS. The following Consolidated Financial Statements
of ESS Technology, Inc. are included in Item 8.
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1995 and 1994
Consolidated Statements of Operations for the years ended December 31,
1995, 1994 and 1993
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1995, 1994 and 1993
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1994 and 1993
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES. Financial statement schedules have been
omitted because the information called for is not required or is shown either in
the Consolidated Financial Statements or Notes thereto.
3. EXHIBITS
EXHIBIT
NUMBER EXHIBIT TITLE
- - ------ -----------------------------------------------------------------------------------
2.01 -- Agreement and Plan of Reorganization dated December 12, 1995 among Registrant, ESS
Acquisition Corporation and VideoCore Technology, Inc. ("VideoCore") (Incorporated
herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K
dated January 17, 1996 (the "Form 8-K")).
2.02 -- Agreement of Merger dated as of January 3, 1996 among Registrant, ESS Acquisition
Corporation and VideoCore. (Incorporated herein by reference to Exhibit 2.2 to the
Form 8-K).
3.01 -- Registrant's Articles of Incorporation (Incorporated herein by reference to Exhibit
3.01 to the Registrant's Form S-1 registration statement (File No. 33-95388)
declared effective by the Securities and Exchange Commission on October 5, 1995
(the "Form S-1")).
3.02 -- Registrant's Bylaws (Incorporated herein by reference to Exhibit 3.02 to the Form
S-1).
4.01 -- Form of Specimen Certificate for Registrant's Common Stock (Incorporated herein by
reference to Exhibit 4.01 to the Form S-1).
10.01 -- Registrant's 1986 Stock Option Plan and related documents (Incorporated herein by
reference to Exhibit 10.01 to the Form S-1).*
10.02 -- Registrant's 1992 Stock Option Plan and related documents (Incorporated herein by
reference to Exhibit 10.02 to the Form S-1).*
10.03 -- Registrant's 1995 Equity Incentive Plan and related documents (Incorporated herein
by reference to Exhibit 10.03 to the Form S-1).*
10.04 -- Registrant's 1995 Directors Stock Option Plan and related documents (Incorporated
herein by reference to Exhibit 10.04 to the Form S-1).*
10.05 -- Registrant's 1995 Employee Stock Purchase Plan and related documents (Incorporated
herein by reference to Exhibit 10.05 to the Form S-1).*
10.06 -- Registrant's Amended 401(k) Plan (Incorporated herein by reference to Exhibit 10.06
to the Form S-1).*
10.07 -- Registrant's Rights Agreement dated May 28, 1993 among the Registrant and certain
security holders (Incorporated herein by reference to Exhibit 10.07 to the Form
S-1).
10.08 -- Stock Transfer Agreement dated May 22, 1995 among WK Technology Fund, WK Technology
Fund II, WK Technology Fund III, Fred S.L. Chan, Annie M.H. Chan and Fred S.L. and
Annie M.H. Chan Charitable Trust, dated November 20, 1992 (Incorporated herein by
reference to Exhibit 10.08 to the Form S-1).
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EXHIBIT
NUMBER EXHIBIT TITLE
- - ------ -----------------------------------------------------------------------------------
10.09 -- Stock Transfer Agreement dated May 22, 1995 among Technology Associates
Corporation, Tekkang Management Consulting Inc., Kummell Investments Limited, Fred
S.L. Chan, Annie M.H. Chan and Fred S.L. and Annie M.H. Chan Charitable Trust,
dated November 20, 1992 (Incorporated herein by reference to Exhibit 10.09 to the
Form S-1).
10.10 -- Stock Transfer Agreement dated May 22, 1995 among Universe Electron Corporation,
Fred S.L. Chan, Annie M.H. Chan and Fred S.L. and Annie M.H. Chan Charitable Trust,
dated November 20, 1992 (Incorporated herein by reference to Exhibit 10.10 to the
Form S-1).
10.11 -- Form of Indemnity Agreement entered into by Registrant with each of its directors
and executive officers (Incorporated herein by reference to Exhibit 10.11 to the
Form S-1).
