===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2003
[ ] 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)
1341 Orleans Drive, Sunnyvale, California 94089-1136
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 542-3000
---------------
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
At September 10, 2003, 26,930,798 shares of common stock of the Registrant
were outstanding.
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OMNIVISION TECHNOLOGIES, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - July 31, 2003 and
April 30, 2003.................................................. 3
Condensed Consolidated Income Statements - Three Months Ended
July 31, 2003 and 2002.......................................... 4
Condensed Consolidated Statements of Cash Flows - Three Months
Ended July 31, 2003 and 2002.................................... 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 36
Item 4. Controls and Procedures........................................... 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 38
Item 2. Changes in Securities and Use of Proceeds......................... 39
Item 5. Other Information................................................. 39
Item 6. Exhibits and Reports on Form 8-K.................................. 39
Signatures................................................................. 40
2
PART I - FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
July 31, April 30,
2003 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 164,898 $ 50,438
Short-term investments................................. 15,997 10,224
Accounts receivable, net............................... 26,366 19,133
Inventories............................................ 15,897 13,642
Refundable and deferred income taxes................... 6,438 7,642
Prepaid expenses and other assets...................... 2,310 1,195
--------- ---------
Total current assets................................. 231,906 102,274
Property, plant and equipment, net....................... 15,863 12,456
Long-term investments.................................... 4,854 2,845
Other non-current assets................................. 387 378
--------- ---------
Total assets......................................... $ 253,010 $ 117,953
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 19,731 $ 10,528
Accrued expenses and other liabilities................. 12,737 8,037
Deferred income on shipments to distributors........... 2,219 2,845
--------- ---------
Total current liabilities............................ 34,687 21,410
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock, $0.001 par value; 100,000,000 shares
authorized; 26,806,836 and 23,402,908 shares issued
and outstanding...................................... 27 23
Additional paid-in capital............................. 220,353 104,848
Deferred compensation related to stock options......... (102) (159)
Accumulated deficit.................................... (1,955) (8,169)
--------- ---------
Total stockholders' equity........................... 218,323 96,543
--------- ---------
Total liabilities and stockholders' equity........... $ 253,010 $ 117,953
========= =========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Revenues................................................ $ 46,492 $ 16,790
Cost of revenues(1)..................................... 29,128 10,274
--------- ---------
Gross profit............................................ 17,364 6,516
--------- ---------
Operating expenses:
Research and development.............................. 3,580 2,630
Selling, general and administrative................... 4,490 2,080
Stock-based compensation charge(2).................... 101 114
--------- ---------
Total operating expenses............................ 8,171 4,824
--------- ---------
Income from operations.................................. 9,193 1,692
Interest income, net.................................... 222 216
--------- ---------
Income before income taxes.............................. 9,415 1,908
Provision for income taxes.............................. 3,201 286
--------- ---------
Net income.............................................. $ 6,214 $ 1,622
========= =========
Net income per share:
Basic................................................. $ 0.26 $ 0.07
========= =========
Diluted............................................... $ 0.23 $ 0.07
========= =========
Shares used in computing net income per share:
Basic................................................. 23,848 22,265
========= =========
Diluted............................................... 26,819 24,137
========= =========
(1) Stock-based compensation charges:
Cost of revenues (included)....................... $ 2 $ 3
========= =========
(2) Other stock-based compensation charges by functional
area:
Research and development.......................... $ 28 $ 46
Selling, general and administrative............... 73 68
--------- ---------
$ 101 $ 114
========= =========
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)
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income............................................ $ 6,214 $ 1,622
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization....................... 255 205
Amortization of deferred compensation............... 103 117
Changes in assets and liabilities:
Accounts receivable, net.......................... (7,233) (2,787)
Inventories....................................... (2,255) (2,831)
Refundable and deferred income taxes.............. 1,204 --
Prepaid expenses and other assets................. (1,124) (1,295)
Accounts payable.................................. 9,203 3,723
Accrued expenses and other liabilities............ 4,700 148
Deferred income on shipments to distributors...... (626) 223
--------- ---------
Net cash provided by (used in) operating
activities.................................... 10,441 (875)
--------- ---------
Cash flows from investing activities:
Purchase of short-term investments.................... (5,773) --
Proceeds from sale of short-term investments.......... -- 2,002
Purchase of long-term investment...................... (2,009) --
Purchases of property, plant and equipment............ (3,662) (1,457)
--------- ---------
Net cash provided by (used in) investing
activities.................................... (11,444) 545
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net........... 115,463 804
Payment for repurchase of common stock, net........... -- (1)
--------- ---------
Net cash provided by financing activities....... 115,463 803
--------- ---------
Net increase in cash and cash equivalents............... 114,460 473
Cash and cash equivalents at beginning of period........ 50,438 55,803
--------- ---------
Cash and cash equivalents at end of period.............. $ 164,898 $ 56,276
========= =========
Supplemental cash flow information:
Taxes paid............................................ $ 800 $ --
========= =========
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 Three Months Ended July 31, 2003 and 2002
(unaudited)
Note 1 - Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements as
of July 31, 2003 and April 30, 2003 and for the three months ended July 31,
2003 and 2002 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, 2003 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, 2003, included in the Company's Annual Report on
Form 10-K.
The results of operations for the three months ended July 31, 2003 are not
necessarily indicative of the results that may be expected for the year ending
April 30, 2004 or any other future interim period, and the Company makes no
representations related thereto.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 - Summary of Significant Accounting Policies
------------------------------------------
Revenue Recognition
-------------------
The Company recognizes revenue from the sale of products to original
equipment manufacturers and value added resellers 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 to the customer,
collection of resulting receivables is considered reasonably assured, product
returns are reasonably estimable, there are no customer acceptance requirements
and there are no remaining significant obligations. The Company provides for
future returns based on historical experiences at the time revenue is
recognized. For certain shipments to distributors under agreements allowing for
return or credits, revenue is deferred until the distributor resells the
product to the end-user customer. Deferred income on shipments to distributors
represents the amount billed less the cost of inventory shipped to but not yet
sold by distributors.
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 which approximates cost. 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 by these financial statements.
Stock-Based Compensation
------------------------
The Company accounts for stock-based employee compensation arrangements
using the intrinsic value method in accordance with the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
------------------------------
Employees" ("APB 25") and the Financial Accounting Standards Board ("FASB")
- ---------
FASB Interpretation 44, "Accounting for Certain Transactions Involving Stock
---------------------------------------------------
Compensation" ("FIN 44") and complies with the disclosure provisions of
- ------------
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
--------------------
Based Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for
--------------
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB
- -----------------------------------------------------------------------
Statement No. 123," ("SFAS 148"). Under APB 25, compensation cost is
- -----------------
recognized based on the difference, if any, on the date of grant between the
fair value of the Company's stock and the amount an employee must pay to
acquire the stock. Deferred compensation is amortized over the vesting period
on an accelerated basis using the multiple option approach as defined in
paragraph 24 of FIN 28. SFAS 123 requires a "fair value" based method of
accounting for an employee stock option or similar equity instrument. The
following table illustrates the effect on net income and net income per share
as if the Company had applied the fair value recognition provisions of SFAS 123
and SFAS 148 to stock-based employee and is referenced to in this Note as "as
adjusted" (in thousands, except per share amounts):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Net income, as reported................................. $ 6,214 $ 1,622
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects.... 38 79
Deduct: Total stock-based employee compensation
determined under fair value based method for all
awards, net of related tax effects.................... 3,105 1,394
--------- ---------
As adjusted net income.................................. $ 3,147 $ 307
========= =========
Net income per share - Basic:
As reported........................................... $ 0.26 $ 0.07
========= =========
As adjusted........................................... $ 0.13 $ 0.01
========= =========
Net income per share - Diluted:
As reported........................................... $ 0.23 $ 0.07
========= =========
As adjusted........................................... $ 0.12 $ 0.01
========= =========
Shares used in computing net income per share - Basic:
As reported........................................... 23,848 22,265
========= =========
As adjusted........................................... 23,848 22,265
========= =========
Shares used in computing net income per share - Diluted:
As reported........................................... 26,819 24,137
========= =========
As adjusted........................................... 25,234 22,422
========= =========
The Company accounts for stock issued to non-employees in accordance with
the provisions of SFAS 123 and Emerging Issues Task Force Consensus No. 96-18,
"Accounting for Equity Instruments that are Offered to Other than Employees for
------------------------------------------------------------------------------
Acquiring or in Conjunction with Selling Goods or Services" ("EITF 96-18").
- ----------------------------------------------------------
Under SFAS 123 and EITF 96-18, stock option awards issued to non-employees are
accounted for at their fair value, determined using the Black-Scholes option
pricing model.
Recent Accounting Pronouncements
--------------------------------
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
--------------------------
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
- ------------------------------------------------
clarifies financial accounting and reporting of derivative instruments and
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
-------------------------------------
and Hedging Activities." SFAS No. 149 amends SFAS No. 133 for decisions made:
- ----------------------
(i) as part of the Derivatives Implementation Group process that require
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
amendment to SFAS No. 133; (ii) in connection with other FASB projects dealing
with financial instruments; and (iii) in connection with the implementation
issues raised related to the application of the definition of a derivative.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003 and for designated hedging relationships after June 30, 2003. The
adoption of SFAS No. 149 has no material impact on the Company's financial
position and results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
----------------------
Financial Instruments with Characteristics of both Liabilities and Equity."
- -------------------------------------------------------------------------
The Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity and further requires that an issuer classify as a liability (or an asset
in some circumstances) financial instruments that fall within its scope because
that financial instrument embodies an obligation of the issuer. Many of such
instruments were previously classified as equity. The statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The Company believes that the adoption of this standard
will not have a material impact on its financial position and results of
operations.
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
Note 3 - Balance Sheet Accounts (In Thousands)
------------------------------------
July 31, April 30,
2003 2003
---- ----
Cash and cash equivalents:
Cash.................................................. $ 1,378 $ 941
Money market funds.................................... 103,629 25,363
Commercial paper...................................... 59,891 24,134
--------- ---------
$ 164,898 $ 50,438
========= =========
Accounts receivable:
Accounts receivable................................... $ 29,169 $ 21,188
Less: Allowance for doubtful accounts................. (1,315) (915)
Sales return reserve................................ (1,488) (1,140)
--------- ---------
$ 26,366 $ 19,133
========= =========
Inventories:
Work in progress...................................... $ 10,686 $ 8,942
Finished goods........................................ 5,211 4,700
--------- ---------
$ 15,897 $ 13,642
========= =========
Prepaid expenses and other assets:
Prepaid expenses...................................... $ 2,196 $ 1,187
Other receivables..................................... 114 8
--------- ---------
$ 2,310 $ 1,195
========= =========
Property, plant and equipment, net:
Building.............................................. $ 8,432 $ --
Building improvements................................. 3,373 --
Machinery and equipment............................... 4,901 3,607
Furniture and fixtures................................ 201 283
Software.............................................. 1,087 976
Construction in progress.............................. 894 10,986
--------- ---------
18,888 15,852
Less: Accumulated depreciation and amortization....... (3,025) (3,396)
--------- ---------
$ 15,863 $ 12,456
========= =========
Note 4 - Net Income Per Share
--------------------
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted
net income per share is computed using the weighted average number of common
and potentially dilutive common shares outstanding during the period using the
treasury stock method. Potentially dilutive common shares include the effect
of stock options. For the three months ended July 31, 2002, 21,300 shares of
common stock subject to outstanding options were not included in the
calculation of diluted net income per share as they were considered
antidilutive (i.e., the per share exercise price for such options exceeded the
trading price of the Company's common stock as reported on The Nasdaq Stock
Market.)
