===============================================================================
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 January 31, 2004
[ ] 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
----------------------
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 Securities Exchange Act of 1934). Yes [X] No [ ]
At March 11, 2004, 55,621,527 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 (unaudited) - January 31,
2004 and April 30, 2003......................................... 3
Condensed Consolidated Income Statements (unaudited) - Three and
Nine Months Ended January 31, 2004 and 2003..................... 4
Condensed Consolidated Statements of Cash Flows (unaudited) - Nine
Months Ended January 31, 2004 and 2003.......................... 5
Notes to Condensed Consolidated Financial Statements (unaudited).. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 41
Item 4. Controls and Procedures........................................... 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 43
Item 6. Exhibits and Reports on Form 8-K.................................. 44
Signatures................................................................ 45
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data and per share data)
(unaudited)
January 31, April 30,
2004 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents............................... $ 190,622 $ 50,438
Restricted cash......................................... 1,071 --
Short-term investments.................................. 6,532 10,224
Accounts receivable, net................................ 34,721 19,133
Inventories............................................. 45,400 13,642
Refundable and deferred income taxes.................... 6,438 7,642
Prepaid expenses and other assets....................... 1,679 1,195
--------- ---------
Total current assets.................................. 286,463 102,274
Property, plant and equipment, net........................ 19,290 12,456
Long-term investments..................................... 7,110 2,845
Other non-current assets.................................. 405 378
--------- ---------
Total assets.......................................... $ 313,268 $ 117,953
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................ $ 37,906 $ 10,528
Accrued expenses and other liabilities.................. 15,343 8,037
Deferred income......................................... 6,632 2,845
--------- ---------
Total current liabilities............................. 59,881 21,410
--------- ---------
Commitments and contingencies (Note 8)
Stockholders' equity:
Common stock, $0.001 par value; 100,000,000 shares
authorized; 54,963,776 and 46,805,816 shares issued
and outstanding at January 31, 2004 and April 30,
2003, respectively.................................... 27 23
Additional paid-in capital.............................. 226,379 104,848
Deferred compensation related to stock options.......... (45) (159)
Retained earnings (accumulated deficit)................. 27,026 (8,169)
--------- ---------
Total stockholders' equity............................ 253,387 96,543
--------- ---------
Total liabilities and stockholders' equity............ $ 313,268 $ 117,953
========= =========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues.............................. $ 94,510 $ 30,522 $ 209,542 $ 69,055
Cost of revenues (1).................. 58,210 18,980 129,814 42,317
--------- --------- --------- ---------
Gross profit.......................... 36,300 11,542 79,728 26,738
--------- --------- --------- ---------
Operating expenses:
Research and development............ 4,065 3,132 10,818 8,251
Selling, general and administrative. 5,665 2,869 15,860 7,659
Stock-based compensation (2)........ 810 68 1,006 332
--------- --------- --------- ---------
Total operating expenses.......... 10,540 6,069 27,684 16,242
--------- --------- --------- ---------
Income from operations................ 25,760 5,473 52,044 10,496
Interest income, net.................. 511 199 1,281 631
--------- --------- --------- ---------
Income before income taxes............ 26,271 5,672 53,325 11,127
Provision for income taxes............ 8,932 1,074 18,130 1,892
--------- --------- --------- ---------
Net income............................ $ 17,339 $ 4,598 $ 35,195 $ 9,235
========= ========= ========= =========
Net income per share:
Basic............................... $ 0.32 $ 0.10 $ 0.68 $ 0.21
========= ========= ========= =========
Diluted............................. $ 0.28 $ 0.09 $ 0.60 $ 0.19
========= ========= ========= =========
Shares used in computing net income
per share:
Basic............................... 54,652 45,615 51,877 44,997
========= ========= ========= =========
Diluted............................. 60,850 51,125 58,835 49,070
========= ========= ========= =========
(1) Stock-based compensation included
in Cost of revenues............. $ -- $ 2 $ 3 $ 9
========= ========= ========= =========
(2) Stock-based compensation by
functional area:
Research and development........ $ 13 $ 35 $ 55 $ 117
Selling, general and
administrative................ 797 33 951 215
--------- --------- --------- ---------
$ 810 $ 68 $ 1,006 $ 332
========= ========= ========= =========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
4
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
January 31,
---------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income............................................... $ 35,195 $ 9,235
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 1,200 639
Stock-based compensation............................... 1,009 341
Changes in assets and liabilities:
Accounts receivable, net............................. (15,588) (7,284)
Inventories.......................................... (31,758) (13,053)
Refundable and deferred income taxes................. 1,204 205
Prepaid expenses and other assets.................... (511) (2,049)
Accounts payable..................................... 27,378 8,417
Accrued expenses and other liabilities............... 7,306 1,139
Deferred income...................................... 3,787 1,593
-------- --------
Net cash provided by (used in) operating activities 29,222 (817)
-------- --------
Cash flows from investing activities:
Purchase of short-term investments....................... (17,329) (5,173)
Restricted cash.......................................... (1,071) --
Proceeds from sale of short-term investments............. 21,021 2,002
Purchase of long-term non-marketable investment.......... (4,265) --
Purchases of property, plant and equipment............... (8,034) (5,234)
-------- --------
Net cash used in investing activities.............. (9,678) (8,405)
-------- --------
Cash flows from financing activities:
Deposit refunded......................................... -- (900)
Proceeds from issuance of common stock, net.............. 120,640 2,908
Payment for repurchase of common stock, net.............. -- (1)
-------- --------
Net cash provided by financing activities.............. 120,640 2,007
-------- --------
Net increase (decrease) in cash and cash equivalents....... 140,184 (7,215)
Cash and cash equivalents at beginning of period........... 50,438 55,803
-------- --------
Cash and cash equivalents at end of period................. $190,622 $ 48,588
======== ========
Supplemental cash flow information:
Taxes paid............................................... $ 13,810 $ 4,188
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
5
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Note 1 - Basis of Presentation
---------------------
The accompanying interim unaudited condensed consolidated financial
statements as of January 31, 2004 and April 30, 2003 and for the three and nine
months ended January 31, 2004 and 2003 have been prepared by OmniVision
Technologies, Inc. and its 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 the
Company's 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 as of and
for the periods presented. These financial statements should be read in
conjunction with the annual audited financial statements and notes thereto as
of and for the year ended April 30, 2003, included in the Company's Annual
Report on Form 10-K for the fiscal year ended April 30, 2003 (the "Form 10-K").
The results of operations for the three and nine months ended January 31,
2004 are not necessarily indicative of the results that may be expected for the
year ending April 30, 2004 or any other future period, and the Company makes no
representations related thereto.
On January 20, 2004, the Company announced that its Board of Directors had
approved a 2-for-1 split of the Company's common stock to be effected in the
form of a stock dividend payable to stockholders of record on January 30, 2004.
Stockholders of record received one additional share of common stock for every
share held on January 30, 2004. The stock split was effected after the close of
market on February 17, 2004 and the additional shares were distributed on
February 18, 2004. All share and per share data in this Quarterly Report on
Form 10-Q are presented on a post-stock split basis.
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 the 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
-------------------
For shipments to original equipment manufacturers ("OEMs"), value added
resellers ("VARs") and distributors without agreements that allow for returns
or credits, the Company recognizes revenue using the "sell-to" method. Under
this method, the Company recognizes revenue upon the shipment of products to
the customer provided that the Company has received a signed purchase order,
the price is fixed or determinable, title and risk of loss 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. For
shipments to distributors under agreements allowing for returns or credits,
revenue is recognized using the "sell-through" method under which revenue is
deferred until the distributor actually resells the product to the end-user
customer and the Company is notified in writing by the distributor of such
sale. Deferred income on shipment to distributors represents the amount billed
less the cost of inventory shipped to but not yet sold by distributors. The
Company provides for future returns based on historical experience at the time
revenue is recognized.
In addition, the Company recognizes revenue from the provision of
engineering assistance to a limited number of its customers from time to time.
The Company recognizes the associated revenue only upon the completion of and
acceptance by the customer of the services performed. The revenue is based on a
fixed fee which is agreed upon prior to initiation of the engineering
assistance. Historically, revenue generated from such arrangements has been
immaterial.
