===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
Commission file number: 0-29939
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OMNIVISION TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0401990
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
930 Thompson Place, Sunnyvale, CA 94085
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 733-3030
---------------
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 and Exchange Act
of 1934 during the preceding 12 months (or for 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 [ ]
At November 26, 2001, 22,104,087 shares of common stock of the Registrant
were outstanding.
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OMNIVISION TECHNOLOGIES, INC.
INDEX
Page
No.
---
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - October 31, 2001
and April 30, 2001.......................................... 3
Condensed Consolidated Statements of Operations - Three and
Six Months Ended October 31, 2001 and 2000.................. 4
Condensed Consolidated Statements of Cash Flows - Six Months
Ended October 31, 2001 and 2000............................. 5
Notes to Condensed Consolidated Financial Statements.......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 30
Item 2. Changes in Securities and Use of Proceeds..................... 30
Item 4. Submission of Matters to a Vote of Security Holders........... 31
Item 6. Exhibits and Reports on Form 8-K.............................. 32
Signatures............................................................... 33
2
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
October 31, April 30,
2001 2001
---- ----
ASSETS
Current assets:
Cash and cash equivalents......................... $ 53,722 $ 51,053
Short-term investments............................ 3,173 3,000
Accounts receivable, net.......................... 7,790 5,269
Inventories....................................... 6,282 11,445
Refundable and deferred income taxes.............. 3,324 3,288
Prepaid expenses and other assets................. 660 219
--------- ---------
Total current assets............................ 74,951 74,274
Property, plant and equipment, net.................. 4,758 4,080
Other non-current assets............................ 293 293
--------- ---------
Total assets.................................. $ 80,002 $ 78,647
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................. $ 4,296 $ 4,284
Accrued expenses and other liabilities............ 6,259 2,255
Deferred revenue.................................. 738 832
--------- ---------
Total current liabilities....................... 11,293 7,371
--------- ---------
Commitments and Contingencies (Note 8)
Stockholders' equity:
Common stock, $0.001 par value; 100,000 shares
authorized; 22,104 and 22,000 shares issued and
outstanding..................................... 22 22
Additional paid-in capital........................ 94,817 94,531
Deferred compensation related to stock options.... (700) (1,058)
Accumulated deficit............................... (25,430) (22,219)
--------- ---------
Total stockholders' equity.................... 68,709 71,276
--------- ---------
Total liabilities and stockholders' equity.... $ 80,002 $ 78,647
========= =========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
---------------------- ----------------------
October 31, October 31, October 31, October 31,
2001 2000 2001 2000
---- ---- ---- ----
Revenues......................... $ 12,265 $ 18,385 $ 23,426 $ 36,204
Cost of revenues*................ 7,591 12,949 13,724 25,244
-------- -------- -------- --------
Gross profit..................... 4,674 5,436 9,702 10,960
-------- -------- -------- --------
Operating expenses:
Research and development*...... 1,798 1,363 3,486 2,644
Selling, general and
administrative*.............. 3,384 1,350 6,623 2,424
Stock compensation charge*..... 167 225 325 509
Litigation settlement.......... 3,500 -- 3,500 --
-------- -------- -------- --------
Total operating expenses..... 8,849 2,938 13,934 5,577
-------- -------- -------- --------
Income (loss) from operations.... (4,175) 2,498 (4,232) 5,383
Interest income (expense), net... 454 967 1,021 1,127
-------- -------- -------- --------
Income (loss) before income taxes (3,721) 3,465 (3,211) 6,510
Provision for income taxes....... -- 1,317 -- 2,474
-------- -------- -------- --------
Net income (loss)................ $ (3,721) $ 2,148 $ (3,211) $ 4,036
======== ======== ======== ========
Net income (loss) per share:
Basic.......................... $ (0.17) $ 0.10 $ (0.15) $ 0.32
======== ======== ======== ========
Diluted........................ $ (0.17) $ 0.09 $ (0.15) $ 0.20
======== ======== ======== ========
Shares used in computing net
income (loss) per share:
Basic.......................... 21,795 21,113 21,738 12,766
======== ======== ======== ========
Diluted........................ 21,795 23,367 21,738 20,687
======== ======== ======== ========
(*) Stock-based compensation
charges included in:
Cost of revenues............... $ 8 $ 38 $ 17 $ 76
======== ======== ======== ========
Operating expenses:
Research and development..... $ 40 $ 138 $ 127 $ 321
Selling, general and
Administrative............. 127 87 198 188
-------- -------- -------- --------
$ 167 $ 225 $ 325 $ 509
======== ======== ======== ========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
4
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
-------------------------
October 31, October 31,
2001 2000
---- ----
Cash flows from operating activities:
Net income (loss)................................... $ (3,211) $ 4,036
Adjustments to reconcile net income (loss) to
net cash (used in) operating activities:
Depreciation and amortization..................... 381 280
Allowance for doubtful accounts and sales returns (159) 25
Amortization of deferred compensation............. 342 585
Changes in assets and liabilities:
Accounts receivable............................. (2,362) (3,133)
Inventories..................................... 5,163 (15,541)
Refundable and deferred income taxes............ (36) --
Prepaid expenses and other assets............... (441) (660)
Accounts payable................................ 12 (4,278)
Accrued expenses and other liabilities.......... 3,504 178
Deferred revenue................................ (94) 239
-------- --------
Net cash provided by (used in) operating
Activities.................................. 3,099 (18,269)
-------- --------
Cash flows from investing activities:
Purchase of short-term investments.................. (173) (5,409)
Purchases of property, plant and equipment.......... (1,059) (463)
-------- --------
Net cash used in investing activities......... (1,232) (5,872)
-------- --------
Cash flows from financing activities:
Deposit received.................................... 500 --
Proceeds from issuance of common stock, net......... 306 67,652
Payment for repurchase of common stock, net......... (4) --
-------- --------
Net cash provided by financing activities..... 802 67,652
-------- --------
Net increase in cash and cash equivalents............. 2,669 43,511
Cash and cash equivalents at beginning of period...... 51,053 5,888
-------- --------
Cash and cash equivalents at end of period............ $ 53,722 $ 49,399
======== ========
Supplemental cash flow information:
Interest paid....................................... $ -- $ 36
======== ========
Taxes paid.......................................... $ 36 $ 3,411
======== ========
Supplemental non-cash investing and financial
information:
Conversion of redeemable convertible preferred stock
to common stock................................... $ -- $ 21,082
======== ========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
5
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended October 31, 2001 and 2000
(unaudited)
Note 1 - Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements as
of October 31, 2001 and April 30, 2001 and for the three and six months ended
October 31, 2001 and 2000 have been prepared by OmniVision Technologies, Inc.
and subsidiaries (the "Company" or "OmniVision") in accordance with the rules
and regulations of the Securities and Exchange Commission. The amounts as of
April 30, 2001 have been derived from our annual audited financial statements.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted in accordance with such rules and regulations.
In the opinion of management, the accompanying unaudited financial statements
reflect all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the financial position of the Company and its
results of operations and cash flows. These financial statements should be read
in conjunction with the annual audited financial statements and notes as of and
for the year ended April 30, 2001, included in the Company's Annual Report on
Form 10-K.
The results of operations for the three and six months ended October 31,
2001 are not necessarily indicative of the results that may be expected for the
year ending April 30, 2002, or any other future interim period, and the Company
makes no representations related thereto.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Note 2 - Revenue Recognition
-------------------
The Company recognizes revenue upon the shipment of its products to the
customer provided that the Company has received a signed purchase order, the
price is fixed, title has transferred, collection of resulting receivables is
probable, product returns are reasonably estimable, there are no customer
acceptance requirements and there are no remaining significant obligations. For
certain shipments to distributors under agreements allowing for return or
credits, revenue is deferred until the distributor resells the product. The
Company provides for future returns based on historical experiences at the time
revenue is recognized.
Note 3 - Short-term Investments
----------------------
The Company's short-term investments, which are classified as available-
for-sale, are invested in high-grade corporate securities and government bonds
maturing approximately twelve months or less from the date of purchase. These
investments are reported at fair value. Unrealized gains or losses are recorded
in stockholders' equity and included in other comprehensive income (losses).
Unrealized gains or losses were not significant during any period covered.
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Six Months Ended October 31, 2001 and 2000
(unaudited)
Note 4 - Balance Sheet Accounts (In Thousands)
-------------------------------------
October 31, April 30,
2001 2001
---- ----
Cash and cash equivalents:
Cash............................................. $ 639 $ 1,918
Money market funds............................... 6,820 3,563
Commercial paper................................. 46,263 45,572
-------- --------
$ 53,722 $ 51,053
======== ========
Short-term investments:
Corporate notes.................................. $ 3,173 $ 3,000
-------- --------
$ 3,173 $ 3,000
======== ========
Work in progress................................... $ 467 $ 3,752
Finished goods..................................... 5,815 7,693
-------- --------
Total inventory.................................. $ 6,282 $ 11,445
======== ========
Note 5 - Net Income Per Share
--------------------
The following table sets forth the computation of basic and diluted income
per share attributable to common stockholders for the period indicated (in
thousands, except per share data):
Three Months Ended Six Months Ended
---------------------- ----------------------
October 31, October 31, October 31, October 31,
2001 2000 2001 2000
---- ---- ---- ----
Numerator:
Net income (loss).............. $ (3,721) $ 2,148 $ (3,211) $ 4,036
======== ======== ======== ========
Denominator:
Weighted average shares........ 22,100 21,755 22,083 13,541
Weighted average unvested
common stock subject to
repurchase................... (305) (642) (345) (775)
-------- -------- -------- --------
Denominator for basic net
income (loss) per share...... 21,795 21,113 21,738 12,766
Effect of dilutive securities:
Common stock options......... -- 1,612 -- 1,506
Unvested common stock subject
to repurchase.............. -- 642 -- 775
Convertible preferred stock.. -- -- -- 5,640
-------- -------- -------- --------
Denominator for dilutive net
income (loss) per share........ 21,795 23,367 21,738 20,687
======== ======== ======== ========
Basic net income (loss) per share $ (0.17) $ 0.10 $ (0.15) $ 0.32
======== ======== ======== ========
Diluted net income (loss) per
Share.......................... $ (0.17) $ 0.09 $ (0.15) $ 0.20
======== ======== ======== ========
Note 6 - Equity
------
In July 2000, the Company completed its initial public offering of
5,000,000 shares of common stock at $13.00 per share. Net proceeds aggregated
approximately $59.2 million after paying the underwriters' fee and related
expenses. At the closing of the offering, all issued and outstanding shares of
the Company's preferred stock were converted into an aggregate of 12,305,001
shares of common stock. In August 2000, the underwriters of the Company's
initial public offering exercised their over-allotment option to purchase an
additional 750,000 shares of common stock at $13.00 per share. Net proceeds
aggregated approximately $8.5 million after paying the underwriters' fee and
related expenses.