9
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
The following table sets forth the computation of basic and diluted income
per share attributable to common stockholders for the periods indicated (in
thousands, except per share data):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Numerator:
Net income............................................ $ 6,214 $ 1,622
========= =========
Denominator:
Weighted average shares............................... 23,887 22,422
Weighted average unvested common stock subject to
repurchase.......................................... (39) (157)
--------- ---------
Denominator for basic net income per share............ 23,848 22,265
Effect of dilutive securities:
Common stock options.................................. 2,932 1,715
Unvested common stock subject to repurchase........... 39 157
--------- ---------
Denominator for dilutive net income per share....... 26,819 24,137
========= =========
Basic net income per share.............................. $ 0.26 $ 0.07
========= =========
Diluted net income per share............................ $ 0.23 $ 0.07
========= =========
In July 2003, the Company sold 3,093,226 shares of common stock in a
follow-on public offering at a price of $38.75 per share for net proceeds of
approximately $113.9 million. The incremental shares are reflected in the
weighted average shares outstanding as of and for the three-month period ended
July 31, 2003.
Note 5 - Segment, Product Line 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.
Revenues from the Company's two product lines, digital and analog image
sensors, were as follows (in thousands):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Digital image sensors................................... $ 38,547 $ 8,494
Analog image sensors.................................... 7,945 8,296
--------- ---------
Total................................................. $ 46,492 $ 16,790
========= =========
10
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
The Company sells its products primarily to customers in the Asia Pacific
region and in the United States of America. Revenues by geographic locations
are not necessarily representative of the geographic distribution of sales into
end-user markets as the Company's customers sell their products globally. The
revenues by geographic locations in the following table are based on the
country or region in which the customer is located (in thousands):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Hong Kong............................................... $ 18,678 $ 7,647
Taiwan.................................................. 15,604 4,142
China................................................... 5,895 427
United States........................................... 624 2,778
All other............................................... 5,691 1,796
--------- ---------
$ 46,492 $ 16,790
========= =========
In December 2000, the Company formed a subsidiary to conduct testing
operations and other processes associated with the manufacturing of its
products in China. The registered capital of this subsidiary was initially
$12.0 million, of which $3.8 million was funded by the Company in the fiscal
year ended April 30, 2001, as required by Chinese law. The Company funded an
additional $3.7 million during fiscal 2002. In August 2002, the Company
increased the registered capital to $30.0 million and funded an additional $4.0
million during fiscal 2003. A total of $11.5 million of the $30.0 million of
registered capital of the subsidiaries had been funded as of July 31, 2003,
from the Company's available working capital. The remaining $18.5 million of
registered capital must be funded as follows; $3.2 million by January 2004, and
$15.3 million by January 2005. The $11.5 million invested through July 31,
2003, was used primarily to pay for the construction of a building and
associated leasehold improvements.
The Company's long-lived assets are located in the following countries (in
thousands):
July 31, April 30,
2003 2003
---- ----
China.................................................... $ 12,181 $ 8,968
United States............................................ 3,775 3,588
Taiwan................................................... 4,907 2,845
All other................................................ 241 278
--------- ---------
$ 21,104 $ 15,679
========= =========
Note 6 - Employee Stock Options and Stock Purchase Plans
-----------------------------------------------
Employee Stock Option Grants
----------------------------
Options to purchase 1,421,425 shares of common stock were granted to
employees during the three months ended July 31, 2003. As of July 31, 2003,
options to purchase 4,860,088 shares of common stock were outstanding.
2000 Employee Stock Purchase Plan
---------------------------------
As of July 31, 2003, 675,980 shares had been purchased under the 2000
Employee Stock Purchase Plan (the "2000 Purchase Plan").
11
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
Fair Value Disclosures
----------------------
Information regarding net income and net income per share, as adjusted, is
required by SFAS 123, which also requires that the information be determined as
if the Company had accounted for its employee stock options granted under the
fair value method. The fair value for these options was estimated using the
Black-Scholes option pricing model. The per share weighted average estimated
fair value for employee options granted was $25.25 and $9.36 during the three
months ended July 31, 2003 and 2002, respectively. The Black-Scholes model was
developed for use in estimating the fair value of traded options that have no
restrictions and are fully transferable and negotiable in a free trading
market. Black-Scholes does not consider the employment, transfer or vesting
restrictions that are inherent in the Company's employee options. Use of an
option valuation model, as required by SFAS 123, includes highly subjective
assumptions based on long-term predictions, including the expected stock price
volatility and average life of each option grant. Because the Company's
employee options have characteristics significantly different from those of
freely traded options, and because changes in the subjective input assumptions
can materially affect the Company's estimate of the fair value of those
options, in the Company's opinion, the existing valuation models, including
Black-Scholes, are not reliable single measures and may misstate the fair value
of the Company's employee options.
The following weighted average assumptions are included in the estimated
fair value calculations for stock option grants in the three months ended July
31, 2003 and 2002:
Employee Stock Option
---------------------
July 31,
---------------------
2003 2002
---- ----
Risk-free interest rate................................. 1.73% 2.10%
Expected term of options (in years)..................... 3.5 3.5
Expected volatility..................................... 130.4% 134.6%
Expected dividend yield................................. 0% 0%
Using Black-Scholes, the per share weighted average estimated fair value
of rights issued pursuant to the Company's 2000 Purchase Plan during the three
months ended July 31, 2003 and 2002 was $8.96 and $6.58, respectively.
The following weighted average assumptions are included in the estimated
grant date fair value calculations for rights to purchase stock under the 2000
Purchase Plan:
Employee Stock Purchase
-----------------------
July 31,
---------------------
2003 2002
---- ----
Risk-free interest rate.................................. 1.16% 1.80%
Expected term of options (in years)...................... 0.5 0.5
Expected volatility...................................... 130.4% 134.6%
Expected dividend yield.................................. 0% 0%
Note 7 - Commitments and Contingencies
-----------------------------
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.
12
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2003 and 2002
(unaudited)
On November 29, 2001, a complaint captioned McKee v. OmniVision
Technologies, Inc., et. al., Civil Action No. 01 CV 10775, was filed in the
United States District Court for the Southern District of New York against
OmniVision, some of the Company's directors and officers, and various
underwriters for the Company's initial public offering. Plaintiffs generally
allege that the named defendants violated federal securities laws because the
prospectus related to the Company's offering failed to disclose, and contained
false and misleading statements regarding, certain commissions purported to
have been received by the underwriters, and other purported underwriter
practices in connection with their allocation of shares in the Company's
offering. The complaint seeks unspecified damages on behalf of a purported
class of purchasers of the Company's common stock between July 14, 2000 and
December 6, 2000. Substantially similar actions have been filed concerning the
initial public offerings for more than 300 different issuers, and the cases
have been coordinated as In re Initial Public Offering Securities Litigation,
21 MC 92. The Company's directors and officers have been dismissed without
prejudice pursuant to a stipulation. On February 19, 2003, the Court granted in
part and denied in part a motion to dismiss brought by defendants including
OmniVision. The order dismisses all claims against the Company except for a
claim brought under Section 11 of the Securities Act of 1933. A proposal has
been made for the settlement and release of claims against the issuer
defendants, including OmniVision. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the Court.
If the settlement does not occur, and litigation against the Company continues,
the Company believes that it has meritorious defenses and intends to defend the
case vigorously.
On August 21, 2002 the Company initiated a patent infringement action in
Taiwan, R.O.C. against IC Media Corporation of San Jose, CA for infringement of
Taiwan patent NI-139439 owned by OmniVision. The action was brought in the
Civil Tribunal of the Shih Lin District Court and assigned Civil Action Number
91 Su-Zi 1074. The patent infringement action seeks damages and injunctive
relief against IC Media Corporation. In response to the Company's patent
infringement action, on October 2, 2002, IC Media Corporation initiated a
cancellation proceeding (Cancellation No. 089123560N01) in the Taiwan
Intellectual Property Office with respect to the Company's Taiwan patent NI-
139439. On July 23, 2003, the Taiwan Intellectual Property Office made an
initial determination to grant the cancellation of Taiwan patent NI-139439. On
August 22, 2003, OmniVision appealed the decision of the Taiwan Intellectual
Property Office to the Taiwan Ministry of Economic Affairs.
On June 30, 2003, Mr. Chia-Chin Ku filed a complaint in Santa Clara County
Superior Court against the Company and its president and chief executive
officer, Mr. Shaw Hong. The complaint alleges that, by forming OmniVision in
1995, Mr. Hong breached a fiduciary duty owed to HK Technology, Inc., a
privately-held corporation Mr. Hong and others founded in 1988. The complaint
further alleges that the Company "misappropriated and converted" assets and
technology belonging to HK Technology, Inc. The complaint seeks damages in an
unspecified amount. The Company believes that it has meritorious defenses to
the allegations and claims and intends to defend itself vigorously. The Company
understands that HK Technology, Inc. has not engaged in significant substantive
operations since the early 1990s. The Company also understands that HK
Technology Inc.'s primary line of business was the design of chipsets for
personal computers, and that it did not engage in any business concerning image
sensors, which is OmniVision's primary line of business. The Company does not
believe that OmniVision's technology or products incorporate or use any
proprietary technology of HK Technology, Inc.
On July 14, 2003, Sunex, Inc. filed a complaint against OmniVision in San
Diego County Superior Court. Sunex was a supplier of optical lenses and lens
holders for one of the Company's cell phone products. Under its complaint,
Sunex is seeking to recover approximately $1.8 million plus interest and
attorney's fees. Sunex's complaint relates to parts delivered by Sunex to
OmniVision in the quarter ended April 30, 2003 and the Company's cancellation
in that quarter of additional purchase orders it had previously placed with
Sunex. The Company intends to defend itself vigorously and has filed a
counterclaim against Sunex in which the Company alleges breach of contract and
breach of warranties, and seeks damages in an amount yet to be determined. The
Company believes that any amount it may ultimately owe Sunex in excess of the
amount it had accrued as of April 30, 2003 will not have a material adverse
affect on its financial condition or results of operation.
13
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 completion of the consolidation of our testing operations in
China, the expansion of the scope of our operations at our Chinese facility and
the expansion of our testing capabilities in the seventh paragraph under
"Overview;" the statements relating to maintaining our position as a leader in
CMOS sensor technology in the eighth paragraph under "Overview;" the statements
relating to the future revenues from sales of CameraChips for digital
applications in the third paragraph under "Revenues;" the statements relating
to our gross margin during the remainder of fiscal 2004 in the first paragraph
under "Gross Profit;" the statements relating to research and development
expenses during the remainder of fiscal 2004 in the second paragraph under
"Research and Development;" the statements relating to future selling, general
and administrative expenses in the second paragraph under "Selling, General and
Administrative;" the statements relating to the expected effective tax rate for
fiscal 2004 under "Provision for Income Taxes;" the statements relating to the
expected effect of our contractual obligations and commercial commitments on
our liquidity and cash flows in future periods in the first paragraph under
"Contractual Obligations and Commercial Commitments;" the statements relating
to the consolidation of our testing operations in China, the expansion of the
scope of our operations at our Chinese facility, the expansion of our testing
capabilities, the funding of the capital commitment to our Chinese subsidiary,
third party financing, the issuance of equity securities and the issuance of
debt securities in the second paragraph under "Contractual Obligations and
Commercial Commitments;" the statements relating to cash resources available to
meet capital requirements in the third paragraph under "Contractual Obligations
and Commercial Commitments;" the statements relating to the effect of and
exposure to foreign currency exchange rate risk under "Foreign Currency
Exchange Risk;" the statements relating to the effect of and exposure to market
interest rate risk under "Quantitative and Qualitative Discussion of Market
Interest Rate Risk;" the statements relating to our expectation of the ability
of our disclosure controls and procedures to prevent errors in the first
paragraph under "Controls and Procedures;" and the statements relating to the
affect that the implementation of a new enterprise resource planning system
will have on our internal controls in the fourth paragraph under "Controls and
Procedures;" 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." All subsequent written and oral forward-
looking statements by or attributable to us or persons acting on our behalf are
expressly qualified in their entirety by such factors.