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Restricted Cash
---------------
Restricted cash represents cash that has been set aside as a result of
court proceedings in which the parties stipulated to the filing of a bond, in
lieu of an attachment, that the Company posted with the San Diego County
Superior Court. As of January 31, 2004, restricted cash of approximately $1.1
million secured the bond. Restricted cash is classified in current assets on
the condensed consolidated balance sheet. The Company maintains its restricted
cash with a commercial bank.
Short-Term Investments
----------------------
The Company's short-term investments, which are classified as available-
for-sale, are invested in marketable high-grade corporate securities and
government bonds maturing in 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 (loss). Unrealized gains or losses were not
significant during any period presented in these financial statements.
Intangible Assets
-----------------
The Company's patent, copyright, trademark and trade secrets have been
developed internally to date. In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets,"
the Company recognizes as expense when incurred the associated costs of the
internal development of these intellectual property rights.
Warranty Reserve for Defective Products
---------------------------------------
The Company accounts for its warranty reserve for defective products as a
portion of the sales return reserve. The Company warrants to its customers that
its products will work in accordance with their specifications. If a product
is defective, the customer is to notify the Company and return the defective
product to the Company. The Company then sends replacement products to the
customer. The Company does not repair any defective products due to cost and
other complexities associated with the products.
Land Use Right Acquired in China
--------------------------------
In December 2000, the Company established a Chinese subsidiary to conduct
testing operations in China. Subsequently, the Company constructed a
manufacturing facility in Shanghai owned by the Chinese subsidiary. This
manufacturing facility was placed in service in July 2003. However, the Chinese
subsidiary does not own the land that underlies the facility; rather, it holds
a "land use right" that was acquired from the local Chinese government in
December 2000 for approximately $0.8 million, which entitles the Company to use
the land for 50 years. The cost of this land use right was recorded as a
portion of property, plant and equipment and is being depreciated over the
useful life of the right.
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")
- ---------
Interpretation 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN 44"), and complies with the disclosure provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by
---------------------------------------
SFAS No. 148, "Accounting for 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 stock-based compensation is then
amortized over the vesting period of the option on an accelerated basis using
the multiple option approach as defined in paragraph 24 of FIN 28. SFAS 123
describes a "fair value" based method of accounting for an employee stock
option or similar equity instrument. The following table illustrates the effect
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
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
grants compensation and is referenced to in this Note as "as adjusted" (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income, as reported............... $ 17,339 $ 4,598 $ 35,195 $ 9,235
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects 486 53 544 192
Deduct: Total stock-based employee
compensation determined under
fair value based method for all
awards, net of related tax
effects....................... 4,671 1,888 12,367 5,265
--------- --------- --------- ---------
As adjusted net income................ $ 13,154 $ 2,763 $ 23,372 $ 4,162
========= ========= ========= =========
Net income per share - Basic:
As reported......................... $ 0.32 $ 0.10 $ 0.68 $ 0.21
========= ========= ========= =========
As adjusted......................... $ 0.24 $ 0.06 $ 0.45 $ 0.09
========= ========= ========= =========
Net income per share - Diluted:
As reported......................... $ 0.28 $ 0.09 $ 0.60 $ 0.19
========= ========= ========= =========
As adjusted......................... $ 0.23 $ 0.06 $ 0.44 $ 0.09
========= ========= ========= =========
Shares used in computing net income
per share - Basic:
As reported......................... 54,652 45,615 51,877 44,997
========= ========= ========= =========
As adjusted......................... 54,652 45,615 51,877 44,997
========= ========= ========= =========
Shares used in computing net income
per share - Diluted:
As reported......................... 60,850 51,125 58,835 49,070
========= ========= ========= =========
As adjusted......................... 58,024 46,013 53,087 45,246
========= ========= ========= =========
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
--------------------------------
During December 2003, the U.S. Securities and Exchange Commission released
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition" ("SAB 104"),
-------------------
which supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB
--------------------------------------------
104 updates portions of the interpretative guidance included in Topic 13 of
staff accounting bulletin, "Revenue Recognition," in order to make this
--------------------
interpretive guidance consistent with current authoritative accounting
guidance. The principal revisions relate to the deletion of interpretive
material that is no longer necessary because of private sector developments in
U.S. generally accepted accounting principles. The revenue recognition
principles of SAB 101, however, remain largely unchanged by the issuance of SAB
104, which was effective upon issuance. The Company's adoption of SAB 104 did
not have any effect on its financial position or results of operations.
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Note 3 - Balance Sheet Accounts (In Thousands)
------------------------------------
January 31, April 30,
2004 2003
---- ----
Cash and cash equivalents:
Cash.................................................... $ 4,056 $ 941
Money market funds...................................... 104,566 25,363
Commercial paper........................................ 82,000 24,134
--------- ---------
$ 190,622 $ 50,438
========= =========
Accounts receivable:
Accounts receivable..................................... $ 43,537 $ 21,188
Less: Allowance for doubtful accounts................... (2,615) (915)
Sales returns reserve............................. (6,201) (1,140)
--------- ---------
$ 34,721 $ 19,133
========= =========
Inventories:
Work in progress........................................ $ 11,836 $ 8,942
Finished goods.......................................... 33,564 4,700
--------- ---------
$ 45,400 $ 13,642
========= =========
Prepaid expenses and other assets:
Prepaid expenses........................................ $ 1,401 $ 1,187
Other receivables....................................... 278 8
--------- ---------
$ 1,679 $ 1,195
========= =========
Property, plant and equipment, net:
Building and land use right............................. $ 7,013 $ --
Building improvements................................... 1,869 --
Machinery and equipment................................. 9,452 3,607
Furniture and fixtures.................................. 217 283
Software................................................ 1,112 976
Construction in progress................................ 4,296 10,986
--------- ---------
23,959 15,852
Less: Accumulated depreciation and amortization......... (4,669) (3,396)
--------- ---------
$ 19,290 $ 12,456
========= =========
9
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Note 4 - Inventory Write-Off
-------------------
During the three months ended January 31, 2001, the Company wrote off
$18.1 million of inventory due to a significant imbalance in the PC camera
market. The following table summarizes the activity in the original $18.1
million of previously written-off inventory (in thousands):
Inventory
Previously
Written-off in
Fiscal 2001
-----------
Balance at January 31, 2001....................................... $ 18,090
Sale of previously reserved inventory through April 30, 2003...... 12,765
---------
Balance at April 30, 2003......................................... 5,325
Sale of previously reserved inventory during the nine months ended
January 31, 2004................................................ 1,189
---------
Balance at January 31, 2004....................................... $ 4,136
=========
Note 5 - Net Income Per Share
--------------------
Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed according to the treasury stock method using
the weighted average number of common and potentially dilutive common shares
outstanding during the period. Potentially dilutive common shares include the
effect of stock options. For the three and nine months ended January 31, 2004,
40,000 and 133,750 shares of common stock, respectively, 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). For the three and nine months ended January 31, 2003,
5,626 and 33,226 shares of common stock, respectively, subject to outstanding
options were not included in the calculation of diluted net income per share as
they were considered antidilutive.
10
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(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 Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Numerator:
Net income.......................... $ 17,339 $ 4,598 $ 35,195 $ 9,235
========= ========= ========= =========
Denominator:
Weighted average shares............. 54,686 45,791 51,941 45,247
Weighted average unvested common
shares subject to repurchase...... (34) (176) (64) (250)
--------- --------- --------- ---------
Denominator for basic net income per
share............................. 54,652 45,615 51,877 44,997
Effect of dilutive securities:
Common stock options................ 6,164 5,334 6,894 3,823
Unvested common stock subject to
repurchase........................ 34 176 64 250
--------- --------- --------- ---------
Denominator for dilutive net income
per share......................... 60,850 51,125 58,835 49,070
========= ========= ========= =========
Basic net income per share............ $ 0.32 $ 0.10 $ 0.68 $ 0.21
========= ========= ========= =========
Diluted net income per share.......... $ 0.28 $ 0.09 $ 0.60 $ 0.19
========= ========= ========= =========
In July 2003, the Company sold 6,186,452 shares of common stock in a
follow-on public offering at a price of $19.38 per share, resulting in net
proceeds of approximately $113.2 million. The incremental shares are reflected
in the weighted average shares outstanding during the three- and nine-month
periods ended January 31, 2004.