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Six Months Ended October 31, 2001 and 2000
(unaudited)
Note 7 - Segment and Geographic Information
----------------------------------
The Company identifies its operating segments based on business
activities, management responsibility and geographic location. For all periods
presented, the Company operated in a single business segment.
The Company sells its products primarily in the United States and to the
Asia Pacific region. Revenues by geographic locations based on the country or
region of the customer were as follows (in thousands):
Three Months Ended Six Months Ended
---------------------- ----------------------
October 31, October 31, October 31, October 31,
2001 2000 2001 2000
---- ---- ---- ----
United States.............. $ 3,775 $ 2,251 $10,264 $ 3,938
Hong Kong.................. 2,956 1,168 4,324 3,072
Taiwan..................... 2,936 3,839 4,407 12,186
Japan...................... 1,317 1,700 1,987 2,645
Korea...................... 596 1,223 1,057 3,926
Europe..................... 649 1,308 870 1,699
Singapore.................. 17 5,854 332 7,400
China...................... -- -- 94 --
All other.................. 19 1,042 91 1,338
------- ------- ------- -------
$12,265 $18,385 $23,426 $36,204
======= ======= ======= =======
Note 8 - Commitments and Contingencies
-----------------------------
In December 2000, the Company formed a new subsidiary to conduct design
and testing operations in Shanghai, the People's Republic of China. The
registered capital of this new company is $12.0 million, of which $3.8 million
was funded by the Company in the fiscal year ended April 30, 2001, as required.
The Company is further obligated to fund the remaining $8.2 million of
registered capital by December 2003. As of October 31, 2001, $2.8 million of
the $3.8 million was paid for land use rights and to building contractors, $0.7
million was deposited in a bank account in China and $0.3 million was expended
for general purposes. The formation and operation of the new company in China
requires a large initial capital investment, and there may be significant
administrative, legal and governmental barriers in China, which may prevent the
Company's ability to begin operation of the new company as well as using the
funds outside of China.
From time to time, the Company has been subject to legal proceedings and
claims with respect to such matters as patents, product liabilities and other
actions arising out of the normal course of business.
In March 2000, the Company received a letter from Koninklijke Philips N.V.
in which Philips claimed to have patent rights in a serial bus system for data
transmission, known as the I2C bus system. Although the Company does not
believe any of its products infringe any Philips patent, the Company is
currently discussing possible royalty or licensing arrangements as a means of
business resolution. In the meantime, the Company has completed implementation
of a new serial bus system for its products.
The Company has entered into an agreement with Photobit Corporation
("Photobit") and the California Institute of Technology ("CalTech"), effective
September 18, 2001, to settle all litigation that the Company had with Photobit
and CalTech, including an action in the U.S. District Court, Northern District
of California, Case No. C 00 3791 PJH, and an investigation before the U.S.
International Trade Commission ("ITC"), Inv. No. 337-TA-451. Both actions
involved patents alleged to pertain to its CMOS image sensor products, such as
those used in digital cameras, PC cameras and other optical applications. The
action pending in California was dismissed on September 24, 2001, and final
termination of the ITC investigation occurred on November 9, 2001. The
confidential settlement includes non-exclusive cross-licenses for seven years
under the Company's and Photobit's respective patent portfolios, including
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Six Months Ended October 31, 2001 and 2000
(unaudited)
patents and applications licensed by CalTech to Photobit. The Company has also
made a one-time payment to Photobit of $3.5 million dollars.
The settlement agreement referred to in the above paragraph relates only
to claims made by Photobit and CalTech. It is possible that other companies
might pursue litigation with respect to any claims such companies purport to
have against the Company. The results of any litigation are inherently
uncertain. In the event of an adverse result in any litigation with respect to
intellectual property rights relevant to the Company's products that could
arise in the future, the Company could be required to obtain licenses to the
infringing technology, pay substantial damages under applicable law, including
treble damages if the Company is held to have willfully infringed, cease the
manufacture, use and sale of infringing products or to expend significant
resources to develop non-infringing technology. Litigation frequently involves
substantial expenditures and can require significant management attention, even
if the Company ultimately prevails.
Note 9 - Recent Accounting Pronouncements
--------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141 ("SFAS No. 141"),
"Business Combinations." SFAS 141 requires the purchase method of accounting
for business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The Company believes that the adoption of SFAS 141
will not have a significant impact on its consolidated financial statements.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets", which is effective for fiscal years beginning after December 15, 2001.
SFAS 142 requires, among other things, the discontinuance of goodwill
amortization. In addition, the standard includes provisions upon adoption for
the reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. The
Company is currently assessing but has not yet determined the impact of SFAS
142 on its financial position and results of operations.
In June 2001, the FASB issued SFAS 143, "Accounting for Obligations
Associated with the Retirement of Long-Lived Assets." The objectives of SFAS
143 are to establish accounting standards for the recognition and measurement
of an asset retirement obligation and its associated asset retirement cost.
SFAS 143 will be effective for financial statements issued for fiscal years
beginning after June 15, 2002. The Company believes that the adoption of SFAS
143 will not have any material impact on its consolidated financial statements.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which is effective for fiscal years
beginning after December 15, 2001. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of." It establishes a single accounting
method, based on the framework established in SFAS 121, for long-lived assets
to be disposed of by sale. The Company is currently assessing, but has not yet
determined the impact of SFAS 144 on its financial position and results of
operations.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors that include, but are not
limited to, the risks discussed in "Factors Affecting Future Results". These
forward-looking statements include, but are not limited to: the statements
relating to the development of new products in new and existing markets, the
expansion of the range of picture resolutions offered, the development of new
products which require only three volts for portable applications, the
improvement of image quality, the integration of additional functions and the
improvement to the interface chip in the third paragraph under "Overview;" the
statements relating to the generation of revenues from five volt products in
the remainder of fiscal year 2002 in the fourth paragraph under "Overview;" the
statements relating to technology leadership and increase in research and
development expenses in the seventh paragraph under "Overview;" the statements
regarding factors which may continue gross margins in the future under "Gross
Profit;" the statements regarding the potential fluctuations and expected
increases of research and development costs under "Research and Development;"
the statements regarding decreases in selling, general and administrative
expenses under "Selling, General and Administrative;" the statements regarding
the size of and amortization of compensation charges under "Stock Compensation
Charge;" the statements regarding cash resources available to meet capital
requirements, the factors affecting capital requirements and the raising and
availability of additional funds and investment in the sixth paragraph under
"Liquidity and Capital Resources;" and the statements regarding evaluation of
acquisitions in the seventh paragraph under "Liquidity and Capital Resources,"
the statements under "Part II Other Information - Item 1. Legal Proceedings,"
and the statements under "Part II Other Information - Item 2. Changes in
Securities and Use of Proceeds," among others. These forward-looking statements
are based on current expectations and entail various risks and uncertainties
that could cause actual results to differ materially from those projected in
the forward-looking statements. Such risks and uncertainties are set forth
below under "Factors Affecting Future Results."
Overview
- --------
We design, develop and market high performance, high quality, highly
integrated and cost efficient semiconductor image sensor devices. Our highly
integrated image sensors are used in a variety of electronic cameras and camera
related products for both still picture and live video applications. Our image
sensors are used in cameras and camera related products such as personal
computer cameras, digital still cameras, closed circuit TV's, mobile phone
cameras and personal digital assistant cameras, security and surveillance
cameras and cameras for toys. Our image sensors are designed to use the
complementary metal oxide semiconductor, or CMOS, fabrication process. Our
single chip image sensors can allow our customers to build cameras that are
smaller, require fewer chips, consume less power and cost less to build than
cameras using traditional charged couple device, or CCD, technology, or
multiple chip CMOS image sensors. Unlike competitive image sensors, which
require multiple chips to achieve the same functions, we are able to integrate
nearly all camera functions into a single chip. This leads us to believe that
we supply one of the most highly integrated single chip CMOS image sensor
solutions.
We sell our products worldwide through a direct sales force and indirectly
through distributors and manufacturers' representatives. Our image sensors are
sold to camera manufacturers who market camera products under their own brand.
We also sell to large manufacturing companies that produce camera products for
others to market under different brand names.
Image sensors are characterized by several important attributes such as
picture resolution, color, lens size, voltage requirements and type of video
output. We intend to continue developing new products aimed at new and existing
markets. We plan to expand the range of picture resolutions we offer, provide
additional products that require only three volts for portable applications and
further improve image quality and integrate additional functions into our image
sensor. In addition, we developed and market an interface chip that connects a
camera to the universal serial bus on personal computers, and we plan to
continue to make improvements to that product as well.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Our first image sensor was a low resolution, black and white sensor
introduced in 1996. We introduced an improved version of this sensor in early
1997. In addition, we introduced color and digital image sensors in 1997 and
higher resolution and higher quality image sensors in 1998, 1999 and 2000. For
the year ended April 30, 2001, or Fiscal Year 2001, and the three and six
months ended October 31, 2001, the majority of our revenues were generated from
sales of our five-volt color image sensors. Given the growth of the Internet
and multimedia applications which allow for digital images to be captured,
stored and transported, we expect that a significant portion of our revenues in
the remainder of the year ended April 30, 2002, Fiscal Year 2002, will be
generated from our five volt color image sensors, which are used primarily in
affordable and easy to use personal computer and security cameras, and
increasingly from 3.2 volt color image sensors which are used in both personal
computer cameras and cellular phone accessories.