Overview
- --------
We design, develop and market high performance, highly integrated and cost
efficient semiconductor image sensor devices. Our main product, an image
sensing device called the CameraChip(tm), is used to capture an image in a
number of consumer and commercial mass market applications. Our CameraChips are
designed to use the complementary metal oxide semiconductor, or CMOS,
fabrication process. We have designed our CameraChip as a single chip solution
that integrates several distinct functions including image capture, image
processing, color processing and the conversion and output of a fully processed
image or video stream. Our highly integrated CMOS CameraChips help enable mass
market camera device manufacturers to build camera applications that generally
have high image quality and resolution, are low cost, small in size, and
consume low amounts of power.
Our CameraChips are currently used in a number of consumer applications
including digital still and video cameras, cell phones, personal computers and
toys and games such as interactive video games.
Our CameraChips are sold to customers who incorporate them in either
digital or analog mass market applications. Some examples of digital mass
market applications that currently incorporate our CameraChips are digital
still cameras, cell phone cameras and personal computer camera applications.
Some examples of analog applications that currently incorporate our CameraChips
are security and surveillance cameras and toy cameras.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We sell our products worldwide by a direct sales force to original
equipment manufacturers, or OEMs, which include branded customers and contract
manufacturers, and value added resellers, or VARs, and indirectly through
distributors.
We currently outsource the wafer fabrication, color filter application and
packaging of our CameraChip products. This approach allows us to focus our
resources on the design, development and marketing of our products and
significantly reduces our capital requirements.
We have designed and developed a complete PC-based system for the testing
of our CameraChips. This system has automatic handling capability, an image
source, a lighting and lens system and automatic output sorting capability. We
believe that this proprietary testing process helps us to reduce our testing
costs, maintain consistent product quality, and identify areas for continued
improvement in product quality.
We have initiated the process of consolidating our global testing
operations at our Chinese subsidiary. As part of this consolidation, we have
begun to relocate our automated image testing equipment from the United States
to China. We anticipate that we will substantially complete this transition
prior to the end of fiscal 2004. In addition, over approximately the next 18
months, we anticipate expanding the scope of our operations at our Chinese
facility to include other processes associated with the manufacture of our
products, such as color filter applications and sensor packaging. We also
expect to expand our testing capabilities with additional automated testing
equipment, which also will be located in China.
We intend to maintain our position as a leader in CMOS sensor technology
by continuing to develop our core technology through our in-house research and
development efforts.
In July 2003, we sold 3,093,226 shares of common stock at a price of
$38.75 per share for net proceeds of approximately $113.9 million.
As of July 31, 2003, we had $164.9 million in cash and cash equivalents
and $16.0 million in short-term investments. To mitigate credit risk related to
short-term investments, we have an investment policy to preserve the value of
capital and generate interest income from these investments without undue
exposure to market fluctuations. Market risk is the potential loss due to the
change in value of a financial instrument due to changes in interest rates or
bond prices. Our policy is to invest in financial instruments with short
durations, limiting interest rate exposure, and to measure performance against
comparable benchmarks. We maintain our portfolio of cash equivalents and short-
term investments in a variety of securities, including both government and
corporate obligations with ratings of A or better and money market funds.
Critical Accounting Policies
----------------------------
For a discussion of the critical accounting policies, please see the
discussion in our Annual Report on Form 10-K for the fiscal year ended April
30, 2003.
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.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Revenues................................................ 100.0% 100.0%
Cost of revenues........................................ 62.7 61.2
------- -------
Gross profit.......................................... 37.3 38.8
------- -------
Operating expenses:
Research and development.............................. 7.7 15.6
Selling, general and administrative................... 9.6 12.4
Stock compensation charge............................. 0.2 0.7
------- -------
Total operating expenses............................ 17.5 28.7
------- -------
Income from operations.................................. 19.8 10.1
Interest income, net.................................... 0.5 1.3
------- -------
Income before income taxes.............................. 20.3 11.4
Provision for income taxes.............................. 6.9 1.7
------- -------
Net income.............................................. 13.4% 9.7%
======= =======
Three Months Ended July 31, 2003 as Compared to Three Months Ended July 31,
- --------------------------------------------------------------------------
2002
- ----
Revenues
- --------
We derive revenues from the sale of our CameraChip products for use in a
wide variety of consumer and commercial mass market applications including
digital still cameras, cell phones, video game consoles and security and
surveillance cameras. Revenues for the three months ended July 31, 2003 and
2002 were approximately $46.5 million and $16.8 million, respectively.
Revenues from Sales of CameraChips for Digital as Compared to Analog
- --------------------------------------------------------------------
Applications.
- ------------
Our CameraChips are sold to customers who incorporate them into either
digital or analog applications. Examples of digital applications that
incorporate our CameraChips are digital still cameras, cellular phone cameras,
personal computer camera applications and digital toy cameras. Examples of
analog applications that incorporate our CameraChips are security and
surveillance cameras and toy cameras. We sell a large portion of our products
through VARs and distributors and often we do not know the identity of the
manufacturer who is embedding our CameraChips into their products. As a result
of our sales to VARs and distributors and because our CameraChips can be used
in a wide variety of digital or analog products, we cannot accurately confirm
the distribution of our revenues across specific product categories. However,
we are able to confirm the distribution of our revenues by digital and analog
product categories and they are as follows (in thousands):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Digital image sensors................................... $ 38,547 $ 8,494
Analog image sensors.................................... 7,945 8,296
--------- ---------
Total................................................. $ 46,492 $ 16,790
========= =========
Digital Revenues. Revenues from sales of CameraChips for digital
----------------
applications increased 353.8% to approximately $38.5 million for the three
months ended July 31, 2003 from $8.5 million for the three months ended July
31, 2002 and represented 82.9% and 50.6% of our revenues in the three months
ended July 31, 2003 and 2002, respectively. This increase in revenue from sales
of CameraChips for digital image sensor applications was due to increased unit
sales. We believe this increase resulted from heightened demand for CameraChips
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
designed for digital still cameras, toys and games, partially offset by a
slight decrease in the revenues from the cell phone market as a result of the
transition from attachment cameras to embedded cameras. We expect our revenue
from sales of our CameraChips for digital applications will increase in the
second quarter fiscal 2004 primarily as a result of increased sales of CMOS
image sensors in the digital still camera markets, cell phones with embedded
cameras and video games incorporating camera devices.
Analog Revenues. Revenues from sales of CameraChips for analog
---------------
applications decreased 4.2% to approximately $7.9 million for the three months
ended July 31, 2003 from $8.3 million for the three months ended July 31, 2002
and represented 17.1% and 49.4% of our revenues in the three months ended July
31, 2003 and 2002, respectively. We believe this decrease in sales of
CameraChips for analog image sensor applications was due primarily to decreased
demand for our CameraChips for use in security surveillance cameras.
Revenues from Sales to OEMs and VARs as Compared to Distributors
----------------------------------------------------------------
We sell our CameraChips either directly to OEMs and VARs or through
distributors. The following table illustrates the percentage of revenues from
sales to OEMs and VARs as compared to distributors in each of the three months
ended July 31, 2003 and 2002:
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
OEMs and VARs........................................... 60.5% 59.7%
Distributors............................................ 39.5 40.3
------- -------
Total................................................. 100.0% 100.0%
======= =======
OEMs and VARs. In the three months ended July 31, 2003 and 2002, no
-------------
single OEM or VAR customer accounted for more than 10% of our revenues.
Revenues from Distributors. In the three months ended July 31, 2003,
--------------------------
our only distributor customer that accounted for more than 10% of our revenues
was World Peace Industrial Co. Ltd., or World Peace, headquartered in Taiwan,
which accounted for approximately 29% of revenues. This revenue figure for
sales to World Peace includes purchases by World Peace's subsidiary, GainTune
based in Hong Kong. For the three months ended July 31, 2003, no other
distributor customer accounted for 10% or more of our revenues. Our largest
distributor during the three months ended July 31, 2002 was World Peace, which
accounted for 24.4% of revenues including sales to World Peace's subsidiary,
GainTune. For the three months ended July 31, 2002, no other distributor
customer accounted for 10% or more of our revenues.
Revenues from Domestic Sales as Compared to Foreign Sales
---------------------------------------------------------
The following table illustrates the percentage of revenues from sales of
our CameraChip products to domestic customers as compared to foreign customers
for the three months ended July 31, 2003 and 2002:
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Domestic sales.......................................... 1.3% 16.6%
Foreign sales........................................... 98.7 83.4
------- -------
Total................................................. 100.0% 100.0%
======= =======
The majority of our foreign sales are attributable to sales made to
customers in Asia and, to a lesser extent, in Europe. Over time, our sales
to Asia-Pacific customers have increased primarily as a result of the
continuing trend of outsourcing production to Asian manufacturers and
facilities. Because of the preponderance of Asia-Pacific manufacturers and the
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
fact that virtually all products incorporating our CameraChips are sold
globally, we believe that such figures do not accurately reflect geographic
distribution of sales of our products into end-user markets.
Gross Profit
- ------------
Gross margins for the three months ended July 31, 2003 and 2002 were 37.3%
and 38.8% of revenues, respectively. The decrease in gross margin for the three
months ended July 31, 2003, as compared to the similar period in the prior
year, was primarily due to a reduction in sales of previously written-off
inventory, as well as to a shift in product mix in the cell phone market from
sensor arrays sold in chip form to module-based products, which typically carry
lower gross margins. The module-based product is sold with respect to cell
phone applications. For the three months ended July 31, 2003, approximately
$0.3 million of the margin was attributable to gross profit from the sale of
previously written-off inventory. Excluding the revenues and gross profit from
the sale of the written-off inventory, the gross margin for the three months
ended July 31, 2003 would have been approximately 36.9% of revenues as compared
to 35.8% of revenues during the similar period in the prior year. Excluding the
impact of any sales of previously written-off inventory, we expect our gross
margin during the remainder of fiscal 2004 to remain relatively stable as
compared to the similar period in fiscal 2003.
The following table summarizes the effect of sales of previously written-
off inventory on our gross profits for the three months ended July 31, 2003 and
2002 (in thousands):
Three Months Ended
July 31,
---------------------
2003 2002
---- ----
Sales of all products................................... $ 46,492 $ 16,790
Gross profit............................................ $ 17,364 $ 6,516
Gross margin............................................ 37.3% 38.8%
Sales excluding products for which the costs were
previously written off................................ $ 46,149 $ 15,995
Gross profit excluding the effect of sales of products
for which the costs were previously written off....... $ 17,021 $ 5,721
Gross margin excluding the effect of sales of products
for which the costs were previously written off....... 36.9% 35.8%
Research and 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. Research and
development expenses for the three months ended July 31, 2003 and 2002 were
approximately $3.6 million and $2.6 million, respectively. As a percentage of
revenues, research and development expenses for the three months ended July 31,
2003 and 2002 represented 7.7% and 15.6%, respectively.