Note 6 - 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 Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Digital image sensors................. $ 87,939 $ 26,745 $ 187,660 $ 51,360
Analog image sensors.................. 6,571 3,777 21,882 17,695
--------- --------- --------- ---------
Total............................... $ 94,510 $ 30,522 $ 209,542 $ 69,055
========= ========= ========= =========
11
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
The Company sells its products primarily to customers in the Asia Pacific
region and the United States of America. Revenues by geographic locations are
not necessarily representative of the geographic distribution of sales to end-
user markets, as the Company's customers sell their products globally. The
revenues by geographic location in the following table are based on the country
or region in which the customers are located (in thousands):
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Hong Kong............................. $ 26,483 $ 11,354 $ 66,988 $ 32,232
Taiwan................................ 16,960 6,604 55,501 16,389
China................................. 28,339 8,533 49,833 10,093
Korea................................. 14,753 1,923 22,940 3,391
Japan................................. 5,433 336 6,624 1,475
United States......................... 1,435 1,567 2,409 4,733
All other............................. 1,107 205 5,247 742
--------- --------- --------- ---------
Total............................... $ 94,510 $ 30,522 $ 209,542 $ 69,055
========= ========= ========= =========
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 $14.7 million of the $30.0 million of
registered capital of the subsidiary had been funded as of January 31, 2004
from the Company's available working capital. The remaining $15.3 million of
registered capital must be funded by January 2005. The $14.7 million invested
through January 31, 2004 was used primarily to pay for the construction of a
building and associated building improvements and purchase of machinery and
equipment.
The Company's long-lived assets are located in the following countries (in
thousands):
January 31, April 30,
2004 2003
---- ----
China..................................................... $ 12,966 $ 8,968
Taiwan.................................................... 7,507 2,845
United States............................................. 6,034 3,588
All other................................................. 298 278
--------- ---------
Total................................................... $ 26,805 $ 15,679
========= =========
Note 7 - Employee Stock Option and Stock Purchase Plans
----------------------------------------------
Employee Stock Option Grants
----------------------------
Options to purchase 137,750 and 3,582,350 shares of common stock were
granted to employees during the three and nine months ended January 31, 2004,
respectively. As of January 31, 2004, options to purchase 8,732,216 shares of
common stock were outstanding.
2000 Employee Stock Purchase Plan
---------------------------------
As of January 31, 2004, 1,425,938 shares had been purchased under the 2000
Employee Stock Purchase Plan (the "2000 Purchase Plan").
12
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(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 $20.39 and $4.60 during the three
months ended January 31, 2004 and 2003, respectively. The per share weighted
average estimated fair value for employee options granted was $13.39 and $4.63
during the nine months ended January 31, 2004 and 2003, 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 freely traded market. Black-Scholes does not consider the
employment, transfer or vesting restrictions that are inherent in the Company's
employee options. The usage 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, it is the Company's opinion that
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 and nine months
ended January 31, 2004 and 2003:
Employee Stock Options
---------------------------------------
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate................. 2.39% 2.10% 2.14% 2.10%
Expected term of options (in years)..... 3.5 3.5 3.5 3.5
Expected volatility..................... 122.8% 134.6% 130.4% 134.6%
Expected dividend yield................. 0% 0% 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
and nine months ended January 31, 2004 was $8.95 and $5.69, respectively. 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 and nine
months ended January 31, 2003 was $3.88 and $2.86, 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
---------------------------------------
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate................. 1.30% 1.32% 1.59% 1.32%
Expected term of options (in years)..... 0.50 0.50 0.50 0.50
Expected volatility..................... 59.0% 134.6% 105.3% 134.6%
Expected dividend yield................. 0% 0% 0% 0%
13
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Note 8 - Commitments and Contingencies
-----------------------------
Litigation
----------
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.
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. Claims against the Company's directors and officers have been
- --------
dismissed without prejudice pursuant to a stipulation. On February 19, 2003,
the Court issued an order dismissing 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 the Company. 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. The Company further believes that the settlement is not
expected to have any material adverse affect on its financial condition,
results of operations or cash flows.
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 that had been issued to the Company related to the
integration of certain computer interfacing technology in system designs. The
patent infringement action seeks damages and injunctive relief from IC Media
Corporation. In response to the Company's patent infringement action, on
October 2, 2002, IC Media Corporation initiated a cancellation proceeding 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, which decision was upheld by the Taiwan Ministry of Economic Affairs on
November 21, 2003. On January 20, 2004, the Company filed an action with the
High Administrative Court of Taiwan to reverse the grant of cancellation.
On October 11, 2002, the Company filed a complaint against IC Media
Corporation in Superior Court of California, Santa Clara County (Case No. CV
811866). In its complaint, the Company alleges misappropriation of trade
secrets, unfair competition and other business torts, and seek damages and
injunctive relief. IC Media Corporation has answered the complaint by denying
the allegations and raising various defenses. In accordance with the
Alternative Dispute Resolution practices of the Court, this matter was
submitted for non-binding arbitration. On February 19, 2004, the Court issued
a notice reflecting the parties' agreement to withdraw from arbitration and to
submit the matter to non-binding mediation.
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. Mr. Ku never served the complaint on the Company. On
January 29, 2004, the Court dismissed the complaint on its own motion due to
Mr. Ku's failure to make any appearance in the case, failure to show cause in
writing why the dismissal should not be entered, or otherwise pursue the case
after filing the complaint.
On July 14, 2003, Sunex, Inc. filed a complaint against the Company 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 the
14
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three and Nine Months Ended January 31, 2004 and 2003
(unaudited)
Company in the fiscal quarters ended January 31, 2003 and April 30, 2003 and
the Company's cancellation in that quarter of additional purchase orders it had
previously placed with Sunex. In October 2003, the Superior Court granted
Sunex's request for a prejudgment writ of attachment. The parties stipulated to
the filing of a bond in lieu of an attachment which the Company posted with the
Superior Court in the approximate amount of $1.1 million. The attachment order
and subsequent filing of the bond are not reflective of the merits of the case
and are expressly prohibited from being referred to at the time of trial. 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 January 31, 2004 will not have a material adverse affect on
its financial condition, results of operations or cash flows.
Commitments
-----------
In October 2003, the Company entered into a Shareholders' Agreement with
Taiwan Semiconductor Manufacturing Company, or TSMC, pursuant to which the
Company agreed with TSMC to form VisEra Technology Company, or VisEra, a joint
venture in Taiwan, for the purposes of providing manufacturing services and
automated final testing services. The Company has committed with TSMC and
certain employees and affiliates of VisEra to provide an aggregate of $50.0
million in total capital to VisEra, which commitments may be made in the form
of cash or asset contributions. The Company and TSMC will have equal interests
in VisEra. The Company's share of this capital commitment to VisEra is $23.5
million and becomes due in stages as VisEra's business and service capabilities
develop over a number of years. The Company's net cash commitment to VisEra is
approximately $4.5 million. In November 2003, the Company made a $1.5 million
cash investment in this joint venture. The Company will also contribute
approximately $19.0 million of assets to the joint venture, including
technology, plant and equipment currently owned by the Company or to be
purchased with funds for existing commercial commitments. (See Note 6.)
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the condensed
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report on Form 10-Q. Except for historical information, the following
discussion 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, statements including the words
"may," "will," "plans," "seeks," "expects," "anticipates," "outlook," "intends"
and words of similar import as well as the negative of those terms. 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" and
elsewhere in this Quarterly Report, and other documents we file with the U.S.
Securities and Exchange Commission. 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 and 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.
We sell our products worldwide directly 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 relocating some of 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, we also expect to expand testing capabilities with additional
automated testing equipment, which will also be located in China.
In October 2003, we entered into a Shareholders' Agreement with Taiwan
Semiconductor Manufacturing Company, or TSMC, pursuant to which we agreed with
TSMC to form VisEra Technology Company, or VisEra, a joint venture in Taiwan,
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
for the purposes of providing manufacturing services and automated final
testing services. In connection with the formation of VisEra, we and TSMC have
separately agreed to enter into nonexclusive license agreements with VisEra
pursuant to which both parties will license certain intellectual property to
VisEra relating to manufacturing services and automated final testing services.