10.12 -- Sublease dated October 15, 1992 between Raychem Corporation (as successor in
interest to Remtek Corporation) and Registrant, as amended November 1, 1993, and
September 1, 1994; Master Lease dated April 11, 1986 between Renco Equities III and
Remtek Corporation, as amended January 29, 1994; and Option to Renew Lease dated
January 25, 1989 between Renco Equities III and Remtek Corporation (Incorporated
herein by reference to Exhibit 10.12 to the Form S-1).
10.13 -- Standard Industrial/Commercial Multi-Tenant Lease -- Modified Net dated April 3,
1995 between Gagos Living Trust and Registrant, as amended May 1, 1995; and
Addendum thereto dated as of April 8, 1995 (Incorporated herein by reference to
Exhibit 10.13 to the Form S-1).
10.14 -- Real Property Purchase Agreement and Deposit Receipt dated July 5, 1995 between
King & Lyons and Registrant (Incorporated herein by reference to Exhibit 10.14 to
the Form S-1).
10.15 -- License Agreement dated November 12, 1987 among Forrest S. Mozer, Registrant and
Sharp Kabushiki Kaisha (Incorporated herein by reference to Exhibit 10.15 to the
Form S-1).**
10.16 -- License Agreement dated September 20, 1991 between Registrant and Zilog, Inc.
(Incorporated herein by reference to Exhibit 10.16 to the Form S-1).**
10.17 -- Software License Agreement dated July 18, 1995 among Registrant, Sensory Circuits,
Inc. and Forrest Mozer (Incorporated herein by reference to Exhibit 10.17 to the
Form S-1).**
10.18 -- Foundry Agreement dated March 29, 1993 between Registrant and Integrated Circuit
Works Incorporated (Incorporated herein by reference to Exhibit 10.18 to the Form
S-1).**
10.19 -- Purchase Agreement dated June 17, 1994 between Compaq Computer Corporation and
Registrant (Incorporated herein by reference to Exhibit 10.19 to the Form S-1).**
10.20 -- International Distributorship Agreement dated July 1, 1994 between Registrant and
Universe Electron Corporation (Incorporated herein by reference to Exhibit 10.20 to
the Form S-1).
10.21 -- Option I Agreement between Registrant and Taiwan Semiconductor Manufacturing Co.,
Ltd. ("TSMC") dated November 30, 1995, as amended December 28, 1995.***
10.22 -- Option II Agreement between Registrant and TSMC dated November 30, 1995.***
10.23 -- Foundry Venture Agreement between Registrant and United Microelectronics
Corporation ("UMC") dated November 28, 1995, as amended January 31, 1996.***
10.24 -- FabVen Foundry Capacity Agreement among FabVen, UMC and Registrant dated November
28, 1995.***
10.25 -- Form of Employment and Non-Competition Agreement among the Registrant, VideoCore
and Jan Fandrianto dated December 12, 1995. (Incorporated herein by reference to
Exhibit 2.1 to the Form 8-K).*
10.26 -- Form of Employment and Non-Competition Agreement among the Registrant, VideoCore
and Chi-Shin Wang dated December 12, 1995. (Incorporated herein by reference to
Exhibit 2.1 to the Form 8-K).*
11.01 -- Statement regarding computation of per share earnings.
21.01 -- List of Registrant's subsidiaries.
23.01 -- Consent of Independent Accountants.
- - ---------------
* Represents a management contract or compensatory plan of arrangement.
** Confidential treatment has been granted with respect to certain portions of
this agreement.
*** Confidential treatment has been requested with respect to certain portions
of this agreement.
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(b) Reports on Form 8-K: The Company did not file a report on Form 8-K
during the quarter ended December 31, 1995.
With the exception of the information incorporated by reference to the
Company's Proxy Statement for the 1996 Annual Meeting of Shareholders in Items
10, 11, 12 and 13 of Part III, the Proxy Statement is not deemed to be filed as
part of this Report.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment to Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
ESS TECHNOLOGY, INC.
Dated: May 17, 1996 By: /s/ RALPH J. HARMS
------------------------------------
Ralph J. Harms
Vice President, Chief Financial
Officer
and Secretary