We outsource all of our semiconductor manufacturing and assembly. This
approach allows us to focus our resources on the design, development and
marketing of our products and significantly reduces our capital requirements.
We outsource our wafer manufacturing to Taiwan Semiconductor Manufacturing
Company, or TSMC, and Powerchip Semiconductor Company, or PSC. A majority of
our unit sales of image sensors for the three and six months ended October 31,
2001 are color image sensors. These require a color filter to be applied to the
wafer before packaging. We outsource the application of this color filter to
Toppan Printing Co., or Toppan and TSMC. We outsource the packaging of our
image sensors to Kyocera Corporation, or Kyocera, and Alphatec Semiconductor
Packaging Co., or Alphatec. Outside testing services do not offer suitable
tests for the key parameter of product performance and image quality.
Therefore, we design and produce our own automatic testing equipment
specifically for image sensor testing, and we do substantially all of our
testing in house. Our control over the testing process helps us maintain
consistent product quality and identify areas to improve product quality and
reduce costs.
Sales of our image sensors are subject to seasonality. Some of the
products using our image sensors such as personal computer video cameras and
digital still cameras are consumer electronics goods. Typically, these goods
are subject to seasonality with generally increased consumer sales in November
and December due to the holidays. As a result, product sales are impacted by
seasonal purchasing patterns with higher sales generally occurring in the
second half of the calendar year. In addition, we typically experience a
decrease in orders in the quarter ended January 31 from our Chinese and
Taiwanese customers primarily due to the Chinese New Year.
We intend to maintain our technology leadership by continuing to develop
our core technology through our in house research and development efforts. As a
result, we expect our research and development expenses to increase on a dollar
basis and may increase on a percentage of revenue basis during the remainder of
Fiscal Year 2002.
In December 2000, we formed a new subsidiary to conduct design and testing
operations in Shanghai, the People's Republic of China. The registered capital
of this new company is $12.0 million, of which $3.8 million was funded by us in
Fiscal Year 2001, as required by Chinese law. We are further obligated to fund
the remaining $8.2 million of registered capital by December 2003. As of
October 31, 2001, $2.8 million of the $3.8 million was paid for land use rights
and to building contractors, $0.7 million was deposited in a bank account in
China and $0.3 million was expended for general purposes. The formation and
operation of the new company in China requires a large initial capital
investment, and there may be significant administrative, legal and governmental
barriers in China, which may prevent our ability to begin operation of the new
company as well as using the funds outside of China.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Results of Operations
- ---------------------
The following table sets forth the results of our operations as a
percentage of revenues. Our historical operating results are not necessarily
indicative of the results for any future period.
Three Months Ended Six Months Ended
---------------------- ----------------------
October 31, October 31, October 31, October 31,
2001 2000 2001 2000
---- ---- ---- ----
Revenues....................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues............... 61.9 70.4 58.6 69.7
----- ----- ----- -----
Gross profit................. 38.1 29.6 41.4 30.3
----- ----- ----- -----
Operating expenses:
Research and development...... 14.7 7.4 14.9 7.3
Selling, general and
Administrative.............. 27.6 7.4 28.3 6.7
Stock compensation charge..... 1.3 1.2 1.4 1.4
Litigation settlement......... 28.5 -- 14.9 --
----- ----- ----- -----
Total operating expenses.. 72.1 16.0 59.5 15.4
----- ----- ----- -----
Income (loss) from operations... (34.0) 13.6 (18.1) 14.9
Interest income (expense), net.. 3.7 5.3 4.4 3.1
----- ----- ----- -----
Income (loss) before income taxes (30.3) 18.9 (13.7) 18.0
Provision for income taxes...... -- 7.2 -- 6.8
----- ----- ----- -----
Net income (loss)............... (30.3)% 11.7% (13.7)% 11.2%
===== ===== ===== =====
Three and Six Months Ended October 31, 2001 as Compared to Three and Six Months
Ended October 31, 2000
Revenues
- --------
We derive revenues from the sale of our standard image sensor array
products and other companion circuits for use in a variety of applications.
Revenues for the three months ended October 31, 2001 decreased 33.3% to
approximately $12.3 million from $18.4 million for the three months ended
October 31, 2000. Revenues for the six months ended October 31, 2001 decreased
35.3% to approximately $23.4 million from $36.2 million for the six months
ended October 31, 2000. The decrease in revenues during the three months ended
October 31, 2001 was due to a decrease in the number of units sold, primarily
caused by reduced demand resulting from the general economic slowdown. The
decrease in revenues during the six months ended October 31, 2001 was due to a
decrease in the number of units sold, primarily caused by reduced demand and
excess customer inventory in the personal computer camera manufacturing
business resulting from the general economic slowdown. Domestic and
international revenues for the three months ended October 31, 2001 were $3.8
million and $8.5 million, respectively, as compared to $2.3 million and $16.1
million, respectively, for the three months ended October 31, 2000. Domestic
and international revenues for the six months ended October 31, 2001 were $10.3
million and $13.1 million, respectively, as compared to $3.9 million and $32.3
million, respectively, for the six months ended October 31, 2000. For the three
months ended October 31, 2001, one of our security camera manufacturer
customers, X-10 Wireless Technology, Inc., or X10, represented approximately
26.1% of revenues. No other single customer accounted for 10% or more of
revenues in the three months ended October 31, 2001. Our two largest
distributors during the three months ended October 31, 2001 were World Peace
Industrial Co. Ltd., or World Peace, headquartered in Taiwan, which accounted
for 16.7% of revenues, and SEC Development Co. Ltd., or SEC, headquartered in
Hong Kong, which accounted for 10.0% of revenues. For the six months ended
October 31, 2001, X10 represented 39.5% of revenues, World Peace accounted for
approximately 12.6% of revenues and SEC accounted for approximately 8.2% of
revenues. For the three months ended October 31, 2000, one of our distributors,
World Peace, represented approximately 11.7% of revenues and one of our camera
manufacturer customers, Creative Technology Ltd. or Creative, accounted for
approximately 31.8% of revenues. For the six months ended October 31, 2000,
World Peace represented approximately 19.8% of revenues and Creative accounted
for approximately 20.4% of revenues.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Gross Profit
- ------------
Gross margins for the three months ended October 31, 2001 and 2000 were
38.1% and 29.6% of revenues, respectively. Gross margins for the six months
ended October 31, 2001 and 2000 were 41.4% and 30.3% of revenues, respectively.
The increase in gross margin for the three months ended October 31, 2001 was
primarily due to favorable product mix and improved yields on certain products.
Gross margins also benefited from the sale of approximately $0.5 million of
product that was previously written off in the three months ended January 31,
2001. On a pro-forma basis, excluding the benefit of previously written-off
inventory, the gross margin was 34.3% of revenues for the quarter ended October
31, 2001 as compared to 29.6% of revenues in the corresponding quarter of the
previous fiscal year. On a pro-forma basis, excluding the benefit of previously
written-off inventory, the gross margin was 34.6% of revenues for the six
months ended October 31, 2001 as compared to 30.3% of revenues in the
corresponding quarter of the previous fiscal year. The increase in gross
margins on a pro-forma basis for the three and six months ended October 31,
2001 was due to favorable changes in product mix and yield improvements. These
factors may continue to influence gross margin in the future.
Research and Development
- ------------------------
Research and development expenses for the three months ended October 31,
2001 and 2000 were approximately $1.8 million and $1.4 million, respectively.
Research and development expenses for the six months ended October 31, 2001 and
2000 were approximately $3.5 million and $2.6 million, respectively.
As a percentage of revenues, research and development expenses for the
three months ended October 31, 2001 and 2000 represented 14.7% and 7.4%,
respectively. As a percentage of revenues, research and development expenses
for the six months ended October 31, 2001 and 2000 represented 14.9% and 7.3%,
respectively. As revenues decreased from the three and six months ended October
31, 2000, to the three and six months ended October 31, 2001, research and
development expenses increased as a percentage of revenues. Our research and
development expenses increased for the three and six months ended October 31,
2001 by approximately $0.4 million and $0.8 million, respectively, from the
three and six months ended October 31, 2000 due to an increase in salaries,
payroll related expenses associated with additional personnel and contracted
costs associated with new product development. Research and development
expenses consist primarily of compensation and personnel related expenses and
costs for purchased materials, designs and tooling, depreciation of computers
and workstations, and amortization of computer aided design software, all of
which may fluctuate significantly from period to period as a result of our
product development cycles. We expect that our future research and development
expenses will increase in absolute dollars and may increase as a percentage of
revenues as we design and develop our next generation of image sensor products.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses for the three months ended
October 31, 2001 and 2000 were approximately $3.4 million and $1.4 million,
respectively. Selling, general and administrative expenses for the six months
ended October 31, 2001 and October 31, 2000 were approximately $6.6 million and
$2.4 million, respectively. The increase in selling, general and administrative
expenses of approximately $2.0 million for the three months ended October 31,
2001 from the same period in the prior year was principally due to higher than
normal expenses for legal fees resulting from patent litigation. The increase
in selling, general and administrative expenses of approximately $4.2 million
for the six months ended October 31, 2001 was principally due to an increase in
salaries and payroll related expenses associated with additional personnel, and
increased litigation expense, partially offset by a decrease in commissions
paid to distributors and manufacturers' representatives. As a percentage of
revenues, selling, general and administrative expenses for the three months
ended October 31, 2001 and 2000 represented
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
27.6% and 7.4%, respectively. As a percentage of revenues, selling, general and
administrative expenses for the six months ended October 31, 2001 and October
31, 2000 represented 28.3% and 6.7%, respectively. As revenues decreased for
the three and six months ended October 31, 2001, selling, general and
administrative expenses increased as a percentage of revenues. As a result of
our recently settled intellectual property claims litigation, we expect that
our future selling, general and administrative expenses are likely to decrease
in absolute dollars and may decrease as a percentage of revenues.
Stock Compensation Charge
- -------------------------
We incurred stock compensation charges of approximately $0.2 million for
the three months ended October 31, 2001 and 2000, respectively. We incurred
stock compensation charges of approximately $0.3 million and $0.5 million for
the six months ended October 31, 2001 and 2000, respectively. Deferred
compensation represents the difference between the deemed fair market value of
our common stock on the date of grant and the exercise price of stock options
to purchase our common stock on the date of grant, and it is amortized on an
accelerated basis as the stock options vest. We expect deferred compensation
charges of approximately $0.7 million as of October 31, 2001 to be amortized on
an accelerated basis over the vesting period of the stock options of generally
five years.