Once VisEra has the capability to deliver high quality manufacturing services
and automated final testing services, we have committed to direct a substantial
portion of our requirements in these areas to VisEra, subject to pricing and
technology requirements. We and TSMC have also committed not to compete
directly or indirectly in the future with VisEra in the fields of certain
manufacturing services and automated final testing services.
Historically, we have relied upon TSMC to provide us with a substantial
proportion of our wafers. However, we had never entered into a long-term supply
agreement with TSMC and instead had traditionally secured manufacturing
availability on a purchase order basis. As a part of the Shareholders'
Agreement, TSMC has agreed to commit substantial wafer manufacturing capacity
to us in exchange for our commitment to purchase a substantial portion of our
wafers from TSMC, subject to pricing and technology requirements.
As of January 31, 2004, we had approximately $190.6 million in cash and
cash equivalents and approximately $6.5 million in short-term investments. To
mitigate credit risk related to short-term investments, we have an investment
policy designed to preserve the value of capital and to generate interest
income from these investments without material exposure to market fluctuations.
Market risk is the potential loss due to the change in value of a financial
instrument as a result of 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.
In June 2003, we purchased approximately 27% of a privately held company
based in Taiwan for a total of $2.0 million in cash. The Taiwanese company
provides plastic packaging services, and we are a major customer. We have
accounted for this investment using the equity method. In November 2003, we
made an additional cash contribution in the amount of approximately $0.8
million to maintain our equity ownership percentage in this company. This
investment is unrelated to our announced transaction in October 2003 to form a
joint venture with TSMC.
On January 20, 2004, we announced that our Board of Directors had approved
a 2-for-1 split of our common stock to be effected in the form of a stock
dividend payable to stockholders of record on January 30, 2004. Stockholders of
record received one additional share of common stock for every share held on
January 30, 2004. The additional shares were distributed on February 18, 2004.
The stock split was effected after the close of market on February 17, 2004 and
the additional shares were distributed on February 18, 2004. All share and per
share data in this Quarterly Report on Form 10-Q are presented on a post-split
basis.
The Current Economic Environment
--------------------------------
We have operated in a challenging economic environment that has undergone
significant changes in technology and global trade. We have striven to remain
a leader in the development and marketing of image sensing devices based on the
CMOS fabrication process and have benefited from the growing market demand for
and acceptance of this emerging technology. The shift in global fabrication to
Asia has introduced a range of cost pressures on domestic manufacturers. In
response to these pressures, and in order to be closer to our primary customer
base and our source of offshore fabrication, we relocated a substantial portion
of our testing operations to China during the first three quarters of this
fiscal year.
We shipped more than 17 million image sensors in the three months ended
January 31, 2004, which demonstrated the capabilities of our production system,
including our source of offshore fabrication. To enhance our production
capabilities, we have initiated partnerships with a number of vendors,
including TSMC, one of the largest wafer fabrication companies in Asia.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The digital still camera market demonstrates a continuing trend toward
higher resolution products with a growing acceptance of CMOS based image
sensors. We have continued to benefit from a shift in product mix toward higher
resolution two- and three-megapixel products. We believe that this shift in
product mix will continue through 2004.
We believe camera phones are still in the very early stages of adoption
and that the opportunity presented by this market is still largely untapped. We
believe that, like the digital still camera market, camera phone demand will
continue to shift toward higher resolutions. As a result, we released our
quarter-inch 1.3 megapixel CameraChip designed specifically for camera phones.
We are currently in mass production with this product. Currently, we believe
that video graphics array ("VGA") resolution will account for a large majority
of the volume shipments in handsets during 2004, with an increasing transition
to higher resolutions towards the end of 2004 and beyond.
Sources of Revenues
-------------------
We generate our revenue by selling our products directly to OEMs and VARs
and indirectly to distributors. In addition, we derive a minimal portion of our
revenue by providing engineering assistance to a limited number of our
customers. The grouping of sales to OEMs and VARs together, in contrast to
sales to distributors, is also consistent with the differences in the Company's
revenue recognition policies between the two groups.
We recognize revenue on sales to OEMs, VARs and all distributors without
agreements that allow for returns or credits using the "sell-to" method. Under
this method, revenue is recognized upon the shipment of our products to our
customer provided that we have received a signed purchase order, the price is
fixed or determinable, title and risk of loss has transferred, collection of
resulting receivables is considered reasonably assured, product returns are
reasonably estimable and there are no remaining significant obligations.
For shipments to distributors under agreements allowing for returns or
credits, revenue is recognized using the "sell-through" method under which
revenue is deferred until the distributor actually resells the product to the
end-user customer and we are notified in writing by the distributor of such
sale. Under both methods of revenue recognition, we provide for future returns
based on historic experiences at the time revenue is recognized.
With respect to our revenue derived from providing engineering assistance,
we recognize the associated revenue only upon the completion and acceptance by
the customer of the services performed. The revenue is based on a fixed fee
which is agreed upon prior to initiation of the engineering assistance.
Historically, we have only entered into such services from time to time, and
revenue generated from such arrangements has been immaterial to date.
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.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues.............................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues...................... 61.6 62.2 62.0 61.3
------- ------- ------- -------
Gross profit........................ 38.4 37.8 38.0 38.7
------- ------- ------- -------
Operating expenses:
Research and development............ 4.3 10.3 5.1 11.9
Selling, general and administrative. 6.0 9.4 7.6 11.1
Stock-based compensation charge..... 0.8 0.2 0.5 0.5
------- ------- ------- -------
Total operating expenses.......... 11.1 19.9 13.2 23.5
------- ------- ------- -------
Income from operations................ 27.3 17.9 24.8 15.2
Interest income, net.................. 0.5 0.7 0.6 0.9
------- ------- ------- -------
Income before income taxes............ 27.8 18.6 25.4 16.1
Provision for income taxes............ 9.5 3.5 8.6 2.7
------- ------- ------- -------
Net income............................ 18.3% 15.1% 16.8% 13.4%
======= ======= ======= =======
Three and Nine Months Ended January 31, 2004 as Compared to Three and Nine
- --------------------------------------------------------------------------
Months Ended January 31, 2003
- -----------------------------
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 January 31, 2004
increased 209.6% to approximately $94.5 million from $30.5 million for the
three months ended January 31, 2003. Revenues for the nine months ended January
31, 2004 increased 203.4% to approximately $209.5 million from $69.1 million
for the nine months ended January 31, 2003. These increased revenues are
primarily due to this substantial increase in unit sales of our CameraChips for
digital applications during these time periods.
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, camera phones, personal
computer camera applications and digital toy cameras. Examples of analog
applications that incorporate our CameraChips are security and surveillance
cameras and analog toy cameras. We sell a large portion of our products through
VARs and distributors, and often we do not know the identity of the
manufacturers who ultimately embed 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 Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Digital image sensors................. $ 87,939 $ 26,745 $ 187,660 $ 51,360
Analog image sensors.................. 6,571 3,777 21,882 17,695
--------- --------- --------- ---------
Total............................... $ 94,510 $ 30,522 $ 209,542 $ 69,055
========= ========= ========= =========
Digital Revenues. For the three months ended January 31, 2004, revenues
----------------
from sales of CameraChips for digital applications increased 228.8% to
approximately $87.9 million from $26.7 million for the three months ended
January 31, 2003. Revenues from sales of CameraChips for digital applications
represented 93.0% and 87.6% of revenues for the three months ended January 31,
2004 and 2003, respectively. For the nine months ended January 31, 2004,
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
revenues from sales of CameraChips for digital applications increased 265.4% to
approximately $187.7 million from $51.4 million for the nine months ended
January 31, 2003. Revenues from sales of CameraChips for digital applications
represented 89.6% and 74.4% of revenues for the nine months ended January 31,
2004 and 2003, respectively. The increase in revenues from sales of CameraChips
for digital applications for the three and nine months ended January 31, 2004
primarily was due to increases in unit sales of approximately 12.1 million, or
302.5%, and 23.0 million, or 299.6%, respectively. The increase in unit sales
for the three and nine months ended January 31, 2004 was led by increases of
approximately 9.9 million, or 399.8%, and 17.0 million, or 454.4%,
respectively, in unit sales of lower resolution CameraChips products used
primarily in cell phone and toy applications, which carry a lower average sales
price than CameraChips used for digital still camera applications. We believe
that demand in the cell phone market resulted from increased requirements from
service providers to include camera functionality on handsets as consumers
upgrade their cell phones due to number portability. The increase in revenues
from sales of high resolution CameraChips used primarily for digital still
camera applications also resulted from increases in unit sales of 2.1 million,
or 140.1%, and 6.3 million, or 184.1%, for the three and nine months ended
January 31, 2004, respectively. The increase in unit sales was partially offset
by a decline in average sales prices for the three and nine months ended
January 31, 2004. We expect revenues from sales of CameraChips for digital
applications to increase in the fourth quarter of fiscal 2004 primarily as a
result of increased sales to the cell phone market.