The increase on an absolute dollar basis in research and development of
approximately $1.0 million for the three months ended July 31, 2003 from the
similar period in the prior year resulted primarily from a $0.4 million
increase in salary and payroll-related expenses associated with additional
personnel and $0.3 million in expenses related to new product development
required to improve our current product line and support new product
introductions. Examples of new product development expenses include tape-out
and prototype runs with our wafer manufacturers. Research and development
expenses also increased for the three month period ended July 31, 2003 due to a
$0.1 million increase in patent prosecution related expenses. The decline in
research and development as a percentage of revenues was due to the
proportionately greater increase in revenues for the three months ended July
31, 2003 from levels in the prior year. We expect research and development
expenses to increase in absolute dollars in the remainder of fiscal 2004 as we
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
develop our next generation of CameraChip products and as we continue to grow
our business, including our research and development team.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses consist primarily of
compensation and personnel related expenses, commissions paid to distributors
and manufacturers' representatives, and insurance and legal expenses. Selling,
general and administrative expenses include the expenses associated with the
startup of our Chinese subsidiary. Selling, general and administrative expenses
for the three months ended July 31, 2003 and 2002 were approximately $4.5
million and $2.1 million, respectively. As a percentage of revenues, selling,
general and administrative expenses for the three months ended July 31, 2003
and 2002 represented 9.6% and 12.4%, respectively.
The increase on an absolute dollar basis in selling, general and
administrative expenses of approximately $2.4 million for the three months
ended July 31, 2003 from the similar period in the prior year resulted
primarily from a $0.8 million increase in commissions associated with
increased revenues, a $0.7 million increase in employment expenses, a $0.5
million increase in legal and accounting expenses and a $0.4 million increase
in provisions for bad debts related to the increase in accounts receivable.
Selling, general and administrative expenses decreased as a percentage of
revenues the three months ended July 31, 2003 as compared to the similar period
in the prior year as a result of the proportionately greater increase in
revenues. We expect that our future selling, general and administrative
expenses will increase in absolute dollars as we continue to grow our business.
In particular, we expect our selling, general and administrative expenses will
increase in absolute dollars in the remainder of fiscal 2004, partly as a
result of increased litigation expenses and as a result of personnel additions
to support our expanding organization.
Interest Income, Net
- --------------------
Our cash, cash equivalents and short-term and long-term investments are
invested in interest-bearing accounts consisting primarily of money market
accounts and high-grade corporate securities and government bonds maturing
approximately twelve months or less from the date of purchase. Interest income,
net, remained stable for both the three months ended July 31, 2003 and 2002 at
approximately $0.2 million.
Provision for Income Taxes
- --------------------------
We generated approximately $9.4 million and $1.9 million in income before
income taxes for the three months ended July 31, 2003 and 2002, respectively.
We recorded a provision for income taxes for the three months ended July 31,
2003 and 2002 of approximately $3.2 million and $0.3 million, respectively. We
expect the effective tax rate for fiscal 2004 will increase as compared to
fiscal 2003 but will be less than the combined federal and state statutory
rate. The increase in rate is due to the anticipated mix of income between
domestic and foreign entities for the fiscal year. Achieving an effective tax
rate in fiscal 2004 that is less than the combined federal and state statutory
rates is principally contingent upon our foreign affiliates generating income.
Liquidity and Capital Resources
- -------------------------------
Principal sources of liquidity at July 31, 2003 consisted of cash, cash
equivalents and short-term investments of $180.9 million.
Our working capital increased by approximately $116.3 million to $197.2
million as of July 31, 2003 from $80.9 million as of April 30, 2003. The
increase was primarily attributable to a $114.5 million increase in cash and
cash equivalents principally resulting from our follow-on public offering of
common stock in July 2003, a $7.2 million increase in accounts receivable, net,
consistent with the increase in revenues from prior year levels during the
three months ended July 31, 2003, a $5.8 million increase in short-term
investments, a $2.3 million increase in inventories to support future sales and
a $1.1 million increase in prepaid expenses and other assets, partially offset
by a $9.2 million increase in accounts payable, and a $4.7 million increase in
accrued liabilities to support increased levels of operations. The $7.2 million
increase in accounts receivable, net, reflects the higher level of sales during
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
the three months ended July 31, 2003 and an increase in days sales outstanding
to 52 days as of July 31, 2003 from 43 days as of April 30, 2003. The $2.3
million increase in inventories is attributable to higher inventory levels to
support future sales. Inventory turns, calculated based on the fiscal quarters
ended July 31, 2003 and April 30, 2003, remained relatively stable at 7.3 as of
July 31, 2003 as compared to 7.2 as of April 30, 2003.
For the three months ended July 31, 2003, net cash provided by operating
activities totaled approximately $10.4 million as compared to our use of cash
for operating activities of $0.9 million for the similar period in the prior
year, primarily due to net income of approximately $6.2 million for the three
months ended July 31, 2003 as compared to $1.6 million for the similar period
in the prior year, a $9.2 million increase in accounts payable, a $4.7 million
increase in accrued expenses and other liabilities, and a $1.2 million decrease
in refundable and deferred income taxes, which were partially offset by a $7.2
million increase in accounts receivable, net, a $2.3 million increase in
inventories to support future sales and a $1.1 million increase in prepaid
expenses and other assets.
For the three months ended July 31, 2003, our cash used in investing
activities increased to approximately $11.4 million from cash provided by
investing activities of $0.5 million for the similar prior year period, due to
$7.8 million in purchases of short-term and long-term investments and $3.7
million in purchases of property, plant and equipment. Net cash provided by
investing activities of $0.5 million for the three months ended July 31, 2002,
resulted from $2.0 million in proceeds from the sale of short-term investments,
partially offset by $1.5 million in purchases of property, plant and equipment.
For the three months ended July 31, 2003, net cash provided by financing
activities increased to approximately $115.5 million from $0.8 million for the
similar prior year period. The increase was primarily due to approximately
$113.9 million in net proceeds resulting from our follow-on public offering of
common stock in July 2003 and $1.6 million in proceeds from the issuance and
sale of common stock pursuant to the exercise of stock options and from
employee purchases through the employee stock purchase plan during the three
months ended July 31, 2003 as compared to $0.8 million for the similar period
in the prior year.
In June 2003, we purchased approximately 27% of the equity of a privately
held company based in Taiwan for a total of $2.0 million in cash. The Taiwan
company provides plastic packaging services and we will be a major customer. We
will account for this investment using the equity method.
Contractual Obligations and Commercial Commitments
- --------------------------------------------------
The following summarizes our contractual obligations and commercial
commitments as of July 31, 2003 and the effect such obligations and commitments
are expected to have on our liquidity and cash flows in future periods (in
thousands):
Less than 1 - 3 4 - 5 After
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
Contractual Obligations
Operating leases............... $ 4,686 $ 1,051 $ 2,342 $ 839 $ 454
Noncancelable orders........... 46,873 46,873 -- -- --
------- ------- ------- ------- -------
Total contractual obligations 51,559 47,924 2,342 839 454
Other Commercial Commitments
Investment in China............ 18,500 3,200 15,300 -- --
------- ------- ------- ------- -------
Total contractual obligations
and commercial commitments... $70,059 $51,124 $17,642 $ 839 $ 454
======= ======= ======= ======= =======
The $18.5 million commercial commitment referenced in the table above
relates to the remaining $18.5 million of registered capital for our Chinese
subsidiary. We established this subsidiary as part of our efforts to reduce the
costs associated with the testing of our CameraChips. We have initiated the
process of consolidating our global testing operations at our Chinese
subsidiary. As part of this consolidation, we have begun to relocate our
automated image testing equipment from the United States to China. We
anticipate that we will substantially complete this transition prior to the end
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
of fiscal 2004. In addition, over approximately the next 18 months, we
anticipate expanding the scope of our operations at our Chinese facility to
include other processes associated with the manufacture of our products, such
as color filter applications and sensor packaging. We also expect to expand our
testing capabilities with additional automated testing equipment, which also
will be located in China. We expect to fund the capital commitment to our
Chinese subsidiary through a combination of funds invested from our available
working capital or by investments from third parties. Third party financing
could include debt financing from banking institutions or an equity financing
transaction. Third party financing may not be available to us when and as
required or on terms that are favorable to our stockholders and us. In the
event we are unable to obtain financing from third parties, the issuance of our
equity securities, including securities convertible into our equity securities,
would dilute the ownership interests of our existing stockholders and the
issuance of debt securities could increase the risk or perceived risk of our
business. Issuance of debt securities could also impair our financial condition
and interest payments could have an adverse effect on our results of operation.
We currently expect our available cash, cash equivalents, and short-term
investments, together with cash that we anticipate to be generated from
business operations, to be sufficient to satisfy our foreseeable working
capital requirements. Our ability to generate cash from operations is subject
to substantial risks described below under the caption "Factors Affecting
Future Results." We encourage you to review these risks carefully. If we are
unable to generate sufficient cash from our operations, it would have a
material adverse effect on our business and financial condition.
Factors Affecting Future Results
- --------------------------------
This Quarterly Report on Form 10-Q, including this Management's Discussion
and Analysis, contains forward-looking statements. These forward-looking
statements are subject to substantial risks and uncertainties that could cause
our future business, financial condition or results of operations to differ
materially from our historical results or currently anticipated results,
including those set forth below.
Risks Related to Our Business
-----------------------------
We face intense competition in our markets from more established CCD and
------------------------------------------------------------------------
CMOS image sensor manufacturers, and if we are unable to compete
----------------------------------------------------------------
successfully we may not be able to maintain or grow our business.
-------------------------------------------------------------
The image sensor market is intensely competitive and we expect competition
in this industry to continue to increase. This competition has resulted in
rapid technological change, evolving standards, reductions in product sales
prices and rapid product obsolescence. If we are unable to successfully meet
these competitive challenges, we may be unable to maintain and grow our
business. Any failure to compete successfully would also adversely affect our
results of financial operation and impair our financial condition.
Our CameraChips face competition from a number of sources, including
companies that sell CCD image sensors, as well as other companies that sell
CMOS image sensors. Many of our competitors have longer operating histories,
greater presence in key markets, greater name recognition, larger customer
bases, more established strategic and financial relationships 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 products. Our competitors
include CCD image sensor manufacturers such as Fuji, Matsushita, NEC, Sharp,
Sony, Sanyo and Toshiba, as well as established CMOS image sensor manufacturers
such as Agilent, ESS, Fujitsu, Hynix, Micron, Mitsubishi Electronic, Motorola,
National Semiconductor, Samsung, Sharp, Sony, STMicroelectronics and Toshiba.
In addition, we compete with a large number of smaller CMOS manufacturers
including Foveon, IC Media Corporation, PixArt and Zoran.
Our competitors may acquire or enter into strategic or commercial
agreements or arrangements with foundries or providers of color filter
processing, assembly or packaging services. These strategic arrangements
between our competitors and third party service providers could involve
preferential or exclusivity arrangements for our competitors. As a result,
these strategic alliances could impair our ability to secure sufficient
capacity from foundries and service providers to meet our demand for wafer
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
manufacturing, color filter processing, assembly or packaging services,
adversely affecting our ability to meet customer demand for our products. In
addition, competitors may enter into exclusive relationships with distributors,
which could reduce available distribution channels for our products and impair
our ability to sell our products and grow our business.