Stock Option Exchange Program
- -----------------------------
On November 1, 2001, we announced a voluntary stock option exchange
program for our employees. Under the program, our employees are being given
the opportunity to elect to cancel outstanding stock options held by them in
exchange for an equal number of new options to be granted at a future date,
expected to be June 5, 2002. These elections need to be made by December 3,
2001 and must include all options granted during the prior six months. The
exercise price of the new options will be equal to the fair market value of our
common stock on the date of grant. The exchange program is not available to
our executives, directors or any of our employees who live or work outside the
United States.
Litigation Settlement
- ---------------------
Litigation settlement expenses for the three months ended October 31, 2001
and 2000 were $3.5 million and zero, respectively. Litigation settlement
expenses for the six months ended October 31, 2001 and October 31, 2000 were
$3.5 million and zero, respectively. The increase in litigation settlement
expenses of $3.5 million for the three and six months ended October 31, 2001
from the same period in the prior year was due to a one-time payment of $3.5
million to Photobit Corporation, or Photobit, to settle all pending litigation
between us and Photobit. As a percentage of revenue, litigation settlement
expenses for the three months ended October 31, 2001 and 2000 represented 28.5%
and zero, respectively. As a percentage of revenues, litigation settlement
expenses for the six months ended October 31, 2001 and October 31, 2000
represented 14.9% and zero, respectively.
Interest Income (Expense), Net
- ------------------------------
Interest income and interest expense, net for the three months ended
October 31, 2001 and 2000 were income of approximately $0.5 million and $1.0
million, respectively. Interest income and interest expense, net for the six
months ended October 31, 2001 and 2000 were income of approximately $1.0
million and $1.1 million respectively. Interest income and interest expense,
net, decreased primarily due to the investment of the net proceeds from our
initial public offering in interest-bearing accounts consisting primarily of
high-grade corporate securities and government bonds maturing approximately
twelve months or less from the date of purchase.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Provision for Income Taxes
- --------------------------
We recorded approximately $3.7 million loss before income taxes and $3.5
million in income before income taxes for the three months ended October 31,
2001 and 2000, respectively. We recorded a loss before income taxes of
approximately $3.2 million and income before income taxes of $6.5 million for
the six months ended October 31, 2001 and October 31, 2000, respectively. We
had no provision for income taxes for the three and six months ended October
31, 2001, respectively. During the three and six months ended October 31, 2000
we recorded a provision for income taxes amounting to approximately $1.3 and
$2.5 million, respectively, after taking into consideration the utilization of
prior years' net operating loss carryforwards and credits.
Recent Accounting Pronouncements
- --------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141 ("SFAS No. 141"),
"Business Combinations." SFAS 141 requires the purchase method of accounting
for business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. We believe that the adoption of SFAS 141 will not
have a significant impact on our consolidated financial statements.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets", which is effective for fiscal years beginning after December 15, 2001.
SFAS 142 requires, among other things, the discontinuance of goodwill
amortization. In addition, the standard includes provisions upon adoption for
the reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. We are
currently assessing but have not yet determined the impact of SFAS 142 on our
financial position and results of operations.
In June 2001, the FASB issued SFAS 143, "Accounting for Obligations
Associated with the Retirement of Long-Lived Assets." The objectives of SFAS
143 are to establish accounting standards for the recognition and measurement
of an asset retirement obligation and its associated asset retirement cost.
SFAS 143 will be effective for financial statements issued for fiscal years
beginning after June 15, 2002. We believe that the adoption of SFAS 143 will
not have any material impact on our consolidated financial statements.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which is effective for fiscal years
beginning after December 15, 2001. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of." It establishes a single accounting
method, based on the framework established in SFAS 121, for long-lived assets
to be disposed of by sale. We are currently assessing, but have not yet
determined the impact of SFAS 144 on our financial position and results of
operations.
Liquidity and Capital Resources
- -------------------------------
Since inception, we have financed our growth through sales of common stock
and private sales of equity securities, totaling approximately $90.1 million.
Principal sources of liquidity at October 31, 2001 consisted of cash, cash
equivalents and short-term investments of $56.9 million.
Our working capital decreased by approximately $3.2 million to $63.7
million as of October 31, 2001 from $66.9 million as of April 30, 2001. The
decrease was attributable to a $5.2 million decrease in inventories and $3.5
million increase in accrued expenses and other liabilities, which were
partially offset by $2.7 million increase in cash and cash equivalents and a
$2.5 million increase in accounts receivable, net.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
For the six months ended October 31, 2001, net cash provided by operating
activities increased to approximately $3.1 million as compared to our use of
cash for operating activities of $18.3 million for the similar period in the
prior year, primarily due to a $5.2 million decrease in inventories and a $3.5
million increase in accrued expenses and other liabilities which were partially
by a net loss of approximately $3.2 million for the six months ended October
31, 2001 as compared to net income of $4.0 million for the corresponding prior
year period and $2.4 million decrease in accounts receivable. For the six-
month period ended October 31, 2000, we used approximately $18.3 million in
cash for operating activities, primarily due to a $15.5 million increase in
inventory in anticipation of future sales and a $3.1 million increase in
accounts receivable, combined with a $4.3 million decrease in accounts payable,
partially offset by net income of $4.0 million.
For the six months ended October 31, 2001, our use of cash for investing
activities decreased to approximately $1.2 million from a use of $5.9 million
for the similar period in the prior year, primarily due to a $5.2 million
reduction in purchases of short-term investments. This decrease was partially
offset by a $0.6 million increase in purchases of property, plant and
equipment. Net cash used for investing activities for the six-month period
ended October 31, 2000, resulted primarily from purchases of short-term
investments.
For the six months ended October 31, 2001, net cash provided from
financing activities decreased to approximately $0.8 million from $67.7 million
for the similar period in the prior year. The decrease was primarily due to a
reduction in proceeds from the issuance and sale of common stock which totaled
$0.3 million during the six months ended October 31, 2001 and resulted from
purchases through the employee stock purchase plan as compared to $67.7 million
aggregate net proceeds, including the proceeds from the exercise of the over-
allotment option, after deducting underwriting discounts and commissions of
approximately $5.2 million and directly paying expenses of the offering of
approximately $1.9 million. Approximately $38.2 million of these proceeds was
invested in cash equivalents and short-term investments.
Based on our current working capital position and the cash flows that we
expect to generate through the end of fiscal 2002, we believe these cash
resources will be sufficient to meet our capital and investment requirements,
including anticipated capital expenditures in the amount of approximately $2.0
million and anticipated investment expenditures of approximately $7.0 million
associated with the new company that we have formed in The People's Republic of
China and other potential investments, for at least the next 12 months. After
this period, capital requirements will depend on many factors, including the
levels at which we maintain inventory and accounts receivable, costs of
securing access to adequate manufacturing capacity and increases in our
operating expenses. To the extent that existing cash resources are insufficient
to fund our future activities, we may need to raise additional funds through
public or private equity or debt financing. Additional funds may not be
available, or if available, we may not be able to obtain them on terms
favorable to us or to our stockholders. In the event that we do raise
additional cash through financings, current investors could be further diluted.
From time to time, we may evaluate acquisitions of companies, products or
technologies that complement our business. Although we have no current plans in
this regard, any transactions, if consummated, may consume a portion of our
working capital or require the issuance of securities that may result in
further dilution to existing stockholders.
FACTORS AFFECTING FUTURE RESULTS
Our limited operating history makes it difficult to evaluate our future
- -----------------------------------------------------------------------
prospects and your investment.
- -----------------------------
We were incorporated in May 1995 and only began selling our products in
1996. We introduced our first black and white image sensor for the security and
surveillance and toy and game markets in 1996 and our first color image sensor
for the PC video camera and toy and game markets in October 1997. We are
continuing to develop and produce new products for the digital still camera and
PC video camera markets. Thus, we have a limited operating history, which makes
an evaluation of our future prospects and your investment difficult.
Accordingly, we face risks and difficulties frequently encountered by early
stage companies in new and rapidly evolving markets.
16
We have a history of losses, we were only profitable on an annual basis in
- --------------------------------------------------------------------------
Fiscal Year 2000 and we may not ever return to profitability.
- -------------------------------------------------------------
We incurred net loss of approximately $11.6 million in Fiscal Year 2001
and approximately $4.0 million in Fiscal Year 1999. For the year ended April
30, 2000, the only year in which we have been profitable, our net income was
approximately $3.4 million. In the six months ended October 31, 2001, our net
loss was $3.2 million. In the future, as we develop new products, we expect
research and development expenses to increase. In addition, if we are not able
to accurately forecast the number of wafers we need, our operating expenses
will increase. If these expenses increase and our revenues do not increase for
any reason including the recent slowdown of the United States economy, we may
not subsequently sustain profitability.
We may not adequately forecast the number of wafers we need, and therefore we
- -----------------------------------------------------------------------------
may not be able to react to fluctuations in demand for our products, which
- --------------------------------------------------------------------------
could result in higher operating expenses and lower revenues.
- -------------------------------------------------------------
We must forecast the number of wafers we need from each of our foundries.
However, if customer demand falls below our forecast and we are unable to
reschedule or cancel our wafer orders, we may retain excess wafer inventories,
which could result in higher operating expenses and reduced gross margins.
Conversely, if customer demand exceeds our forecasts, we may be unable to
obtain an adequate supply of wafers to fill customer orders, which could result
in lower revenues and could harm our relationship with key customers. For
example, as a consequence of a product order forecast which proved to be
greater than market demand for our products, we recognized an $18.7 million
inventory adjustment in Fiscal Year 2001.
The recent economic slowdown and other economic conditions have reduced and may
- -------------------------------------------------------------------------------
continue to reduce our revenues and to harm our business.