Analog Revenues. For the three months ended January 31, 2004, revenues
---------------
from sales of CameraChips for analog applications increased 74.0% to
approximately $6.6 million from $3.8 million for the three months ended January
31, 2003. Revenues from sales of CameraChips for analog applications
represented 7.0% and 12.4% of revenues for the three months ended January 31,
2004 and 2003, respectively. For the nine months ended January 31, 2004,
revenues from sales of CameraChips for analog applications increased 23.7% to
approximately $21.9 million from $17.7 million for the nine months ended
January 31, 2003. Revenues from sales of CameraChips for analog applications
represented 10.4% and 25.6% of revenues for the nine months ended January 31,
2004 and 2003, respectively. The increase in revenues from sales of CameraChips
for analog applications for the three and nine months ended January 31, 2004
primarily was due to increases of approximately 0.5 million, or 105.9%, and 1.5
million, or 75.6%, in unit sales, respectively. The decline in analog revenues
as a percentage of revenues for the three and nine month period ended January
31, 2004 resulted from the proportionately greater increase in digital
revenues. Such CameraChips for analog applications are used primarily in
cameras for toys and games and security applications. The increase in unit
sales was partially offset by a decline in average sales prices for the three
and nine months ended January 31, 2004. We expect revenues from sales of
CameraChips for analog applications to increase in the fourth quarter of fiscal
2004 primarily due to increased demand from the security and surveillance
markets.
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 the three and nine months
ended January 31, 2004 and 2003:
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
OEMs and VARs......................... 79.7% 75.1% 72.5% 69.4%
Distributors.......................... 20.3 24.9 27.5 30.6
------- ------- ------- -------
Total............................... 100.0% 100.0% 100.0% 100.0%
======= ======= ======= =======
OEMs and VARs. In the three months ended January 31, 2004, Nam Tai
-------------
Electronics, Inc., or Nam Tai, headquartered in Hong Kong, accounted for 10.6%
of revenues. In the three months ended January 31, 2003, Primax Electronics
Products Huizhou, or Primax, based in China, accounted for 21.9% of revenues,
Aiptek International, Inc., or Aiptek, headquartered in Taiwan, which is a
manufacturer and supplier to various OEMs, accounted for 11.5% of revenues, and
Nam Tai (both directly and through Actrontech Co., Ltd., a distributor)
accounted for approximately 12.5% of revenues. No single OEM or VAR accounted
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
for 10% or more of revenues in the nine months ended January 31, 2004. In the
nine months ended January 31, 2003, Primax represented 11.5% of revenues and
Aiptek represented 10.2% of revenues. No other OEM or VAR customer accounted
for 10% or more of revenues during any of these periods.
Distributors. In the three months ended January 31, 2004, World Peace
------------
Industrial Co. Ltd., or World Peace, headquartered in Taiwan, accounted for
16.3% of revenues. In the three months ended January 31, 2003, World Peace
accounted for 17.6% of revenues, including sales to World Peace's subsidiary,
GainTune, based in Hong Kong. In the nine months ended January 31, 2004, World
Peace accounted for 19.9% of revenues, including sales to GainTune. In the nine
months ended January 31, 2003, World Peace accounted for 20.2% of revenues,
including sales to GainTune. No other distributor accounted for 10% or more of
revenues during any of these periods.
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 and nine months ended January 31, 2004 and 2003:
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Domestic sales........................ 1.5% 5.1% 1.1% 6.9%
Foreign sales......................... 98.5 94.9 98.9 93.1
------- ------- ------- -------
Total............................... 100.0% 100.0% 100.0% 100.0%
======= ======= ======= =======
The majority of our foreign sales is 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 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 January 31, 2004 and 2003 were
38.4% and 37.8% of revenues, respectively. Gross margins for the nine months
ended January 31, 2004 and 2003 were 38.0% and 38.7% of revenues, respectively.
The increase in gross margins for the three months ended January 31, 2004, as
compared to the corresponding period in the prior year, was primarily due to
lower unit costs as a result of higher unit volumes, as well as from improved
efficiency in our production sequence, particularly in product testing. The
decrease in gross margins for the nine months ended January 31, 2004, as
compared to the corresponding period in the prior year, was primarily due to a
reduction in sales of previously written off inventory. For the three months
ended January 31, 2004, approximately $0.6 million of gross profit was
attributable to the sale of previously written off inventory. For the nine
months ended January 31, 2004, approximately $1.4 million of gross profit was
attributable to the sale of previously written off inventory. Excluding the
revenues and gross profit from the sale of previously written off inventory,
the gross margin for the three months ended January 31, 2004 would have
increased to approximately 38.0% of revenues, as compared to 37.1% of revenues
during the comparable period in the prior year. Excluding the revenues and
gross profit from the sale of previously written off inventory, the gross
margin for the nine months ended January 31, 2004 would have increased to
approximately 37.6% of revenues, as compared to 36.8% of revenues during the
comparable period in the prior year.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The following table summarizes the effect of sales of previously written-
off inventory on gross profits for the three and nine months ended January 31,
2004 and 2003 (in thousands):
Three Months Ended Nine Months Ended
January 31, January 31,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Sales of all products................. $ 94,510 $ 30,522 $ 209,542 $ 69,055
Gross profit.......................... $ 36,300 $ 11,542 $ 79,728 $ 26,738
Gross margin.......................... 38.4% 37.8% 38.0% 38.7%
Sales excluding products for which the
costs were previously written off... $ 93,939 $ 30,175 $ 208,187 $ 66,956
Gross profit excluding the effect of
sales of products for which the
costs were previously written off... $ 35,729 $ 11,195 $ 78,373 $ 24,639
Gross margin excluding the effect of
sales of products for which the
costs were previously written off... 38.0% 37.1% 37.6% 36.8%
Of the previously written-off inventory, $18.1 million was written-off in
the three months ended January 31, 2001 due to a significant imbalance in the
PC camera market. The following table summarizes the activity with respect to
the original $18.1 million of previously written-off inventory (in thousands):
Inventory
Previously
Written-off in
Fiscal 2001
-----------
Balance at January 31, 2001....................................... $ 18,090
Sale of previously reserved inventory through April 30, 2003...... 12,765
---------
Balance at April 30, 2003......................................... 5,325
Sale of previously reserved inventory during the nine months ended
January 31, 2004................................................ 1,189
---------
Balance at January 31, 2004....................................... $ 4,136
=========
We were able to recover and sell $1.2 million of this inventory in the
nine months ended January 31, 2004 primarily due to a build-out of internet
infrastructure in China that created new demand for PC cameras. However, we
believe there is little opportunity to sell the remaining $4.1 million of this
inventory, primarily because these image sensors are not as technologically
advanced as other competing products in this market segment.
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, some 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 January 31, 2004 and 2003 were
approximately $4.1 million and $3.1 million, respectively. As a percentage of
revenues, research and development expenses for the three months ended January
31, 2004 and 2003 represented 4.3% and 10.3%, respectively. Research and
development expenses for the nine months ended January 31, 2004 and 2003 were
approximately $10.8 million and $8.3 million, respectively. As a percentage of
revenues, research and development expenses for the nine months ended January
31, 2004 and 2003 represented 5.1% and 11.9%, respectively.
The increase in research and development expenses of approximately $0.9
million, or 29.8%, for the three months ended January 31, 2004 from the
corresponding period in the prior year resulted primarily from a $0.4 million
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
increase in expenses related to new product development to improve our current
product line and support new product introductions, a $0.3 million increase in
salary and payroll-related expenses associated with additional personnel, $0.1
million in software expenses and $0.1 million in facility-related expenses.