In addition, some of our customers may also be developers of image
sensors, and this could potentially adversely affect our results of operations,
business and prospects. Samsung, for example, is a current customer that uses
our CMOS products in certain of its products, but also independently
manufactures CMOS image sensors. A customer such as Samsung that develops its
own image sensors may reduce or cease purchases from us, and this could
materially and adversely affect our ability to sustain and grow our business
and could impair our financial results. Samsung is also a third party service
provider that has fabricated, and may in the future fabricate, our interface
chips or other products. If Sansung were to decide not to fabricate our
interface chips for competitive or other reasons, that could impair our ability
to meet customer demand for our products.
Problems with wafer manufacturing yields could result in higher operating
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costs, and could impair our ability to meet customer demand for our
-------------------------------------------------------------------
products.
--------
If the foundries manufacturing the wafers used in our products cannot
achieve expected yields, we may incur higher per unit costs and reduced product
availability. Any reduction in our ability to timely deliver products to
customers could adversely affect our customer relations and make it more
difficult to sustain and grow our business. Foundries that supply our wafers
have experienced problems in the past achieving acceptable wafer manufacturing
yields. Wafer 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. We
perform a final test of our products after they are assembled, as their optical
nature makes earlier testing difficult and expensive. As a result, yield
problems may not be identified until our products are well into the production
process. The risks associated with low yields are exacerbated 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.
We depend on the increased acceptance of CMOS technology for mass market
------------------------------------------------------------------------
image sensor applications, and any delay in the acceptance of this
------------------------------------------------------------------
technology could adversely affect our ability to grow our business and
----------------------------------------------------------------------
increase our revenues.
---------------------
Our business strategy depends in large part on the continued growth of
various markets into which we sell our CameraChips, including the markets for
digital still and video cameras, cell phones, personal computers, toys and
games, including interactive video games, and commercial and home security and
surveillance applications. Our ability to sustain and grow our business also
depends on the emergence of new markets for our products such as cameras for
automotive applications, personal identification systems and medical imaging
devices. If these current and new markets do not grow and develop as
anticipated, we may be unable to sustain or grow the sales of our products.
Although CMOS technology has been available for over 20 years, CMOS
technology has been used in image sensors only relatively recently. Along with
the other risk factors described in this section, the following are examples of
factors that may delay the increasing adoption of the CMOS fabrication process
and our single chip technology for mass market image sensor applications:
o the failure of the emergence of a universal platform for imaging solutions
for computers and the Internet;
o improvements in or price reductions for CCD image sensors, which could
slow the adoption of CMOS image sensors in markets already dominated by
CCD image sensors or prevent or delay the adoption of CMOS image sensors
in emerging markets; and
o the failure to develop easy to use and affordable products using CMOS
image sensors.
In addition, the market price of our common stock may be adversely
affected if certain of these new markets do not emerge or develop as expected
such as the market for image sensor products in automobiles and personal
identification systems. Securities analysts may have already factored revenue
from such new markets into their future estimates of our financial performance
and any failure for such markets to develop as expected by such security
analysts, may adversely affect the trading price of our common stock.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The occurrence of any of these factors could adversely affect our ability
to sustain and grow our business and increase our revenues and earnings.
If we do not forecast customer demand correctly, our business could be
----------------------------------------------------------------------
impaired as a result of excess inventory or the loss of existing or
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potential customers.
-------------------
Our sales are generally made on the basis of purchase orders rather than
long-term purchase commitments and we manufacture products and build inventory
based on our estimates of customer demand. Accordingly, we must rely on
multiple assumptions concerning forecasted customer demand. In addition, our
customers may cancel or defer orders at any time. If we overestimate customer
demand, we may manufacture products that we may be unable to sell, or we may
have to sell our products to other customers at lower prices. This could
materially and adversely affect our results of operation and financial
condition. We have experienced problems with accurately forecasting customer
demand in the past. For example, beginning in the third quarter of fiscal 2001,
the demand for our CameraChips for use in PC cameras decreased significantly
and one of our significant OEM customers unexpectedly cancelled its purchase
orders. If we underestimate customer demand, we may be unable to manufacture
sufficient product quickly enough to meet actual demand, causing us to lose
customers and impairing our ability to grow our business. In recent periods,
due to customer demand we have had relatively low levels of inventory and we
have turned over our inventory several times per year. Low levels of inventory
could materially impair our ability to meet customer demand for our CameraChip
products. We are trying to increase our levels of inventory, but this subjects
us to concerns regarding our ability to sell all of the products we
manufacture.
Sales of our CameraChips for digital still cameras have accounted for a
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significant portion of our revenues on both a quarterly and annual basis,
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and any decline in sales to the digital still market or failure for this
------------------------------------------------------------------------
market to continue to grow as we expect could adversely affect our results
--------------------------------------------------------------------------
of operation.
------------
We derive a substantial portion of our revenues from sales to the digital
still camera market. Although we can only estimate the percentages of our
products that are used in the digital still camera market due to the
significant amount of our CameraChips that are sold through distributors and
value added resellers, we believe that the digital still camera market
accounted for approximately 42% of our revenue in fiscal 2003 and 49% of our
revenue in the three months ended July 31, 2003. We expect that revenues from
sales of our CameraChips to the digital still camera market will continue to
account for a substantial portion of our revenues during fiscal 2004 and for
each of our fiscal quarters during such year. Sales of our CameraChips for the
digital still camera market are subject to seasonality fluctuations as sales
tend to be greater in our fiscal quarters ended January 31 and July 31 than in
our other fiscal quarters. Any factors adversely affecting the demand for our
CameraChips in the digital still camera market could cause our business to
suffer and adversely affect our results of operation. The digital image
sensor market for digital still cameras is extremely competitive and we expect
to face increased competition in this market in the future. If we fail to
continue to receive design wins with key digital still camera manufacturers,
our market share or revenues could decrease. In addition, digital still camera
manufacturers typically purchase digital image sensors through distributors and
we do not have contracts with any distributor that obligates them to sell our
products. Such distributors may also sell products of our competitors. We may
not be able to successfully increase or maintain the rate of sales of our
CameraChip products for digital still cameras through distributors in the
future. The image sensor market for digital still cameras is also subject to
frequent technology change. In order to compete successfully in such market,
we will have to correctly forecast customer demand for technological
improvements and be able to deliver such products on a timely basis at
competitive costs. If we fail to do this, our results of operation, business
and prospects would be materially adversely affected. In the past, we have
experienced problems accurately forecasting customer demand in other markets.
For example, beginning in the third quarter of fiscal 2001, the demand for our
CameraChips for use in PC cameras decreased significantly and one of our
significant OEM customers unexpectedly cancelled its purchase orders. If
customer demand in the digital still camera market were to fall suddenly due to
oversupply of product or for any other reason, we will be subject to excess
inventory risks.
23
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, which reduces
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our ability to control our manufacturing process.
------------------------------------------------
We do not own or operate a semiconductor fabrication facility. Instead, we
rely on Taiwan Semiconductor Manufacturing Company, or TSMC, and Powerchip
Semiconductor Company, or PSC, to produce a substantial majority of our wafers.
Samsung has fabricated and may in the future fabricate one of our interface
chips on its standard fabrication line. 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
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.
Our reliance on a limited number of foundries also increases our risk of
capacity shortages. Our requirements represent a small portion of the total
production capacities of these foundries and, without long-term agreements,
foundries may reallocate capacity to other customers, even during periods of
high demand for our products. In addition, such foundries could suffer
financial difficulties or disruptions in their operations due to causes beyond
our control. 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, we would have to identify
and qualify substitute foundries, which would be time consuming and difficult,
and could increase our costs or 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 transfer our production of
semiconductors from one foundry to another as such transfer could interrupt our
manufacturing process. Further, some of our foundries, such as Samsung, are
also developers of image sensor products. If Samsung or one of our other
foundries were to decide not to fabricate our interface chips for competitive
or other reasons, we would have to identify and qualify additional foundries.
We rely on third party service providers for color filter processing and
------------------------------------------------------------------------
packaging services, which reduces our control over delivery schedules,
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product quality and cost, and could adversely affect our ability to deliver
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products to customers.
---------------------
We rely on TSMC and Toppan for the color filter processing of our
completed wafers. In addition, we rely on Kyocera and Sun Yang Digital Image,
or SYDI, for substantially all of our ceramic chip packages, which are
generally used in our higher-priced products, another service provider for our
plastic chip packages, which are generally used in our lower-priced products,
and yet another service provider for chip scale packages, which are generally
used in our products designed for the smallest form factor applications. We do
not have long-term agreements with any of these service providers and typically
obtain services on a purchase order basis. If for any reason one or more of
these service providers becomes unable or unwilling to continue to provide
color filter processing or packaging services of acceptable quality, at
acceptable costs and in a timely manner, our ability to deliver our products to
our customers could be severely impaired. We would quickly have to identify and
qualify substitute service providers, which could be time consuming and
difficult and could result in unforeseen operations problems. Substitute
service providers might not be available or, if available, might be unwilling
or unable to offer services on acceptable terms.
In addition, if competition for color filter processing or packaging
capacity increases, we may be required to pay or invest significant amounts to
secure access to these services which could adversely impact our operating
results. There are a limited number of companies that provide these services,
some of which have limited operating histories and financial resources. In the
event our current providers refuse or are unable to continue to provide these
services to us, we may be unable to procure services from alternate service
providers. Furthermore, if customer demand for our products increases, we may
be unable to secure sufficient additional capacity from our current service
providers on commercially reasonable terms, if at all. Moreover, our reliance
on a limited number of third party service providers to provide color filter
processing services subjects us to reduced control over delivery schedules,
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
quality assurance and costs. This lack of control may cause us to incur
unforeseen product shortages or may increase our costs of manufacturing,
assembling or testing our products, which would adversely affect our operating
results.
Historically, our revenues have been dependent upon a few key customers, the
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loss of one or more of which could significantly reduce our revenues.
--------------------------------------------------------------------
Historically, a relatively small number of original equipment
manufacturers, or OEMs, value added resellers, or VARs, and distributors have
accounted for a significant portion of our revenues. Any material delay,
cancellation or reduction of purchase orders from one of our major customers or
distributors could result in our failure to achieve anticipated revenue for the
period. If we are unable to retain one or more of our largest OEM, distributor
or VAR customers, or if we are unable to maintain our current level of revenues
from one or more of these significant customers, our business and results of
operation would be impaired and our stock price could decrease, potentially
significantly. In fiscal 2003, our only OEM or VAR customer that accounted for
more than 10% of our revenues was Primax Electronics Products Huizhou based in
China, which accounted for approximately 14% of our revenues in such fiscal
year. In the three months ended July 31, 2003, no single OEM or VAR customer
accounted for more than 10% of our revenues. In fiscal 2003, our only
distributor customer that accounted for more than 10% of our revenues was World
Peace Industrial Co., or World Peace, headquartered in Taiwan which accounted
for approximately 21% of our revenues in such fiscal year. In the three months
ended July 31, 2003, World Peace, which accounted for approximately 29% of
revenues, was our only distributor customer that accounted for more than 10% of
revenues. This revenue figure for sales to World Peace includes purchases by
World Peace's subsidiary, GainTune based in Hong Kong. Our business, financial
condition and results of operations will continue to depend significantly on
our ability to retain our current key customers and attract new customers, as
well as on the financial condition and success of our OEMs, VARs and
distributors.
Our ability to deliver products that meet customer demand is dependent upon
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our ability to meet new and changing requirements for color filter
------------------------------------------------------------------
processing, assembly and product packaging.