- --------------------------------------------------------
In the third and fourth quarters of Fiscal Year 2001 and the first and
second quarters of Fiscal Year 2002, our customers and distributors, primarily
our PC video camera customers and distributors, were impacted by significantly
lower demand for camera related products, which forced them to unexpectedly
reschedule or cancel orders for our products in the third and fourth quarters
of Fiscal Year 2001 and the first and second quarters of Fiscal Year 2002. As
a result, our revenues and earnings were adversely affected. In November 2001,
we announced projected revenues and earnings for the third quarter of Fiscal
Year 2002. If demand for camera related products, in particular PC video
cameras, does not recover in Fiscal Year 2002, or if we are unable to manage
our operating expenses, we will not be able to meet these projections. In
addition, the terrorist attacks of September 11, 2001, the subsequent military
response by the United States and future events occurring in response to or in
connection with the attacks may negatively impact the economy in general. If
our customers decide to delay their product orders or reduce their demand of
our products as a result of any of these occurrences, our results of
operations, revenues and financial condition would be adversely affected.
Fluctuations in our quarterly operating results make it difficult to predict
- ----------------------------------------------------------------------------
our future performance and may result in volatility in the market price of our
- ------------------------------------------------------------------------------
common stock.
- -------------
Our quarterly operating results have varied significantly from quarter to
quarter in the past and are likely to vary significantly in the future based on
a number of factors related to how we manage our business. These factors, many
of which are more fully discussed in other risk factors, include:
o our ability to manage our product transitions;
o our ability to accurately forecast the number of wafers we need;
o the mix of the products we sell and the distribution channels through
which they are sold; and
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o the availability of production capacities at the semiconductor foundries
that manufacture our products or components of our products.
In the past, our introduction of new products and our product mix have
affected our quarterly operating results. We also anticipate that the rate of
orders from our customers may vary significantly from quarter to quarter. Our
expenses and inventory levels are based on our expectations of future revenues
and our expenses are relatively fixed in the short term. Consequently, if
revenues in any quarter do not occur when expected, expenses and inventory
levels could be disproportionately high and our operating results for that
quarter and, potentially future quarters, may be harmed.
Certain other factors have in the past caused and are likely in the future
to cause fluctuations in our quarterly operating results. These factors are
industry risks over which we have little or no control. These factors include:
o the growth of the market for products and applications using CMOS image
sensors;
o the timing and amount of orders from our camera manufacturers and
distributor customers;
o the deferral of customer orders in anticipation of new products, designs
or enhancements by us or our competitors; and
o the announcement and introduction of products and technologies by our
competitors.
Any one or more of these factors is difficult to forecast and could result
in fluctuations in our quarterly operating results. Fluctuations in our
quarterly operating results could adversely affect the price of our common
stock in a manner unrelated to our long term operating performance. Due to the
potential volatility of our stock price, you should not rely on the results of
any one quarter as an indication of our future performance. It is likely that
at some point our quarterly operating results will fall below the expectations
of security analysts and investors. In this event, the price of our common
stock would likely decrease.
We depend on the acceptance of CMOS technology for mass market image sensor
- ---------------------------------------------------------------------------
applications, and any delay in the widespread acceptance of this technology
- ---------------------------------------------------------------------------
could adversely affect our ability to increase our revenues and improve our
- ---------------------------------------------------------------------------
earnings.
- --------
Our business strategy depends on the rapid and widespread adoption of the
CMOS fabrication process for image sensors and the acceptance of our single
chip technology. The image sensor market has been dominated by CCD technology
for over 25 years. Although CMOS technology has been available for over 20
years, CMOS technology has only recently been used in image sensors. Along with
the other risk factors described in this section, the following factors may
delay the widespread adoption of the CMOS fabrication process and our single
chip technology, the occurrence of any of which could adversely affect our
ability to increase our revenues and earnings:
o the failure of the emergence of a universal platform for imaging
solutions for computers and the Internet;
o the limited availability of bandwidth to run CMOS image sensor
applications;
o the uncertainty of emerging markets for products incorporating CMOS
technology;
o the failure of development of user friendly and affordable products; and
o improvements or cost reductions to CCD image sensors, which could slow
the adoption of CMOS image sensors in markets already dominated by CCD
image sensors, such as the security and surveillance market.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We depend on a limited number of third party wafer foundries to manufacture a
- -----------------------------------------------------------------------------
substantial majority of our products, which reduces our ability to control the
- ------------------------------------------------------------------------------
manufacturing process.
- ---------------------
We do not own or operate a semiconductor fabrication facility. We rely on
TSMC and PSC to produce a substantial majority of our wafers and final
products. Our reliance on these third party foundries involves a number of
significant risks, including:
o reduced control over delivery schedules, quality assurance,
manufacturing yields and production costs;
o lack of guaranteed production capacity or product supply; and
o unavailability of, or delayed access to, next generation or key process
technologies.
We do not have long term supply agreements with any of our foundries and
instead secure manufacturing availability on a purchase order basis. These
foundries have no obligation to supply products to us for any specific period,
in any specific quantity or at any specific price, except as set forth in a
particular purchase order. Our requirements represent a small portion of the
total production capacities of these foundries and TSMC or PSC may reallocate
capacity to other customers, even during periods of high demand for our
products. If any of our foundries were to become unable or unwilling to
continue manufacturing our wafers in the required volumes, at acceptable
quality, yields and costs and in a timely manner, our business would be
seriously harmed. As a result, we would have to identify and qualify substitute
foundries, which would be time consuming and difficult and could result in
unforeseen manufacturing and operations problems. In addition, if competition
for foundry capacity increases, our product costs may increase, and we may be
required to pay or invest significant amounts to secure access to manufacturing
services. We are also exposed to additional risks if we decide to transfer our
production of semiconductors from one foundry to another. We may qualify
additional foundries in the future. If we do not qualify additional foundries,
we may be exposed to increased risk of capacity shortages due to our complete
dependence on our foundries.
If we do not achieve acceptable wafer manufacturing yields, our costs could
- ---------------------------------------------------------------------------
increase, and our products may not be deliverable which could lead to higher
- ----------------------------------------------------------------------------
operating expenses and lower revenues and damage to our customer relationships.
- -------------------------------------------------------------------------------
The fabrication of our products requires wafers to be produced in a highly
controlled and clean environment. Semiconductor companies that supply our
wafers sometimes have experienced problems achieving acceptable wafer
manufacturing yields. Semiconductor manufacturing yields are a function of both
our design technology and the particular foundry's manufacturing process
technology. Low yields may result from design errors or manufacturing failures
in new or existing products. Yield problems may not be determined or improved
until an actual image sensor is made and can be tested. As a result, yield
problems may not be identified until the wafers are well into the production
process. We only test our products after they are assembled, as their optical
nature makes earlier testing difficult and expensive. The risks associated with
yields are even greater because we rely on third party offshore foundries for
our wafers which increases the effort and time required to identify,
communicate and resolve manufacturing yield problems. If the foundries cannot
achieve the planned yields, this will result in higher costs and reduced
product availability.
We depend on third party vendors for color filter processing and assembly,
- --------------------------------------------------------------------------
which reduces our control over delivery schedules, product quality and cost.
- ----------------------------------------------------------------------------
After our wafers are produced, they are color filter processed and
assembled by six independent vendors: TSMC and Toppan for the color filtering
process and Kyocera and Alphatec for additional processing and assembly. We do
not have long-term agreements with any of these vendors and typically obtain
services from them on a purchase order basis. Our reliance on these vendors
involves risks such as reduced control over delivery schedules, quality
assurance and costs. These risks could result in product shortages or could
increase our costs of manufacturing, assembling or
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
testing our products. If these vendors are unable or unwilling to continue to
provide color filter processing and assembly services and deliver products of
acceptable quality, at acceptable costs and in a timely manner, our business
would be seriously harmed. We would also have to identify and qualify
substitute vendors, which could be time consuming and difficult and result in
unforeseen operations problems.
Our lengthy manufacturing, packaging and assembly cycle, in addition to our
- ---------------------------------------------------------------------------
customers' design cycle, may result in uncertainty and delays in generating
- ---------------------------------------------------------------------------
revenues.
- --------
A lengthy manufacturing, packaging and assembly process, typically lasting
four months or more, is required to manufacture our image sensors. It can take
additional time before a customer commences volume shipments of products that
incorporate our image sensors. Even when a manufacturer decides to design our
image sensors into its products, the manufacturer may never ship final products
incorporating our image sensors. Given this lengthy cycle, we experience a
delay between the time we incur expenditures for research and development, and
sales and marketing efforts and the time we generate revenues, if any, from
these expenditures. As a result, our revenues and profits could be seriously
harmed if a significant customer reduces or delays orders or chooses not to
release products incorporating our products.
If the demand for our products in current markets and emerging markets fails to
- -------------------------------------------------------------------------------
increase as we anticipate, our growth prospects would be diminished.
- --------------------------------------------------------------------
Our success depends in large part on the continued growth of various
markets that use our products and the emergence of new markets for our
products. The current markets that use our products include digital still
cameras, personal computer video cameras, personal digital assistant cameras,
mobile phone cameras, cameras for security and surveillance systems, closed
circuit television systems, and cameras for toys and games and automotive
applications. Emerging markets for our products include cameras for personal
identification systems, medical imaging devices, machine control systems, and
videophones. If these markets do not continue to grow and develop, the need for
cameras which are lower in cost, smaller, lighter in weight, consume less power
and are more reliable might not fully develop. In such case, it would be
unlikely that our products would achieve commercial success.
Failure to obtain design wins could cause our revenues to level off or decline.
- -------------------------------------------------------------------------------
Our future success will depend on camera manufacturers designing our image
sensors into their systems. To achieve design wins, which are decisions by
those manufacturers to design our products into their systems, we must define
and deliver cost effective, innovative and integrated semiconductor solutions.
Once a manufacturer has designed a supplier's products into its systems, the
manufacturer may be reluctant to change its source of components due to the
significant costs associated with qualifying a new supplier. Accordingly, the
failure to achieve design wins with key camera manufacturers could decrease our
market share or revenues.
Continuing declines in our average sales prices since the first quarter of
- --------------------------------------------------------------------------
Fiscal Year 1999 may result in declines in our gross margins.