Examples of new product development expenses include tape-out and prototype
runs with our wafer manufacturers. The decrease in research and development as
a percentage of revenues for the three months ended January 31, 2004 was due to
the proportionately greater increase in revenues from levels in the prior year.
The increase in research and development expenses of approximately $2.6
million, or 31.1%, for the nine months ended January 31, 2004 from the
corresponding period in the prior year resulted primarily from a $0.9 million
increase in salary and payroll-related expenses associated with additional
personnel, $0.9 million in expenses related to new product development required
to improve our current product line and support new product introductions, and
$0.4 million in expenses for software, patent prosecution and engineering
supplies. The decline in research and development as a percentage of revenues
was due to the proportionately greater increase in revenues for the nine months
ended January 31, 2004 from levels in the prior year. We anticipate that our
research and development expenses will increase in the remainder of fiscal 2004
and the first six months of fiscal 2005 as we 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 some of the expenses associated
with the startup of our Chinese subsidiary. Selling, general and administrative
expenses for the three months ended January 31, 2004 and 2003 were
approximately $5.7 million and $2.9 million, respectively. As a percentage of
revenues, selling, general and administrative expenses for the three months
ended January 31, 2004 and 2003 represented 6.0% and 9.4%, respectively.
Selling, general and administrative expenses for the nine months ended January
31, 2004 and 2003 were approximately $15.9 million and $7.7 million,
respectively. As a percentage of revenues, selling, general and administrative
expenses for the nine months ended January 31, 2004 and 2003 represented 7.6%
and 11.1%, respectively.
The increase in selling, general and administrative expenses of
approximately $2.8 million, or 97.5%, for the three months ended January 31,
2004 from the corresponding period in the prior year resulted primarily from a
$1.0 million increase in selling, general and administrative expenses for our
foreign operations, a $0.9 million increase in commissions associated with
increased revenues, a $0.3 million increase in employment expenses and a $0.3
million increase in legal and accounting expenses. Selling, general and
administrative expenses decreased as a percentage of revenues in the three
months ended January 31, 2004 as compared to the corresponding period in the
prior year as a result of the proportionately greater increase in revenues. The
increase in selling, general and administrative expenses of approximately $8.2
million, or 107.1% for the nine months ended January 31, 2004 from the
corresponding period in the prior year resulted primarily from a $2.7 million
increase in commissions associated with increased revenues, a $1.5 million
increase in selling, general and administrative expenses for our foreign
operations, a $1.3 million increase in legal and accounting expenses, a $1.0
million increase in salary and payroll-related expenses and a $1.0 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 for the nine months ended January 31, 2004, as compared
to the corresponding period in the prior year, as a result of the
proportionately greater increase in revenues. We anticipate that our future
selling, general and administrative expenses will increase in absolute dollars
as we continue to grow our business.
Stock-based compensation
- ------------------------
Stock-based compensation consists primarily of the amortization of the
excess of fair market value over the grant price of options granted prior to
our initial public offering. The stock-based compensation for the three months
ended January 31, 2004 and 2003 was approximately $0.8 million and $0.1
million, respectively. As a percentage of revenues, the stock-based
compensation charge for the three months ended January 31, 2004 and 2003
represented 0.8% and 0.2%, respectively. The stock-based compensation for the
nine months ended January 31, 2004 and 2003 were approximately $1.0 million and
$0.3 million, respectively. As a percentage of revenues, the stock-based
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
compensation for the nine months ended January 31, 2004 and 2003 represented
0.5%. The increase for the three and nine months ended January 31, 2004 was due
to the issuance of stock options to new members of management and the board of
directors. These non-cash charges are not expected to continue at the level
experienced in the quarter ended January 31, 2004, and we expect stock
compensation expense to return to the prior levels.
Interest Income, Net
- --------------------
Our cash, cash equivalents and short-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,
increased for the three months ended January 31, 2004 from the corresponding
period in the prior year to approximately $0.5 million from $0.2 million,
respectively. Interest income, net, increased for the nine months ended January
31, 2004 from the corresponding period in the prior year to approximately $1.3
million from $0.6 million, respectively. Increased interest income, net,
resulted from increased investments in interest-bearing accounts resulting from
approximately $113.2 million in net proceeds from the issuance of common stock
in our follow-on public offering in July 2003 and cash provided by operating
activities, partially offset by lower interest rates.
Provision for Income Taxes
- --------------------------
We generated approximately $26.3 million and $5.7 million in income before
income taxes for the three months ended January 31, 2004 and 2003,
respectively. We recorded provisions for income taxes for the three months
ended January 31, 2004 and 2003 of approximately $8.9 million and $1.1 million,
respectively. We generated approximately $53.3 million and $11.1 million in
income before income taxes for the nine months ended January 31, 2004 and 2003,
respectively. We recorded provisions for income taxes for the nine months ended
January 31, 2004 and 2003 of approximately $18.1 million and $1.9 million,
respectively. For the three months ended January 31, 2004 and 2003, the
effective rate was 34.0% and 18.9%, respectively. For the nine months ended
January 31, 2004 and 2003, the effective rate was 34.0% and 17.0%,
respectively. The lower effective tax rates for the three and nine months ended
January 31, 2003 were due to the release of the valuation allowance offsetting
net deferred tax assets. We anticipate 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 for fiscal 2004. The increase in tax rate is
due to the anticipated combination of income between domestic and foreign
entities for the current 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 January 31, 2004 consisted of cash, cash
equivalents and short-term investments of $197.2 million.
Our working capital increased by approximately $145.7 million to $226.6
million as of January 31, 2004 from $80.9 million as of April 30, 2003. The
increase was primarily attributable to a $140.2 million increase in cash and
cash equivalents principally resulting from our follow-on public offering of
common stock in July 2003, a $31.8 million increase in inventories to support
future sales, a $15.6 million increase in accounts receivable, net, consistent
with the increase in revenues from prior year levels during the nine months
ended January 31, 2004, a $1.1 million increase in restricted cash and a $0.5
million increase in prepaid expenses and other assets, partially offset by a
$27.4 million increase in accounts payable, a $7.3 million increase in accrued
liabilities to support increased levels of operations, a $3.8 million increase
in deferred income and a $3.7 million decrease in short-term investments.
For the nine months ended January 31, 2004, net cash provided by operating
activities totaled approximately $29.2 million as compared to cash used for
operating activities of $0.8 million for the corresponding period in the prior
year, primarily due to net income of approximately $35.2 million for the nine
months ended January 31, 2004 as compared to $9.2 million for the corresponding
period in the prior year, a $27.4 million increase in accounts payable, a $7.3
million increase in accrued expenses and other liabilities, a $3.8 million
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
increase in deferred income, and a $1.2 million decrease in refundable and
deferred income taxes, which were partially offset by a $31.8 million increase
in inventories to support future sales, a $15.6 million increase in accounts
receivable, net, and a $0.5 million increase in prepaid expenses and other
assets. The $15.6 million increase in accounts receivable, net, reflects the
significantly higher level of sales during the nine months ended January 31,
2004, partially offset by a decrease in days of sales outstanding to 33 days as
of January 31, 2004 from 43 days as of April 30, 2003. The increase in accounts
receivable, net, was partially offset by a $5.1 million increase in the reserve
for sales returns, which rose as a result of the large increase in revenues for
the nine months ended January 31, 2004, and by a $1.7 million increase in the
allowance for doubtful accounts, which rose as a result of the large increase
in accounts receivable balances. The $31.8 million increase in inventories was
attributable to higher inventory levels to support future sales. Inventory
turns, calculated based on the fiscal quarters ended January 31, 2004 and April
30, 2003, decreased to 5.1 as of January 31, 2004 as compared to 7.2 as of
April 30, 2003, as we increased inventory levels to reduce supply constraints
in anticipation of increased future sales. Accounts payable increased
concurrently with the increase in inventory purchases. Accrued liabilities
increased primarily due to an increase in our effective tax rate and timing
differences in tax payments. For the remainder of fiscal 2004, we anticipate
that our research and development expenses will increase as we develop our next
generation of CameraChip products and as we continue to grow our business. We
also anticipate that our selling, general and administrative expenses will
increase for the remainder of fiscal 2004 as we continue to grow our business.