------------------------------------------
We expect that as we develop new products to meet technology advances and
new and changing industry and customer demand, our color filter processing and
ceramic and plastic packaging requirements will also evolve. Our ability to
continue to profitably deliver products that meet customer demand is dependant
upon our ability to procure third party services that meet these new
requirements on a cost-effective basis. We have historically relied exclusively
on third parties to provide these services, and there can be no assurances that
these third parties will be able to develop enhancements to the services that
they provide to us that meet these new and changing industry and customer
requirements. Furthermore, even if these third party service providers are able
to develop their services to meet new and evolving requirements, these services
may not be available at a cost that enables us to sustain profitability.
The assembly and packaging of our image sensors into camera modules further
---------------------------------------------------------------------------
complicates and reduces our ability to control the manufacturing process,
------------------------------------------------------------------------
and may decrease our gross margins.
----------------------------------
Recently, some of our camera manufacturer customers have requested that we
deliver our CameraChips in the more finished form of camera modules. This
increases the complexity of the overall manufacturing process and, as a result,
may result in decreased yields. We have engaged third party contract
manufacturers to assemble and package our image sensors into camera modules,
requiring us to manage service provider relationships that have not
historically been a part of our business. If these third party contract
manufacturers are unable to provide timely, reliable and high quality assembly
and packaging services, we could experience product shortages and be unable to
fill customer orders, resulting in loss of revenues, damage to our reputation
and an adverse effect on our ability to retain existing customers and attract
new customers. In addition, several of these third party contract manufacturers
also sell camera modules directly to third parties. Due to the competition with
our camera module products, any of these third party contract manufacturers may
decide to reduce or terminate their relationship with us which could create
product shortages for us and result in a loss of revenues and damage to our
customer relationships. Moreover, we must purchase and hold in our inventory
products that are not related to our business in order to deliver our image
sensors in a more finished form, which adds complexity to the overall
manufacturing process and increases inventory risks. The gross margin
percentage we realize on modules has been lower than the gross margin
percentage we have achieved historically on our CameraChips, and we expect this
to continue. In addition, if we are unable to realize a premium in selling
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
price for camera modules compared to our CameraChips that is greater than the
cost of assembling and packaging camera modules, our profitability would also
be adversely affected.
If we are unable to successfully streamline our manufacturing process, we
-------------------------------------------------------------------------
may be unable to control our costs, resulting in reductions to our gross
------------------------------------------------------------------------
margins.
-------
Currently, wafer production, color filtering and sensor packaging of our
CameraChips is performed in Asia by third party manufacturers and service
providers. Substantially all of our CameraChips are then shipped to our
facility in the United States where they undergo additional sensor testing
before being shipped to customers. This process is time-consuming and the
multiple transits can result in damaged products. Accordingly, we have
initiated the process of consolidating our global testing operations at our
Chinese subsidiary. As part of this consolidation, we have begun to relocate
our automated image testing equipment from the United States to China. We
anticipate that we will substantially complete this transition prior to the end
of fiscal 2004. In addition, over approximately the next 18 months we expect
to consolidate additional manufacturing processes in Asia in order to reduce
our costs of revenues and to achieve other benefits such as decreased risks
from transit, reduced time to market for our CameraChips, and reduced inventory
and lead times. However, we may never be able to achieve the anticipated cost
saving benefits of this consolidation, resulting in failure to improve our
gross margins.
We may never achieve the anticipated benefits from our planned operations in
----------------------------------------------------------------------------
Shanghai, China.
---------------
In December 2000, we established a Chinese subsidiary as part of our
efforts to streamline our manufacturing process and reduce the costs associated
with the testing of our CameraChips. Prior to the end of calendar 2003, we
intend to consolidate our testing operations in Shanghai, China. In addition,
over approximately the next 18 months we anticipate expanding the scope of our
operations at our China facility to include other manufacturing processes such
as color filter applications and sensor packaging. However, there are
significant administrative, legal and governmental risks to operating in China,
and we may not achieve the expected cost savings of performing these
manufacturing processes in China. If our operations in China do not result in
offsetting gains in the form of operating cost reductions, whether because of
the risks and difficulties entailed by foreign operations or for other reasons,
our business and financial condition will be adversely affected.
Operating in China involves substantial risks that could increase our
operating expenses and adversely affect our operating results, financial
condition and ability to deliver our products and grow our business, including:
o difficulties in staffing and managing foreign operations, in particular
attracting and retaining personnel qualified to design, sell and support
CMOS image sensors;
o difficulties in coordinating our operations in China with those in
California;
o diversion of management attention;
o difficulties in maintaining uniform standards, controls, procedures and
policies across our global operations, including inventory management and
financial consolidation;
o political and economic instability, which may have an adverse impact on
foreign exchange rates in Asia, and could impair our ability to conduct
our business in China; and
o inadequacy of the local infrastructure to support our needs.
Declines in our average sales prices may result in a decline in our revenues
----------------------------------------------------------------------------
and gross margin.
----------------
We have experienced and expect to continue to experience pressure to
reduce the sales prices of our products and have experienced declines in our
average sales prices as a result. We expect that the average sales prices for
many of our products will continue to decline over time, in particular for
those products focused on the digital still camera and cell phone markets.
Declines in our average sales prices could result in reduced revenues or a
decline in our gross margin, and could materially and adversely affect our
operating results and impair our financial condition. If we are unable to
achieve cost reductions through manufacturing cost efficiencies and
technological advances, or are unable to timely introduce new products that
incorporate more advanced technology and include more advanced features that
can be sold at higher average sales prices, our financial results will be
adversely affected.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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.
-------------------------------
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. Any cancellation or delay in orders which constitute our current or
future backlog may result in lower than expected revenues.
Our planned operations in China will require substantial capital
----------------------------------------------------------------
expenditures.
------------
We must meet certain minimal capital requirements applicable to our
Chinese subsidiary. Our Chinese subsidiary has $30.0 million in registered
capital, $11.5 million of which had been funded as of July 31, 2003. Of the
remaining $18.5 million, $3.2 million must be funded by January 2004 and $15.3
million must be funded by January 2005. We expect to fund the remaining
registered capital through a combination of funds invested from our available
working capital or by investments from third parties. Third party financing
could include debt financing from banking institutions or an equity financing
transaction. Third party financing may not be available to us when and as
required or on terms that are favorable to our stockholders and us. In
addition, Chinese law may limit the sources that may be eligible to invest in
our Chinese subsidiary. In the event we are unable to obtain suitable financing
from third parties, we may need to raise additional capital which may require
us to issue our equity securities or incur debt. This additional equity
issuance would dilute the ownership interests of our existing stockholders and
the issuance of debt securities could increase the risk or perceived risk of
our business. Issuance of debt securities could also impair our financial
condition and interest payments on debt securities could have an adverse effect
on our results of operation.
We have a limited history of profitability and may be unable to maintain our
----------------------------------------------------------------------------
recent financial success.
------------------------
We have a limited history of profitability and may be unable to maintain
our recent financial success. If we fail to sustain or increase our levels of
profitability, our financial condition may be materially and adversely affected
and the trading price of our common stock may decline. Since our inception in
1995, we have achieved profitability on an annual basis only on two occasions,
in fiscal 2000 and fiscal 2003. In fiscal 2001 we incurred net losses of $11.6
million, and in fiscal 2002 we incurred net losses of $1.3 million. In fiscal
2000, the only year in which we were profitable on a fiscal year basis prior to
fiscal 2003, our net income was $3.4 million. In fiscal 2003 our net income was
$15.3 million. In the future, we expect to incur significant expenses,
including expenses related to our research and development efforts, and our
operations in China and capital commitments to our Chinese subsidiary, which
could impair our ability to sustain profitability. In addition, as we hire
additional personnel, we expect selling, general and administrative and other
expenses to increase. Other risks associated with our business described
elsewhere in this section could also affect our ability to sustain
profitability. If our revenues do not increase or if we cannot effectively
control our expenses, we may be unable to sustain profitability at levels
consistent with our financial performance in fiscal 2003, or at all.
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
provide assurance 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. It is possible that existing or future patents may be
challenged, invalidated or circumvented. For example, IC Media has initiated a
cancellation proceeding in Taiwan with respect to one of our patents. An
initial determination to grant the cancellation requested by IC Media has been
rendered, but has been appealed by us. If IC Media is ultimately successful, we
may lose or suffer diminished rights in the challenged patent. In addition, if
we are not successful in suits in which we claim that third parties infringe
our patents or other intellectual property, our competitive position may be
adversely affected.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Furthermore, 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
patent, copyright, trademark and trade secret protection may be unavailable or
limited in foreign countries. Any disputes over our intellectual property
rights may result in costly and time-consuming litigation or the license of
additional elements of our intellectual property for little or no compensation.
Litigation regarding intellectual property could divert management
------------------------------------------------------------------
attention, be costly to defend and prevent us from using or selling the
-----------------------------------------------------------------------
challenged technology.
---------------------
In recent years, there has been significant litigation in the United
States involving intellectual property rights, including rights of companies in
the semiconductor industry. We have in the past, are currently, and may in the
future be subject to legal proceedings and claims with respect to our
intellectual property, including such matters as trade secrets, patents,
product liabilities and other actions arising out of the normal course of
business. See "Legal Proceedings." These claims may increase as our
intellectual property portfolio becomes larger or more valuable. Intellectual
property claims against us, and any resulting lawsuit, may cause us to incur
significant expenses, subject us to liability for damages and invalidate our
proprietary rights. In one case we paid $3.5 million to settle a litigation
matter. These lawsuits, regardless of their success, would likely be time-
consuming and expensive to resolve and could divert management's time and
attention. Any potential intellectual property litigation against us could also
force us to take actions such as:
o ceasing the sale or use of products or services that incorporate the
infringed intellectual property;
o obtaining from the holder of the infringed intellectual property a license
to sell or use the relevant technology, which license may not be available
on acceptable terms, if at all; or
o redesigning those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses and prevent us from selling the products until the
redesign is completed, if at all.
If we are subject to a successful claim of infringement and we fail to
develop non-infringing intellectual property or license the infringed
intellectual property on acceptable terms and on a timely basis, we may be
unable to sell some or all of our products and our operating results could be
adversely affected. We may in the future initiate claims or litigation against
third parties for infringement of our intellectual property rights or to
determine the scope and validity of our proprietary rights or the proprietary
rights of competitors. These claims could also result in significant expense
and the diversion of technical and management personnel's attention.
If we do not effectively manage our growth, our ability to increase our
-----------------------------------------------------------------------
revenues and improve our earnings could be adversely affected.
-------------------------------------------------------------
Our growth has placed, and will continue to place, a significant strain on
our management and other resources. In particular, we expect that we will
continue to face challenges in managing the expansion of our operations in
China. To manage our growth effectively, we must, among other things:
o implement and improve operational, financial and accounting systems;
o train and manage our employee base; and
o attract and retain qualified personnel with relevant experience.
In addition, in recent fiscal quarters we have also seen significant
growth in the level of our inventory and accounts receivables and an increase
in our days of sales outstanding, primarily as a result of our revenue growth
in fiscal 2003. Our failure to effectively manage our inventory levels could
result in either excess inventories, which could adversely affect our gross
margins and operating results, or lead to an inability to fill customer orders,
which would result in lower sales and could harm our relationships with
existing and potential customers. As part of the increase in our sales, during
the first quarter of fiscal 2004 our accounts receivables and days sales
outstanding increased. If we do not manage effectively our accounts receivable,
our cash balance and operating results will be adversely affected.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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 may not make 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 our ability to expand sales and marketing, research and development,
accounting, finance and administrative support.