- -------------------------------------------------------------
Because the image sensor market is characterized by intense competition,
and price reductions for our products are necessary to meet consumer price-
points, we expect to experience market driven pricing pressures. This will
likely result in a decline in average sales prices for our products. We believe
that we can offset declining average sales prices by achieving manufacturing
cost efficiencies, developing new products that incorporate more advanced
technology and including more advanced features that can be sold at stable
average gross margins. However, if we are unable to achieve such cost
reductions and technological advances, or are unable to timely introduce new
products, we will lose revenues and gross margins will decline.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Seasonality in our business will cause our results of operations to fluctuate
- -----------------------------------------------------------------------------
from period to period and could cause our stock price to fluctuate or decline.
- -----------------------------------------------------------------------------
Sales of our image sensors are subject to seasonality. Some of the
products using our image sensors such as personal computer video cameras and
digital still cameras are consumer electronics goods. Typically, these goods
are subject to seasonality with generally increased consumer sales in November
and December due to the holidays. As a result, product sales are impacted by
seasonal purchasing patterns with higher sales generally occurring in the
second half of the calendar year. In addition, we typically experience a
decrease in orders in the quarter ended January 31 from our Chinese and
Taiwanese customers primarily due to the Chinese New Year. As a result, we
believe product sales are impacted by seasonal purchasing patterns with higher
sales generally occurring in the second half of each calendar year.
We depend on a few key customers, and the loss of any of them could
- -------------------------------------------------------------------
significantly reduce our revenues.
- ----------------------------------
Historically, a relatively small number of customers and distributors has
accounted for a significant portion of our product revenues.
For the three months ended October 31, 2001, one of our security camera
manufacturer customers, X10, represented approximately 26.1% of revenues. No
other single customer accounted for 10% or more of revenues in the three months
ended October 31, 2001. Our two largest distributors during the three months
ended October 31, 2001 were World Peace headquartered in Taiwan, which
accounted for 16.7% of revenues, and SEC headquartered in Hong Kong, which
accounted for 10.0% of revenues. For the six months ended October 31, 2001, X10
represented approximately 39.5% of revenues, World Peace accounted for
approximately 12.6% of revenues and SEC accounted for approximately 8.2% of
revenues.
A significant reduction, delay or cancellation of orders from our key
customers or distributors, or a decision by them to select or distribute
products manufactured by a competitor could seriously harm our business. For
example, in 1999, we had to replace one of our largest distributors with Wintek
Electronics Co., Ltd. because that distributor decided to distribute a
competitor's products. We expect our operating results to continue to depend on
sales to or design decisions of a relatively small number of distributors and
camera manufacturers.
We do not have long-term commitments from our customers, and we allocate
- ------------------------------------------------------------------------
resources based on our estimates of customer demand, which could lead to excess
- -------------------------------------------------------------------------------
inventory and lost revenue opportunities.
- ----------------------------------------
Our sales are generally made on the basis of purchase orders rather than
long-term purchase commitments. In addition, our customers may cancel or defer
purchase orders. We manufacture our products according to our estimates of
customer demand. This process requires us to make multiple demand forecast
assumptions, each of which may introduce error into our estimates. If we
overestimate customer demand, we may allocate resources to manufacturing
products which we may not be able to sell or we may have to sell our products
to other customers for lower prices. As a result, we would have excess
inventory, which would have an adverse impact on our results of operations.
For example, one customer, Creative unexpectedly cancelled its purchase orders
for one of our products in the second quarter of Fiscal Year 2001 which
resulted in our shipping substantially fewer quantities to them in the third
and fourth quarters of Fiscal Year 2001 and contributed to a higher than
expected inventory position. Conversely, if we underestimate customer demand or
if sufficient manufacturing capacity is unavailable, we may forego revenue
opportunities, lose market share and damage our customer relationships.
We face foreign business, political and economic risks because a majority of
- ----------------------------------------------------------------------------
our products, and our customers' products are manufactured and sold outside of
- ------------------------------------------------------------------------------
the United States.
- -----------------
A substantial portion of our business, in particular, the manufacturing,
processing and assembly of our products, is conducted outside of the United
States, and as a result, we are subject to foreign business, political and
economic
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
risks. All of our products are manufactured outside of the United States. Many
of our customers are camera manufacturers or are the manufacturers or suppliers
for camera manufacturers and are located in Japan, Korea, Singapore and Taiwan.
In addition, sales outside of the United States accounted for approximately
69.2% and 56.2% of our revenues for three and six months ended October 31, 2001
and 87.8% and 89.1% of our revenues for three and six months ended October 31,
2000. We anticipate that sales outside of the United States will continue to
account for a substantial portion of our revenue in future periods.
Accordingly, we are subject to foreign risks, including:
o difficulties in managing distributors;
o difficulties in staffing and managing foreign operations;
o difficulties in managing foundries and third party manufacturers;
o political and economic instability which may have an adverse impact on
foreign exchange rates in Asia;
o inadequacy of local infrastructure, in particular with respect to our
future expansion in China; and
o difficulties in accounts receivable collections.
In addition, camera manufacturers who design our solutions into their
products sell them outside of the United States. This exposes us indirectly to
foreign risks. Because sales of our products have been denominated to date
exclusively in United States dollars, increases in the value of the United
States dollar will increase the price of our products so that they become
relatively more expensive to customers in the local currency of a particular
country, leading to a reduction in revenues and profitability in that country.
A portion of our international revenues may be denominated in foreign
currencies in the future, which will subject us to risks associated with
fluctuations in those foreign currencies.
Our dependence on selling through distributors increases the complexity of our
- ------------------------------------------------------------------------------
business which may increase our operating costs and may reduce our ability to
- -----------------------------------------------------------------------------
forecast revenues.
- -----------------
Our revenues depend on design wins with new camera manufacturers which, in
turn, rely on third party manufacturers or distributors to provide inventory
management and purchasing functions. Selling through distributors reduces our
ability to forecast sales and increases the complexity of our business,
requiring us to:
o manage a more complex supply chain;
o manage the level of inventory at each distributor;
o provide for credits, return rights and price protection;
o estimate the impact of credits, return rights, price protection and
unsold inventory at distributors; and
o monitor the financial condition and credit worthiness of our
distributors. Any failure to manage these challenges could reduce our
revenues and damage our relationships with our distributors.
We face intense competition in our markets from more established CCD image
- --------------------------------------------------------------------------
sensor manufacturers and CMOS image sensor manufacturers and if we are unable
- -----------------------------------------------------------------------------
to compete successfully, we will not achieve our financial objectives.
- ---------------------------------------------------------------------
The image sensor market is intensely competitive. These markets are
characterized by rapid technological change, evolving standards, short product
life cycles and decreasing prices. Our current products face competition
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
from a number of sources including companies which sell charged couple device
image sensors as well as other companies which sell multiple chip CMOS image
sensors. We expect competition in our markets to increase.
Many of our competitors have longer operating histories and greater
presence in key markets, greater name recognition, access to large customer
bases and significantly greater financial, sales and marketing, manufacturing,
distribution, technical and other resources than we do. As a result, they may
be able to adapt more quickly to new or emerging technologies and customer
requirements or devote greater resources to the promotion and sale of their
product than we may. Our competition includes CCD image sensor manufacturers,
including Fuji Corporation, or Fuji, Matsushita Electric Industrial, or
Matsushita, Nippon Electric Corporation or NEC, Sharp Corporation, or Sharp,
Sony Corporation, or Sony, and Toshiba Corporation, or Toshiba, as well as CMOS
image sensor manufacturers such as Agilent Technologies, Inc., ST
Microelectronics, Conexant Systems, Inc., Hyundai Electronics Industries Co.
Ltd., Mitsubishi Electronic, Motorola, Inc., and Toshiba Corporation. In
addition, there are a large number of smaller startup companies including
Photobit Corporation and Zoran Corporation, which may or do compete with us. In
particular, Hyundai and Agilent Technologies have introduced multiple chip CMOS
image sensors. We cannot assure you that we can compete successfully against
current or potential competitors, or that competition will not seriously harm
our business by reducing sales of our products, reducing our profits and
reducing our market share.
Our success depends on the development and introduction of new products, which
- ------------------------------------------------------------------------------
we may not be able to do in a timely manner because the process of developing
- -----------------------------------------------------------------------------
products using CMOS image sensors is complex and costly.
- -------------------------------------------------------
The development of new products is highly complex, and we have experienced
delays in completing the development and introduction of new products on
several occasions in the past, some of which exceeded six months. As our
products integrate new and more advanced functions, they become more complex
and increasingly difficult to design and debug. Successful product development
and introduction depend on a number of factors, including:
o accurate prediction of market requirements and evolving standards,
including pixel resolution, output interface standards, power
requirements, optical lens size, input standards and operating systems
for personal computers and other platforms;
o development of advanced technologies and capabilities;
o definition of new products which satisfy customer requirements;
o timely completion and introduction of new product designs;
o use of leading edge foundry processes and achievement of high
manufacturing yields; and
o market acceptance of the new products.
Accomplishing all of this is extremely challenging, time consuming and
expensive. We cannot assure you that any new products or product enhancements
will be developed in time to capture market opportunities or achieve a
significant or sustainable level of acceptance in new and existing markets.
The high level of complexity and integration of functions of our products
- -------------------------------------------------------------------------
increases the risk of latent defects which could damage customer relationships
- ------------------------------------------------------------------------------
and increase our costs.
- ----------------------
Because we integrate many functions on a single chip, our products are
complex. The greater integration of functions and complexity of operations of
our products, the greater the risk that latent defects or subtle faults could
be discovered by customers or end users after volumes of product have been
shipped. Although we test our products, they may contain defects and errors. In
the past we have encountered defects and errors in our products. Delivery of
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
products with defects or reliability, quality or compatibility problems may
damage our reputation and our ability to retain existing customers and attract
new customers. In addition, product defects and errors could result in
additional development costs, diversion of technical resources, delayed product
shipments, increased product returns, product warranty costs for recall and
replacement and product liability claims against us which may not be fully
covered by insurance.
We maintain a backlog of customer orders which is subject to cancellation or
- ----------------------------------------------------------------------------
delay in delivery schedules, and any cancellation or delay may result in lower
- ------------------------------------------------------------------------------
than anticipated revenues.