For the nine months ended January 31, 2004, our cash used in investing
activities increased to approximately $9.7 million from $8.4 million for the
corresponding prior year period, due to $8.0 million in purchases of property,
plant and equipment, $4.3 million in purchases of long-term non-marketable
investments and a $1.1 million increase in restricted cash, partially offset by
$3.7 million in proceeds from the sale of short-term investments. Net cash used
in investing activities of $8.4 million for the nine months ended January 31,
2003 resulted from $5.2 million in purchases of property, plant and equipment
and net $3.2 million in purchases of short-term investments. The $6.8 million
increase in property, plant and equipment was due to the additional investment
in buildings, building improvements and machinery and equipment to support the
expanding operations of our Chinese subsidiary.
For the nine months ended January 31, 2004, net cash provided by financing
activities increased to approximately $120.6 million from $2.0 million for the
corresponding period in the prior year. The increase was primarily due to
approximately $113.2 million in net proceeds resulting from our follow-on
public offering of common stock in July 2003 and $7.4 million in proceeds from
the issuance and sale of common stock pursuant to the exercise of stock options
and employee purchases through our employee stock purchase plan during the nine
months ended January 31, 2004 as compared to $2.9 million for the corresponding
period in the prior year. Proceeds from the issuance and sale of common stock
for the nine months ended January 31, 2003 were partially offset by $0.9
million in refunded deposits related to investments from third parties in our
Chinese subsidiary.
In June 2003, we purchased approximately 27% of a privately held company
based in Taiwan for a total of $2.0 million in cash. The Taiwanese company
provides plastic packaging services, and we will be a major customer. We have
accounted for this investment using the equity method. In November 2003, we
increased our investment in this company by approximately $0.8 million to
maintain our equity ownership percentage in this company. This investment is
unrelated to our joint venture with TSMC.
We expect to fund the capital commitment to our Chinese subsidiary and to
our joint venture with TSMC through a combination of funds from our available
working capital, investments from third parties, or equity or debt financing.
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 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 the 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.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We currently expect our available cash, cash equivalents, and short-term
investments, together with cash that we anticipate to generate from business
operations, to be sufficient to satisfy our working capital requirements for
the next twelve months. 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.
Non-audit Services of Independent Auditors
- ------------------------------------------
Our auditors, PricewaterhouseCoopers LLP, perform tax planning services
for us that had been approved by our Audit Committee of the Board of Directors
during the three months ended January 31, 2004.
Contractual Obligations and Commercial Commitments
- --------------------------------------------------
The following summarizes our contractual obligations and commercial
commitments as of January 31, 2004 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........... $ 6,237 $ 1,864 $ 3,394 $ 839 $ 140
Noncancelable orders....... 42,269 42,269 -- -- --
-------- -------- -------- -------- --------
Total contractual
obligations............ 48,506 44,133 3,394 839 140
-------- -------- -------- -------- --------
Other Commercial Commitments
Investment in China........ 15,300 1 15,300 -- -- --
Joint Venture with TSMC.... 3,500 2 -- 3,500 -- --
-------- -------- -------- -------- --------
Total commercial
commitments............ 18,800 15,300 3,500 -- --
-------- -------- -------- -------- --------
Total contractual
obligations and
commercial commitments. $ 67,306 $ 59,433 $ 6,894 $ 839 $ 140
======== ======== ======== ======== ========
- -------------------------
<FN>
1 Relates to the remaining $15.3 million of registered capital for our
Chinese subsidiary. We established this subsidiary as part of our
efforts to increase capacity and reduce costs for testing our
CameraChips.
2 Pursuant to the Shareholders' Agreement with TSMC, our share of the
capital commitment to VisEra is $23.5 million, which becomes due as
VisEra's business and service capabilities develop over a number of
years. Our net cash investment to the joint venture will be
approximately $4.5 million. In November 2003, we made a $1.5 million
cash investment in this joint venture. We will also contribute
approximately $19.0 million of assets to the joint venture, including
technology, plant and equipment currently owned by us or to be purchased
with funds for existing commercial commitments. Our cash and asset
contributions will be made in three phases. In the first phase, we
contributed $1.5 million in cash to VisEra and granted a non-exclusive
license to certain of our manufacturing and automated final testing
technologies and patents. In the second phase, we will contribute $9.5
million in cash to VisEra and a non-exclusive license to certain of our
manufacturing and automated final testing technologies and patents. In
the third phase, we will contribute $12.5 million in cash and assets to
VisEra and receive back from VisEra an aggregate cash payment of $17.5
million.
</FN>
In October 2003, we entered into a Shareholders' Agreement with TSMC
pursuant to which we agreed with TSMC to form VisEra, a joint venture in
Taiwan, for the purposes of providing manufacturing services and automated
final testing services. We have committed with TSMC and certain employees and
affiliates of VisEra to provide an aggregate of $50.0 million in total capital
to VisEra, which commitments may be made in the form of cash or asset
contributions. Our company and TSMC will have equal interests in VisEra. Our
share of this capital commitment to VisEra is $23.5 million and becomes due in
stages as VisEra's business and service capabilities develop over a number of
years. Our net cash commitment to VisEra is approximately $4.5 million. In
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
November 2003, we made a $1.5 million cash investment in this joint venture. We
will also contribute approximately $19.0 million of assets to the joint
venture, including technology, plant and equipment currently owned by us or to
be purchased with funds for existing commercial commitments. The $3.5 million
commercial commitment referenced in the table above refers to the remaining
$3.5 million of net cash capital contributions to VisEra.
Factors Affecting Future Results
- --------------------------------
This Quarterly Report on Form 10-Q, including this Management's Discussion
and Analysis of Financial Condition and Results of Operations, 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 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.
We released a 1.3-megapixel and 2.0-megapixel CMOS image sensor, as well
as a 1/7-inch low-resolution CMOS image sensor, for cameraphone manufacturers
in February 2004. Our new releases compete against CCD image sensors, and we
cannot guarantee the adoption of our new image sensors by existing or new
customers. We also cannot guarantee the growth of end-user markets that would
embed these new image sensors. If our enhanced products and technologies do
not gain market acceptance, we may not be able to maintain our market share in
this competitive environment.
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 exclusive 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 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
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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 Samsung 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.
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 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;
o the failure of manufacturers that have been using CCD products to adopt
our CMOS CameraChips; and
o the failure to develop easy to use and affordable products using CMOS
image sensors.
The occurrence of any of these factors could adversely affect our ability
to sustain and grow our business and increase our revenues and earnings.
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 markets 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.
Our success depends on the timely development and introduction of new CMOS
--------------------------------------------------------------------------
image sensors, which we might not be able to achieve.
----------------------------------------------------
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. In February 2004, we introduced 1.3
megapixel, 2.0 megapixel and 1/7-inch CMOS image sensors for camera phones. The
development and market acceptance of products such as these are critical to our
ability to sustain and grow our business. Any failure to successfully develop
and introduce new products could materially adversely affect our business and
operating results. 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;
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o development of advanced technologies and capabilities;
o definition, timely completion and introduction of new CMOS image sensors
that satisfy customer requirements;
o development of products that maintain a technological advantage over the
products of our competitors, including our 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 rapid change in one or more of the technologies
related to our products.
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. On the other hand, if we underestimate customer demand, we may be
unable to manufacture sufficient products quickly enough to meet actual demand,
causing us to lose customers and impairing our ability to grow our business. In
recent periods, due to higher-than-anticipated 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. As we build our
inventory levels, this subjects us to the product obsolescence risks described
above.
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,
-------------------------------------------------------------------------
and any decline in sales to the digital still camera market or failure for
--------------------------------------------------------------------------
this market to continue to grow as expected could adversely affect our
----------------------------------------------------------------------
results of operations.
---------------------
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 33% and 41%
of our revenue in the three and nine months ended January 31, 2004,
respectively. 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 the remainder of fiscal 2004 and fiscal 2005. Sales of
our CameraChips for the digital still camera market are subject to seasonal
fluctuations. 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 operations. 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 distributors that obligate 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
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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.