Our future tax rates could be higher than expected if the proportion of
-----------------------------------------------------------------------
future operating income generated outside the U.S. by our foreign
-----------------------------------------------------------------
subsidiaries is less than we expect.
-----------------------------------
A number of factors will affect our tax rate in the future, and the
combined effect of these factors could result in an increase in our effective
rate as compared to our effective tax rate in fiscal 2003. This will adversely
affect our operating results. A key factor that will cause the rate to increase
is that the financial statement benefit of reversing the valuation allowance
offsetting net deferred tax assets has already been fully recognized as of the
end of fiscal 2003. If our foreign subsidiaries are unable to achieve operating
income in fiscal 2004, our effective tax rate in fiscal 2004 may be higher than
the combined federal and state statutory rates. We expect that our tax rate for
fiscal 2004 will be higher than our effective tax rate in fiscal 2003. Further,
our tax provision may vary from quarter to quarter and our effective tax rate
could be higher than we expect.
Our industry and our customers' industries are highly cyclical and currently
----------------------------------------------------------------------------
are experiencing a severe downturn, which has adversely affected and may
------------------------------------------------------------------------
continue to impact our revenues.
-------------------------------
The current global economic slowdown has adversely impacted the businesses
of our customers and distributors and, as a result, has also adversely affected
our business and operating results. Additional declines in our customers'
markets or in general economic conditions would likely result in a further
reduction in demand for our products. In the past, the results of these
economic cycles have negatively impacted our business. For example, beginning
in the third quarter of fiscal 2001, our customers and distributors, primarily
our PC video camera customers and distributors, cancelled or did not place
expected orders for our products. If the macroeconomic climate, especially with
respect to investments in technology such as ours, does not improve, our
revenues and operating results may be adversely affected. In addition, if the
demand for our products, in particular from the digital still camera, cell
phone camera and toys and games markets, does not increase as we expect, or if
it were to lessen for any reason, we may not be able to meet analysts'
projections for future operating results, which would likely cause our stock
price to decline, potentially significantly.
In addition, the semiconductor industry in general is subject to cyclical
variations in product supply and demand and has been experiencing a sustained
decline. Downturns in the industry often occur in connection with, or
anticipation of, maturing product cycles for both semiconductor companies and
their customers and declines in general economic conditions. These downturns
have been characterized by abrupt fluctuations in product demand, production
over-capacity and accelerated decline of average selling prices. In some cases,
these downturns have lasted multiple years.
Our sales through distributors increase the complexity of our business,
----------------------------------------------------------------------
which may increase our operating costs and may reduce our ability to
--------------------------------------------------------------------
forecast revenues.
-----------------
During fiscal 2003 and the three months ended July 31, 2003, approximately
32% and 40%, respectively, of our sales were made through distributors. Selling
through distributors reduces our ability to accurately forecast sales and
increases the complexity of our business, requiring us to, among other matters:
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
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o monitor the financial condition and credit worthiness of our distributors.
Any failure to manage these challenges could cause us to inaccurately
forecast sales and carry excess inventory, thereby adversely affecting our
operating results.
Failure to obtain design wins could cause our market share and revenues to
--------------------------------------------------------------------------
decline and could impair our ability to grow our business in the future.
-----------------------------------------------------------------------
Our future success is dependent upon manufacturers, such as cell phone and
camera manufacturers, designing our CameraChips into their products. 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. Our ability to achieve design wins is
subject to numerous risks including competitive pressures as well as
technological risks. If we do not achieve a design win with a prospective
customer, it may be difficult to sell our CameraChips to such prospective
customer in the future because 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, time, effort and risk
associated with qualifying a new supplier. In addition, a decision by
manufacturers to offer our products in attachments or add-ons to, rather than
embedded in, their products could limit our market share or revenues because
the manufacturer may more easily switch to a competitive product. Accordingly,
if we fail to achieve design wins with key camera device manufacturers that
embed image sensors in their products, our market share or revenues could
decrease. Furthermore, to the extent that our competitors secure design wins,
our ability to expand our business in the future will be impaired.
Our lengthy manufacturing, packaging and assembly cycle, in addition to our
---------------------------------------------------------------------------
customers' design cycle, may result in uncertainty and delays in generating
---------------------------------------------------------------------------
revenues.
--------
Manufacturing our image sensors requires a lengthy manufacturing,
packaging and assembly process, typically lasting fourteen to sixteen weeks or
more. Additional time may pass 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. This delay makes it more difficult to forecast
customer demand which adds uncertainty to the manufacturing planning process
and could adversely affect our operating results.
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, many of which are beyond our control. These factors and
other industry risks, many of which are more fully discussed in our other risk
factors, include:
o our ability to accurately forecast demand for our products;
o our ability to achieve acceptable wafer manufacturing yields;
o the gain or loss by us of a large customer;
o our ability to manage our product transitions;
o the mix of the products we sell and the distribution channels through
which they are sold; and
o the availability of production capacities at the semiconductor foundries
that manufacture our products or components of our products.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
In the past, our introduction of new products and our product mix have
affected our quarterly operating results. Changes in our product mix could
adversely affect our operating results because some products provide higher
margins than others. For example, our gross margin on revenues from sales of
our new line of camera module products are lower than sales of our more
established image sensor products. We typically experience lower yields when
manufacturing new products through the initial production phase, and
consequently our gross margins on new products have historically been lower
than our gross margins on our older, more established products. We also
anticipate that the rate of orders from our customers may vary significantly
from quarter to quarter. Our expenses, including our future capital commitments
to our Chinese subsidiary, and our inventory levels, are based on our
expectations of future revenues and are relatively fixed. Consequently, if we
do not achieve revenues in any quarter as 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, including:
o the growth of the market for products and applications using CMOS image
sensors;
o the timing and size of orders from our customers;
o the volume of our product returns;
o the seasonal nature of customer demand for our products;
o the deferral of customer orders in anticipation of new products, product
designs or enhancements by us; 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. Our operating results in a
given quarter could be substantially less than anticipated and if we fail to
meet market analyst expectations, a substantial decline in our stock price
could result. 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.
Our success depends on the timely development and introduction of new
---------------------------------------------------------------------
products, which we might not be able to achieve.
-----------------------------------------------
The development of new products is highly complex, and we have in the past
experienced delays in completing the development and introduction of new
products. 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, timely completion and introduction of new products that
satisfy customer requirements;
o development of products that maintain a technological advantage over the
products of our competitors, including our current advantages with respect
to the functionality and pixel capability of our CameraChips and our
proprietary testing processes; and
o market acceptance of the new products.
Accomplishing all of this is time consuming and expensive. We may be
unable to develop new products or product enhancements in time to capture
market opportunities or achieve a significant or sustainable acceptance in new
and existing markets. In addition, our products could become obsolete sooner
than anticipated because of a faster than anticipated change in one or more of
the technologies related to our products. The failure to successfully develop
new products that achieve market acceptance in a timely fashion would adversely
affect our ability to grow our business and our operating results.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We face foreign business, political and economic risks because a majority of
----------------------------------------------------------------------------
our products and those of our customers are manufactured and sold outside of
----------------------------------------------------------------------------
the United States.
-----------------
We face difficulties in managing our third party foundries, color filter
application service providers and ceramic and plastic packaging service
providers, all of whom are located in Asia, and our foreign distributors.
Potential political and economic instability in Asia may have an adverse impact
on foreign exchange rates and could cause service disruptions from our vendors.
Sales outside of the United States accounted for approximately 94% and 74%
of our revenues for fiscal 2003 and fiscal 2002, respectively, and for
approximately 99% and 83% of our revenues for the three months ended July 31,
2003 and 2002, respectively. We anticipate that sales outside of the United
States will continue to account for a substantial portion of our revenues in
future periods. Dependence on sales to foreign customers involves certain
risks, including:
o longer payment cycles;
o the adverse effects of tariffs, duties, price controls or other
restrictions that impair trade;
o decreased visibility as to future demand;
o difficulties in accounts receivable collections; and
o burdens of complying with a wide variety of foreign laws and labor
practices.
Sales of our products have been denominated to date exclusively in U.S.
dollars. Therefore, increases in the value of the U.S. dollar will increase the
price of our products in the currency of the countries in which our customers
are located. This may result in our customers seeking lower-priced suppliers,
which could adversely impact our operating results. A portion of our
international revenues may be denominated in foreign currencies in the future,
which would subject us to risks associated with fluctuations in those foreign
currencies.
The implementation of a new enterprise resource planning system presents
------------------------------------------------------------------------
certain risks and financial requirements.
----------------------------------------
We are currently implementing a new enterprise resource planning, or ERP,
system which is critical to the accounting and financial functions of our
company. In addition, the new ERP system imposes certain financial and various
other demands due to the cost of implementation. The ERP system also imposes
certain risks inherent in the conversion to a new computer system, including
disruption to our accounting controls and problems achieving accuracy in the
conversion of electronic data. Failure to properly or adequately address these
issues could result in the diversion of management's attention and resources,
and could materially adversely affect our operating results and impact our
ability to manage our business.
We may not achieve the anticipated benefits of our alliances with, and
----------------------------------------------------------------------
strategic investments in, third parties.
---------------------------------------
We expect to develop our business through forming alliances or joint
ventures with, and making strategic investments in, other companies, some of
which may be companies at a relatively early stage of development. For example,
in April 2003 we completed an investment in a chip scale packaging service
company, and in June 2003 we completed an investment in a packaging service
company. We expect to increase our reliance on partnerships, strategic
alliances and investments, particularly those that enhance our service and
manufacturing capacity. These investments and partnering arrangements are
crucial to our ability to grow our business and meet the increasing demands of
our customers. However, we can not ensure that we will achieve the benefits
expected as a result of these alliances. For instance, we may not be able to
receive acceptable wafer manufacturing yields from these companies which could
result in higher operating costs and could impair our ability to meet customer
demand for our products. We also may be required to account for some of these
investments under the equity method or to consolidate them into our operating
results. Under such circumstances, losses that such companies incur could also
adversely affect our operating results. As several of these companies are at a
relatively early stage of development, we expect each of them to incur
significant losses on a quarterly and annual basis for the foreseeable future.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The high level of complexity and integration 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 and are based upon evolving technology. The integration of additional
functions on and complex operations of our products could result in a greater
risk that customers or end users could discover latent defects or subtle faults
after volumes of product have already been shipped. Although we test our
products, we have in the past and may in the future encounter defects or
errors. Delivery of products with defects or reliability, quality or
compatibility problems may damage our reputation and 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.
Our customers experience fluctuating product cycles and seasonality, which
--------------------------------------------------------------------------
cause our results of operations to fluctuate from period to period.
------------------------------------------------------------------
Some of the products using our CameraChips, such as digital still cameras,
cell phone cameras and personal computer cameras and toys and games, are
consumer electronics goods. These mass market camera devices generally have
particular seasonality cycles. For example, sales of our CameraChips for use in
digital still cameras tends to increase in the second quarter of our fiscal
year in anticipation of the holiday sales cycle and in the fourth quarter of
our fiscal year in anticipation of the sales of digital still cameras in
connection with summer vacations. If we fail to predict accurately and respond
appropriately to this consumer demand on a timely basis to meet seasonal
fluctuations, or if there is any disruption of consumer buying habits during
this key period, our business and operating results would be harmed.