- -------------------------
We manufacture and market primarily standard products. Our sales are
generally made pursuant to standard purchase orders. We include in our backlog
only those customer orders for which we have accepted purchase orders and
assigned shipment dates within the upcoming 12 months. Although our backlog is
typically filled within two to four quarters, orders constituting our current
backlog are subject to cancellation or changes in delivery schedules, and
backlog may not necessarily be an indication of future revenue. In addition,
the current backlog will not necessarily lead to revenues in any future period.
Any cancellation or delay in orders which constitute our current or future
backlog may result in lower than expected revenues. Our bookings visibility
continues to be limited with a substantial majority of our quarterly product
revenues coming from orders that are received and fulfilled in the same
quarter.
We must attract and retain qualified personnel to be successful, and
- --------------------------------------------------------------------
competition for qualified personnel is intense in our market.
- ------------------------------------------------------------
Our success depends to a significant extent upon the continued
contributions of our key management, technical and sales personnel, many of who
would be difficult to replace. The loss of one or more of these employees could
seriously harm our business. We do not have key person life insurance on any of
our key personnel. We have no agreements which obligate our employees to
continue working for us. Our success also depends on our ability to identify,
attract and retain qualified technical (particularly analog or mixed signal
design engineers), sales, marketing, finance and management personnel.
Competition for qualified personnel is particularly intense in our industry and
in Silicon Valley, California. This is due to a number of factors, including
the high concentration of established and emerging growth technology companies.
This competition makes it difficult to retain our key personnel and to recruit
new qualified personnel. We have experienced, and may continue to experience,
difficulty in hiring and retaining candidates with appropriate qualifications.
If we do not succeed in hiring and retaining candidates with appropriate
qualifications, our revenues and product development efforts could be harmed.
We may be unable to adequately protect our intellectual property and therefore
- ------------------------------------------------------------------------------
we may lose some of our competitive advantage.
- ---------------------------------------------
We rely on a combination of patent, copyright, trademark and trade secret
laws, as well as nondisclosure agreements and other methods to protect our
proprietary technologies. We have been issued patents and have a number of
pending United States and foreign patent applications. However, we cannot
assure you that any patent will issue as a result of any applications or, if
issued, that any claims allowed will be sufficiently broad to protect our
technology. In addition, it is possible that existing or future patents may be
challenged, invalidated or circumvented. It may be possible for a third party
to copy or otherwise obtain and use our products, or technology without
authorization, develop corresponding technology independently or design around
our patents. Effective copyright, trademark and trade secret protection may be
unavailable or limited in foreign countries. These disputes may result in
costly and time consuming litigation or the license of additional elements of
our intellectual property for free.
24
We could become subject to litigation regarding intellectual property, which
- ----------------------------------------------------------------------------
could divert management attention, be costly to defend and prevent us from
- --------------------------------------------------------------------------
using or selling the challenged technology.
- ------------------------------------------
From time to time, we have been subject to legal proceedings and claims
with respect to such matters as patents, product liabilities and other actions
arising out of the normal course of business.
In March 2000, we received a letter from Koninklijke Philips N.V. in which
Philips claimed to have patent rights in a serial bus system for data
transmission, known as the I2C bus system. Although we do not believe any of
our products infringe any Philips patent, we are currently discussing possible
royalty or licensing arrangements as a means of business resolution. In the
meantime, we have completed implementation of a new serial bus system for our
products.
We entered into an agreement with Photobit Corporation ("Photobit") and
the California Institute of Technology ("CalTech"), effective September 18,
2001, to settle all litigation that we had with Photobit and CalTech, including
an action in the U.S. District Court, Northern District of California, Case No.
C 00 3791 PJH, and an investigation before the U.S. International Trade
Commission ("ITC"), Inv. No. 337-TA-451. Both actions involved patents alleged
to pertain to our CMOS image sensor products, such as those used in digital
cameras, PC cameras and other optical applications. The action pending in
California was dismissed on September 24, 2001, and final termination of the
ITC investigation occurred on November 9, 2001. The confidential settlement
includes non-exclusive cross-licenses for seven years under our and Photobit's
respective patent portfolios, including patents and applications licensed by
CalTech to Photobit. We have also made a one-time payment to Photobit of $3.5
million dollars.
The settlement agreement referred to in the above paragraph relates only
to claims made by Photobit and CalTech. It is possible that other companies
might pursue litigation with respect to any claims such companies purport to
have against us. The results of any litigation are inherently uncertain. In
the event of an adverse result in any litigation with respect to intellectual
property rights relevant to our products that could arise in the future, we
could be required to obtain licenses to the infringing technology, pay
substantial damages under applicable law, including treble damages if we are
held to have willfully infringed, cease the manufacture, use and sale of
infringing products or to expend significant resources to develop non-
infringing technology. Litigation frequently involves substantial expenditures
and can require significant management attention, even if we ultimately
prevail.
Failure to effectively manage our growth could adversely affect our ability to
- ------------------------------------------------------------------------------
increase our revenues and improve our earnings.
- ----------------------------------------------
Our growth has placed, and will continue to place, a significant strain on
our management and other resources. To manage our growth effectively, we must,
among other things:
o implement and improve operational and financial systems;
o train and manage our employee base; and
o attract and retain qualified personnel with relevant experience.
We must also manage multiple relationships with customers, business
partners and other third parties, such as our foundries and process and
assembly vendors. Moreover, our growth may significantly overburden our
management and financial systems and other resources. We also cannot assure you
that we have made adequate allowances for the costs and risks associated with
our expansion. In addition, our systems, procedures or controls may not be
adequate to support our operations, and we may not be able to expand quickly
enough to capitalize on potential market opportunities. Our future operating
results will also depend on expanding sales and marketing, research and
development and administrative support.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Our investment in a Chinese entity to conduct design and testing operations may
- -------------------------------------------------------------------------------
not reduce our design and testing costs nor improve our gross margins and as a
- ------------------------------------------------------------------------------
result our earnings would be adversely affected.
- -----------------------------------------------
In December 2000, we formed a new subsidiary to conduct design and testing
operations in Shanghai, the People's Republic of China. The registered capital
of this Chinese subsidiary is $12.0 million, of which $3.8 million was funded
by us in Fiscal Year 2001, as required by Chinese law. We are further obligated
to fund the remaining $8.2 million of registered capital by December 2003. As
of October 31, 2001, $2.8 million of the $3.8 million was paid for land use
rights and to building contractors, $0.7 million was deposited in a bank
account in China and $0.3 million was expended for general purposes. The
formation and operation of this Chinese subsidiary requires a large initial
capital investment, and there may be significant administrative, legal and
governmental barriers in China, which may prevent or harm us from beginning
operation of this Chinese subsidiary.
We cannot be sure that our investment in our Chinese subsidiary will
eventually result in the reduction of our design and testing costs. The
formation and operation of our Chinese subsidiary requires a large initial
capital investment and will also require significant future capital investment
as we continue to maintain and upgrade our facility. In addition, the design
and testing of our products is a highly complex, sensitive and precise process
which is subject to a wide variety of factors, any number of which could result
in an increase of our costs. If our design and testing costs fail to decrease
as a result of our investment in our China subsidiary our earnings may be
adversely affected.
The incorporation, formation and development of our Chinese subsidiary has
resulted and will continue to result in the diversion of capital away from
other business issues, as the operation of our design and testing facility will
require that we constantly upgrade our technology to remain competitive. The
incorporation, formation and development of our Chinese subsidiary has also
resulted in the diversion of management's attention away from other business
issues. If our ongoing investment in the Chinese subsidiary does not result in
offsetting gains in the form of design and testing improvements accompanied by
reduced design and testing costs, whether because of the risks and difficulties
entailed by foreign operations or for other reasons, our business and financial
condition will be adversely affected.
Provisions in our charter documents and Delaware law, as well as our
- --------------------------------------------------------------------
Stockholders Rights Plan, could prevent or delay a change in control of us and
- ------------------------------------------------------------------------------
may reduce the market price of our common stock.
- -----------------------------------------------
Provisions of our certificate of incorporation and bylaws may discourage,
delay or prevent a merger or acquisition that a stockholder may consider
favorable. These provisions include:
o adjusting the price, rights, preferences, privileges and restrictions of
preferred stock without stockholder approval;
o providing for a classified board of directors with staggered, three year
terms;
o requiring supermajority voting to amend some provisions in our
certificate of incorporation and bylaws;
o limiting the persons who may call special meetings of stockholders; and
o prohibiting stockholder actions by written consent.
Provisions of Delaware law also may discourage, delay or prevent another
company from acquiring or merging with us. Our Board of Directors adopted a
Preferred Stock Rights Agreement in August 2001 (the "Rights Agreement").
Pursuant to the Rights Agreement, our Board of Directors declared a dividend of
one right (a "Right") to purchase one one-thousandth share of our Series A
Participating Preferred Stock ("Series A Preferred") for each outstanding share
of our common stock. The dividend was paid on September 28, 2001 to
stockholders of record as of the close of business on that date. Each Right
entitles the registered holder to purchase from us one one-thousandth of a
share of Series A Preferred at an exercise price of $40.00, subject to
adjustment. The exercise of the
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Rights could have the effect of delaying, deferring or preventing a change of
control of us, including, without limitation, discouraging a proxy contest or
making more difficult the acquisition of a substantial block of our common
stock. The Rights Agreement could also limit the price that investors might be
willing to pay in the future for our common stock.
Our stock has been and will likely continue to be subject to substantial price
- ------------------------------------------------------------------------------
and volume fluctuations due to a number of factors, many of which will be
- -------------------------------------------------------------------------
beyond our control, that may prevent our stockholders from reselling our common
- -------------------------------------------------------------------------------
stock at a profit.
- -----------------
The securities markets have experienced significant price and volume
fluctuations in the past and the market prices of the securities of
semiconductor companies have been especially volatile. This market volatility,
as well as general economic, market or political conditions, could reduce the
market price of our common stock in spite of our operating performance. The
market price of our common stock may fluctuate significantly in response to a
number of factors, including:
o actual or anticipated fluctuations in our operating results;
o changes in expectations as to our future financial performance;
o changes in financial estimates of securities analysts;
o release of lock-up or the transfer restrictions on our outstanding
shares of common stock or sales of additional shares of common stock;
o changes in market valuations of other technology companies; and
o announcements by us or our competitors of significant technical
innovations, design wins, contracts, standards or acquisitions.