Our business could be harmed if we lose the services of one or more members
---------------------------------------------------------------------------
of our senior management team, or if we are unable to attract and retain
------------------------------------------------------------------------
qualified personnel.
-------------------
The loss of the services of one or more of our executive officers or key
employees, or the decision of one or more of these individuals to join a
competitor, could adversely affect our business and harm our operating results
and financial condition. Our success depends to a significant extent on the
continued service of our senior management, in particular, Shaw Hong, our
President and Chief Executive Officer, and Raymond Wu, our Executive Vice
President, and other key technical personnel. None of our senior management is
bound by an employment or non-competition agreement. We do not maintain key man
life insurance on any of our employees.
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. 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.
H. Gene McCown, our Vice President of Finance and Chief Financial Officer,
has announced that he is planning on retiring after his successor is
identified. We may experience difficulty in identifying or attracting a
qualified successor. Any delay in hiring or retaining a new chief financial
officer or any disruption to our business resulting from the transition of
chief financial officer responsibilities could harm our business.
Our operations may be impaired as a result of disasters, business
-----------------------------------------------------------------
interruptions or similar events, including the outbreak of the Severe Acute
---------------------------------------------------------------------------
Respiratory Syndrome.
--------------------
Disasters such as earthquakes, water, fire, electricity failure, or
accidents affecting our operating activities, major facilities, and
employees'/customers' health that occur could materially and adversely affect
our operating results and financial condition. In particular, our operations in
China, as well as most of our third party manufacturers and service providers
involved in the manufacturing of our products, are located within a relatively
close proximity of one another in China. Therefore, any disaster that strikes
within close proximity of that geographic area could be tremendously disruptive
to our business and could materially and adversely affect our operating results
and financial condition. We do not currently have a disaster recovery plan.
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
As a result of the relatively recent outbreak of severe acute respiratory
syndrome, or SARS, which has impacted a number of countries in Asia,
particularly China and Singapore, our facilities and/or the facilities of our
third party manufacturers and service providers located in China could be
quarantined or temporarily closed. If this occurs, it could delay or prevent us
from developing new products or manufacturing, testing or shipping our current
products, and may require us to find other providers of such services, which
may be unavailable or more expensive than our current providers of such
services. Further, if the outbreak of SARS has an adverse impact on the
businesses of our customers, it could reduce the size and/or frequency of our
customers' purchases, which could adversely impact our operating results and
our ability to sustain and expand our business.
Acts of war and terrorist acts may seriously harm our business and revenue,
--------------------------------------------------------------------------
costs and expenses and financial condition.
------------------------------------------
Acts of war or terrorist acts, wherever located around the world, may
cause damage or disruption to our business, employees, facilities, suppliers,
distributors or customers, which could significantly impact our revenue, costs,
expenses and financial condition. In addition, as a company with significant
operations and major distributors and customers located in Asia, we may be
adversely impacted by heightened tensions and acts of war that occur on the
Korean Peninsula. The potential for future terrorist attacks, the national and
international responses to terrorist attacks or perceived threats to national
security, and other acts of war or hostility have created many economic and
political uncertainties that could adversely affect our business and results of
operations in ways that cannot presently be predicted. We are uninsured for
losses and interruptions caused by terrorist acts and acts of war.
Risks related to our stock
- --------------------------
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. Pursuant to the rights
agreement, our board of directors declared a dividend of one right to purchase
one one-thousandth share of our Series A Participating Preferred Stock 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 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 selling our
-------------------------------------------------------------------------
common stock at a profit.
------------------------
The market price of our common stock has fluctuated substantially, and
there can be no assurance that such volatility will not continue. Since the
beginning of fiscal 2002, the trading price of our common stock has ranged from
a high of $47.68 per share to a low of $2.35 per share. The closing sales price
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
of our common stock on September 10, 2003 was $42.89. 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 other transfer restrictions on our outstanding
shares of common stock or sales of additional shares of common stock;
o sales or the perception in the market of possible sales of a shares of our
common stock by our directors, officers, employees or principal
stockholders;
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.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Foreign Currency Exchange Risk
------------------------------
We are an international company, selling our products globally, in
particular, to branded customers, contract manufacturers, VARs and distributors
in China, Hong Kong, Japan, Korea 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.
Quantitative and Qualitative Discussion of Market Interest Rate Risk
--------------------------------------------------------------------
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
of 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.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
(a) Disclosure Controls and Procedures.
----------------------------------
We maintain disclosure controls and procedures that are designed to ensure
that the information required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-15e promulgated under the Exchange Act. In designing
and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures in reaching that level of reasonable assurance. We do not expect
that our disclosure controls and procedures will prevent all error and all
fraud. Because of inherent limitations in any system of disclosure controls and
procedures, no evaluation of controls can provide absolute assurance that all
instances of error or fraud, if any, within our company may be detected.
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. Based on the foregoing, the Chief
Executive Officer and Chief Financial Officer concluded that as of the end of
the period covered by this Quarterly Report on Form 10-Q, our disclosure
controls and procedures were effective.
(b) Changes in Internal Controls.
----------------------------
There was no change in our internal controls over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
36
internal control over financial reporting, or in other factors that could
significantly affect these controls subsequent to the date of their last
evaluation.
We are in the process of implementing a new enterprise resource planning
system. We believe that we have adequate backup procedures and systems in place
such that the process of implementing this new enterprise resource planning
system will not materially adversely affect our internal controls.
37
PART II - OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
On November 29, 2001, a complaint captioned McKee v. OmniVision
Technologies, Inc., et. al., Civil Action No. 01 CV 10775, was filed in the
United States District Court for the Southern District of New York against
OmniVision, some of our directors and officers, and various underwriters for
our initial public offering. Plaintiffs generally allege that the named
defendants violated federal securities laws because the prospectus related to
our offering failed to disclose, and contained false and misleading statements
regarding, certain commissions purported to have been received by the
underwriters, and other purported underwriter practices in connection with
their allocation of shares in our offering. The complaint seeks unspecified
damages on behalf of a purported class of purchasers of our common stock
between July 14, 2000 and December 6, 2000. Substantially similar actions have
been filed concerning the initial public offerings for more than 300 different
issuers, and the cases have been coordinated as In re Initial Public Offering
Securities Litigation, 21 MC 92. Our directors and officers have been dismissed
without prejudice pursuant to a stipulation. On February 19, 2003, the Court
granted in part and denied in part a motion to dismiss brought by defendants
including OmniVision. The order dismisses all claims against us except for a
claim brought under Section 11 of the Securities Act of 1933. A proposal has
been made for the settlement and release of claims against the issuer
defendants, including OmniVision. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the Court.
If the settlement does not occur, and litigation against us continues, we
believe we have meritorious defenses and intend to defend the case vigorously.
On August 21, 2002 we initiated a patent infringement action in Taiwan,
R.O.C. against IC Media Corporation of San Jose, CA for infringement of Taiwan
patent NI-139439 owned by OmniVision. The action was brought in the Civil
Tribunal of the Shih Lin District Court and assigned Civil Action Number 91 Su-
Zi 1074. The patent infringement action seeks damages and injunctive relief
against IC Media Corporation. In response to our patent infringement action, on
October 2, 2002, IC Media Corporation initiated a cancellation proceeding
(Cancellation No. 089123560N01) in the Taiwan Intellectual Property Office with
respect to our Taiwan patent NI-139439. On July 23, 2003, the Taiwan
Intellectual Property Office made an initial determination to grant the
cancellation of Taiwan patent NI-139439. On August 22, 2003, OmniVision
appealed the decision of the Taiwan Intellectual Property Office to the Taiwan
Ministry of Economic Affairs.
On June 30, 2003, Mr. Chia-Chin Ku filed a complaint in Santa Clara County
Superior Court against us and our president and chief executive officer, Mr.
Shaw Hong. The complaint alleges that, by forming OmniVision in 1995, Mr. Hong
breached a fiduciary duty owed to HK Technology, Inc., a privately-held
corporation Mr. Hong and others founded in 1988. The complaint further alleges
that we "misappropriated and converted" assets and technology belonging to HK
Technology, Inc. The complaint seeks damages in an unspecified amount. We
believe that we have meritorious defenses to the allegations and claims and
intends to defend ourselves vigorously. We understand that HK Technology, Inc.
has not engaged in significant substantive operations since the early 1990s. We
also understand that HK Technology Inc.'s primary line of business was the
design of chipsets for personal computers, and that it did not engage in any
business concerning image sensors, which is OmniVision's primary line of
business. We do not believe that OmniVision's technology or products
incorporate or use any proprietary technology of HK Technology, Inc.
On July 14, 2003, Sunex, Inc. filed a complaint against OmniVision in San
Diego County Superior Court. Sunex was a supplier of optical lenses and lens
holders for one of our cell phone products. Under its complaint, Sunex is
seeking to recover approximately $1.8 million plus interest and attorney's
fees. Sunex's complaint relates to parts delivered by Sunex to OmniVision in
the quarter ended April 30, 2003 and our cancellation in that quarter of
additional purchase orders we had previously placed with Sunex. We intend to
defend ourselves vigorously and have filed a counterclaim against Sunex in
which we allege breach of contract and breach of warranties, and seek damages
in an amount yet to be determined. We believe that any amount we may ultimately
owe Sunex in excess of the amount we had accrued as of April 30, 2003 will not
have a material adverse affect on our financial condition or results of
operation.
38
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
On July 25, 2003, we issued a warrant to purchase 20,000 shares of our
common stock at an exercise price of $32.80 per share to our former chief
financial officer. The issuance of the warrant was made in connection with a
severance agreement with our former chief financial officer and was exempt from
registration under Section 4(2) of the Securities Act.
ITEM 5. OTHER INFORMATION
-----------------
Non-Audit Services.
------------------
In accordance with Section 10A(i)(2) of the Securities Exchange Act of
1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002 (Act), we are
required to disclose the non-audit services approved by our Audit Committee to
be performed by PricewaterhouseCoopers LLP (PWC), our external auditor. Non-
audit services are defined in the Act as services other than those provided in
connection with an audit or a review of the financial statements of a company.
The Audit Committee has approved the engagement of PWC for non-audit services
consisting of tax planning services.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
------ --------------------------------------------------------------------
10.16 Common Stock Purchase Warrant dated July 25, 2003 issued to our
former chief financial officer.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
-------------------
We filed a Current Report on Form 8-K on June 11, 2003 to furnish
information that our Board of Directors had issued a press release dated June
11, 2003 announcing our fiscal results for our fourth quarter and fiscal year
ended April 30, 2003. Such report was "furnished," but not "filed."
We filed a Current Report on Form 8-K on June 11, 2003 relating to our
announcement under Rule 135 of the Securities Act of the public sale of our
common stock by means of a firm commitment underwritten offering.
We filed a Current Report on Form 8-K on July 11, 2003 relating to the
June 30, 2003 filing of a lawsuit against OmniVision.
We filed a Current Report on Form 8-K on June 13, 2003 relating to our
announcement of the filing of a registration statement for the public offering
of our common stock by means of a firm commitment underwritten offering.
We filed a Current Report on Form 8-K on July 17, 2003 relating to our
announcement of the pricing of the public offering of our common stock.
39
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: September 12, 2003
By: /s/ SHAW HONG
-------------------------------------
Shaw Hong
Chief Executive Officer, President and Director
(Principal Executive Officer)
Dated: September 12, 2003
By: /s/ H. GENE MCCOWN
-------------------------------------
H. Gene McCown
Vice President of Finance and Chief Financial
Officer (Principal Financial
and Accounting Officer)
40