Due to these factors, the price of our stock may decline and investors may
be unable to resell their shares of our stock for a profit. In addition, the
stock market experiences extreme volatility that often is unrelated to the
performance of particular companies. These market fluctuations may cause our
stock price to decline regardless of our performance.
We rely on a continuous power supply to conduct our operations and California's
- -------------------------------------------------------------------------------
current energy crisis could disrupt our operations and increase our expenses.
- ----------------------------------------------------------------------------
The State of California is in the midst of an energy crisis that could
disrupt our operations and increase our expenses. In the event of an acute
power shortage, that is, when power reserves for the State of California fall
below one and one-half percent, the State of California has on some occasions
implemented, and may in the future continue to implement, rolling blackouts
throughout the state. We currently do not have backup generators or alternate
sources of power in the event of a blackout, and our current insurance does not
provide coverage for any damages we or our customers or distributors may suffer
as a result of any interruption in our power supply. If blackouts interrupt
our ability to continue operations at our facilities, then our reputation could
be damaged, our ability to retain existing customers could be harmed and we
could fail to obtain new customers. These interruptions could also result in
lost revenue, any of which could substantially harm our business and results of
operations.
Furthermore, the deregulation of the energy industry instituted in 1996 by
the California state government has caused power prices to increase. Under
deregulation, utilities were encouraged to sell their plants, which
traditionally had produced most of California's power, to independent energy
companies that were expected to compete aggressively on price. Instead, due in
part to a shortage of supply, wholesale prices have skyrocketed over the past
year. If wholesale energy prices continue to increase, our operating expenses
will likely increase, as our U.S. facilities are located in California.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Class action litigation due to stock price volatility could lead to substantial
- -------------------------------------------------------------------------------
costs and divert our management's attention and resources.
- ----------------------------------------------------------
In the past, securities class action litigation often has been brought
against a company following periods of volatility in the market price of its
securities. Companies in the semiconductor industry and other technology
industries are particularly vulnerable to this kind of litigation due to the
high volatility of their stock prices. Accordingly, we may in the future be the
target of securities litigation. Securities litigation could result in
substantial costs and could divert our management's attention and resources.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are an international company, selling our products globally and, in
particular in China, Japan, Korea, Singapore and Taiwan. Although we transact
our business in U.S. dollars, future fluctuations in the value of the U.S.
dollar may affect the competitiveness of our products, gross profits realized,
and results of operations. Further, we incur expenses in Japan, Korea, Taiwan,
Thailand, China and other countries that are denominated in currencies other
than the U.S. dollar. We cannot estimate the effect that an immediate 10%
change in foreign currency exchange rates would have on our future operating
results or cash flows as a direct result of changes in exchange rates. However,
we do not believe that we currently have any significant direct foreign
currency exchange rate risk, and we have not hedged exposures denominated in
foreign currencies or any other derivative financial instruments.
Our cash equivalents and short-term investments are exposed to financial
market risk due to fluctuation in interest rates, which may affect our interest
income and, in the future, the fair market value of our investments. We manage
our exposure to financial market risk by performing ongoing evaluations of our
investment portfolio. We presently invest in short term bank market rate
accounts, certificates of deposit issued by banks, high-grade corporate
securities and government bonds maturing approximately 12 months or less from
the date of purchase. Due to the short maturities of our investments, the
carrying value should approximate the fair market value. In addition, we do not
use our investments for trading or other speculative purposes. Due to the short
duration of our investment portfolio, we do not expect that an immediate 10%
change in interest rates would have a material effect on the fair market value
or our portfolio. Therefore, we would not expect our operating results or cash
flows to be affected to any significant degree by the effect of a sudden change
in market interest rates.
29
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
From time to time, we have been subject to legal proceedings and claims
with respect to such matters as patents, product liabilities and other actions
arising out of the normal course of business.
In March 2000, we received a letter from Koninklijke Philips N.V. in which
Philips claimed to have patent rights in a serial bus system for data
transmission, known as the I2C bus system. Although we do not believe any of
our products infringe any Philips patent, we are currently discussing possible
royalty or licensing arrangements as a means of business resolution. In the
meantime, we have completed implementation of a new serial bus system for our
products.
We entered into an agreement with Photobit Corporation ("Photobit") and
the California Institute of Technology ("CalTech"), effective September 18,
2001, to settle all litigation that we had with Photobit and CalTech, including
an action in the U.S. District Court, Northern District of California, Case No.
C 00 3791 PJH, and an investigation before the U.S. International Trade
Commission ("ITC"), Inv. No. 337-TA-451. Both actions involved patents alleged
to pertain to our CMOS image sensor products, such as those used in digital
cameras, PC cameras and other optical applications. The action pending in
California was dismissed on September 24, 2001, and final termination of the
ITC investigation occurred on November 9, 2001. The confidential settlement
includes non-exclusive cross-licenses for seven years under our and Photobit's
respective patent portfolios, including patents and applications licensed by
CalTech to Photobit. We have also made a one-time payment to Photobit of $3.5
million dollars.
The settlement agreement referred to in the above paragraph relates only
to claims made by Photobit and CalTech. It is possible that other companies
might pursue litigation with respect to any claims such companies purport to
have against us. The results of any litigation are inherently uncertain. In
the event of an adverse result in any litigation with respect to intellectual
property rights relevant to our products that could arise in the future, we
could be required to obtain licenses to the infringing technology, pay
substantial damages under applicable law, including treble damages if we are
held to have willfully infringed, cease the manufacture, use and sale of
infringing products or to expend significant resources to develop non-
infringing technology. Litigation frequently involves substantial expenditures
and can require significant management attention, even if we ultimately
prevail.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
We completed our initial public offering, or IPO, on July 14, 2000,
pursuant to a Registration Statement on Form S-1 (File No. 333-31926), which
was declared effective by the Securities and Exchange Commission on July 13,
2000. In the IPO, we sold an aggregate of 5.0 million shares of common stock.
In August 2000, the underwriters of our initial public offering exercised their
over-allotment option to purchase an additional 750,000 shares of common stock
at $13.00 per share. Net proceeds from exercise of the over-allotment option
aggregated approximately $8.5 million after paying the underwriters' fees and
related expenses. The sale of the shares of common stock generated aggregate
gross proceeds of approximately $74.8 million, including proceeds from the
exercise of the over-allotment option. The aggregate net proceeds were
approximately $67.7 million, including the proceeds from the exercise of the
over-allotment option, after deducting underwriting discounts and commissions
of approximately $5.2 million and directly paying expenses of the offering of
approximately $1.9 million. Fleet Boston Robertson Stephens Inc., Prudential
Volpe Technology and Needham & Company, Inc. were the lead underwriters for the
IPO. As of October 31, 2001, approximately $24.8 million of the net proceeds
were used for working capital purposes and the remaining $38.2 million were
invested in cash equivalents and short-term investments.
30
From July 14, 2000 to October 31, 2001, we used such net offering
proceeds, in direct or indirect payments to others, as follows (in thousands):
Purchase and installment of property, plant and equipment... $ 905
Working capital............................................. 24,795
Investment in short-term, interest-bearing obligations...... 38,161
Investment in China subsidiary.............................. 3,800
--------
Total..................................................... $ 67,661
========
Each of such amounts is a reasonable estimate of the application of the
net offering proceeds.
Other than anticipated capital expenditures in the amount of approximately
$2.0 million and anticipated investment expenditures of approximately $7.0
million in the next 12 months, we have no specific plan for the proceeds from
our initial public offering. The primary purpose of the offering has been to
use the proceeds for general corporate purposes, including working capital. We
may also use some of the proceeds to meet capacity commitments or to acquire
other companies, technology or products that complement our business, although
we are not currently planning any of these transactions. Pending these uses,
the net proceeds of the offering have been invested in interest bearing,
investment grade securities.
On August 21, 2001, pursuant to the Rights Agreement between us and
EquiServe Trust Company, N.A., as Rights Agent, our Board of Directors declared
a dividend of a Right to purchase one one-thousandth share of our Series A
Preferred Stock for each outstanding share of our common stock. The dividend
was paid on September 28, 2001 to our stockholders of record as of the close of
business on that date. Each Right entitles the registered holder to purchase
from us one one-thousandth of a share of Series A Preferred at an exercise
price of $40.00, subject to adjustment.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Our annual meeting of stockholders was held at our corporate headquarters
at 930 Thompson Place on September 17, 2001 at 2:00 p.m. local time. The
results of matters voted upon were as follows:
1. To elect two Class I directors to serve until the expiration of their
three year terms or until their successors are duly elected or
appointed and qualified.
VOTE
--------------------------------
FOR WITHHELD
--- --------
Shaw Hong 13,791,666 12,885
Edward C. V. Winn 14,607,266 12,885
The term of office of directors Leon Malmed, Raymond Wu and Tsuey-Jiuan
Chen continued after the Annual Meeting.
2. To ratify the appointment of PricewaterhouseCoopers LLP as independent
auditors of the Company for the fiscal year ending April 30, 2002.
FOR AGAINST ABSTAINED
--- ------- ---------
14,180,450 21,101 10,800
31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
--------
None
(b) Reports on Form 8-K
-------------------
The Company filed a Current Report on Form 8-K on August 23, 2001 to
report under Item 5. "Other Events" and Item 7. "Financial Statements and
Exhibits" the Company's issuance of a press release on August 23, 2001
announcing that the Company's Board of Directors approved the adoption of a
Preferred Stock Rights Agreement.
32
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OMNIVISION TECHNOLOGIES, INC.
-----------------------------
(Registrant)
Dated: November 27, 2001
By: /s/ SHAW HONG
-----------------------------------
Shaw Hong
Chief Executive Officer, President and Director
(Principal Executive Officer)
Dated: November 27, 2001
By: /s/ H. GENE MCCOWN
-----------------------------------
H. Gene McCown
Vice President of Finance and Chief Financial
Officer (Principal Financial
and Accounting Officer)
33