Problems with wafer manufacturing yields could result in higher operating
-------------------------------------------------------------------------
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. 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. Any of these
potential problems with wafer manufacturing yields could result in a reduction
in our ability to timely deliver products to customers, which could adversely
affect our customer relations and make it more difficult to sustain and grow
our business.
We depend on a limited number of third party wafer foundries, which reduces
---------------------------------------------------------------------------
our ability to control our manufacturing process.
------------------------------------------------
We do not own or operate a semiconductor fabrication facility. Instead, we
primarily rely on TSMC, Powerchip Semiconductor Company, or PSC, and other
subcontract foundries to produce substantially all of our wafers. Samsung has
fabricated and may in the future fabricate certain of our products.
Historically, we have relied upon TSMC to provide us with a substantial
majority of our wafers. However, we had never entered into a long-term supply
agreement with TSMC and instead had traditionally secured manufacturing
availability on a purchase order basis. As a part of our joint venture with
TSMC, TSMC has agreed to commit substantial wafer manufacturing capacity to us
in exchange for our commitment to purchase a substantial portion of our wafers
from TSMC, subject to pricing and technology requirements. We do not have long-
term supply agreements with any other foundries and instead secure
manufacturing availability on a purchase order basis. These other 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. In general, our reliance on 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;
o unavailability of, or delayed access to, next generation or key process
technologies; and
o financial difficulties or disruptions in the operations of third party
foundries due to causes beyond our control.
If TSMC or any of our other foundries were to become unable 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 we may be
required to pay increased amounts for 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.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We rely on third party service providers for color filter application and
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packaging services, which reduces our control over delivery schedules,
---------------------------------------------------------------------
product quality and cost, and could adversely affect our ability to deliver
---------------------------------------------------------------------------
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. We rely on another service
provider for our plastic chip packages, which are generally used in our lower-
priced products. We rely on 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
have to identify and qualify substitute service providers, which could be time
consuming and difficult and could result in unforeseen operational 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 is 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,
quality assurance and costs. This lack of control may cause 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 nine months ended January 31, 2004, Nam Tai Electronics, Inc.,
headquartered in Hong Kong, accounted for 11% of revenues. In fiscal 2003 and
the nine months ended January 31, 2004, our only distributor customer that
accounted for more than 10% of our revenues was World Peace Industrial Co.,
headquartered in Taiwan, which accounted for approximately 21% and 20% of our
revenues, respectively. 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
------------------------------------------------------------------
application and sensor packaging.
--------------------------------
We expect that as we develop new products to meet technological advances
and new and changing industry and customer demands, our color filter
application and ceramic, plastic and chip-scale packaging requirements will
also evolve. Our ability to continue to profitably deliver products that meet
customer demand is dependent 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.
There can be no assurances that any of these parties will be able to develop
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
enhancements to the services they provide to us to meet these new and changing
industry and customer requirements. Furthermore, even if these 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
---------------------------------------------------------------------------
complicate and reduce our ability to control the manufacturing process, and
---------------------------------------------------------------------------
may decrease our gross margins.
------------------------------
Some of our camera manufacturer customers request 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 the sales price for camera modules
compared to our CameraChips, our profitability would also be adversely
affected.
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 our average sales prices have
declined as a result. We expect that the average sales prices for many of our
products will continue to decline over time. Declines in our average sales
prices could result in reduced revenues and a decline in our gross margin, and
could materially and adversely affect our operating results and impair our
financial condition. For the remainder of fiscal 2004, we intend to increase
our research and development expenses in an attempt to accelerate the
development of our next generation of CameraChip products. However, if we 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.
We may never achieve the anticipated benefits from our operations in China.
--------------------------------------------------------------------------
Currently, wafer production, color filter application and sensor packaging
are performed primarily in Asia and, to a limited extent, in Israel by third
party manufacturers and service providers. Historically, our CameraChips have
been shipped to our facility in the United States to undergo sensor testing
before being shipped to customers. This process is time-consuming and
relatively expensive and can result in damaged products. In December 2000, we
established a Chinese subsidiary as part of our efforts to streamline our
manufacturing process and reduce the costs and working capital associated with
the testing of our CameraChips. We have initiated the process of moving final
testing operations to our Chinese subsidiary and have begun to relocate some of
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, we also expect to expand testing capabilities with
additional automated testing equipment, which will also be located in China.
However, there are significant administrative, legal and governmental risks to
operating in China that could result in increased operating expenses or that
could prevent us from achieving our objectives in operations. Consequently, we
may never be able to achieve the anticipated cost savings from the transition
of testing operations to China, resulting in failure to improve our gross
margins. If our operations in China do not result in offsetting gains in the
form of operating cost reductions, whether because of risks and difficulties
entailed by foreign operations or for other reasons, our business and financial
condition could be adversely affected. The substantial risks from operating in
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
China that could increase our operating expenses and adversely affect our
operating results, financial condition and ability to deliver our products and
grow our business include, without limitation:
o difficulties in staffing and managing foreign operations, particularly in
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 could 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.
We may never achieve the anticipated benefits from our joint venture with
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TSMC.
----
In October 2003, we entered into an agreement with TSMC pursuant to which
we agreed with TSMC to form VisEra, a joint venture in Taiwan, for the purposes
of providing manufacturing services and automated final testing services. We
expect that VisEra will eventually be able to provide us with a committed
supply of high quality manufacturing services and automated final testing
services at competitive prices. However, there are significant legal,
governmental and relationship risks to forming and developing VisEra, and we
cannot ensure that we will be able to receive the expected benefits from this
joint venture. For example, VisEra may not be able to provide manufacturing
services or automated testing services that have competitive technology or
prices, which could adversely affect our product offerings and our ability to
meet customer requirements for our products. In addition, the formation of
VisEra provides us with an additional source for certain manufacturing services
which, in the future, may also make it more difficult for us to secure
dependable services from competing merchant vendors who provide similar
manufacturing services. We are required to account for our investment in VisEra
under the equity method, and any loss that VisEra incurs will negatively impact
our reported earnings.
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 operations in China and our joint venture with TSMC will require
--------------------------------------------------------------------
substantial capital expenditures.
--------------------------------
We must meet certain minimal capital requirements applicable to our
Chinese subsidiary and our joint venture with TSMC. Our Chinese subsidiary has
$30.0 million in registered capital, $14.7 million of which had been funded as
of January 31, 2004. The remaining $15.3 million must be funded by January
2005. In addition, we must meet certain financial requirements with regard to
VisEra, our joint venture with TSMC. We have committed with TSMC and certain
employees and affiliates of VisEra to provide an aggregate of $50.0 million in
total capital to VisEra, which commitments may be made in the form of cash or
asset contributions. Our share of this capital commitment to VisEra is $23.5
million and becomes due in stages as VisEra's business and service capabilities
develop over a number of years. Our net cash investment in the joint venture
will approximate $4.5 million. We will also contribute approximately $19.0
million of assets to the joint venture, including technology, plant and
equipment currently owned by us or to be purchased with funds for existing
commercial commitments. Our cash and net asset contributions to VisEra will be
made in three phases. In the first phase, we contributed $1.5 million in cash
to VisEra and granted a non-exclusive license to certain of our manufacturing
and automated final testing technologies and patents. In the second phase, we
will contribute $9.5 million in cash to VisEra and grant a non-exclusive
license to certain of our manufacturing and automated final testing
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
technologies and patents. In the third phase, we will contribute $12.5 million
in cash and assets to VisEra and receive back from VisEra an aggregate cash
payment of $17.5 million.
We expect to fund the capital commitment to our Chinese subsidiary and to
our joint venture with TSMC through a combination of funds from our available
working capital, investments from third parties, or equity or debt financing.
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 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 the 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 have a limited history of profitability and may be unable to maintain our
----------------------------------------------------------------------------
recent levels of profitability.
------------------------------
We have a limited history of profitability and may be unable to sustain
our recent levels of profitability. 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 a net loss of $11.6 million and in fiscal 2002 we incurred a net loss
of $1.3 million. In fiscal 2000 and fiscal 2003, we recorded net income of $3.4
million and $15.3 million, respectively. In the future, we expect to incur
significant expenses, including expenses related to our research and
development efforts, our operations in China and capital commitments to our
Chinese subsidiary and our joint venture with TSMC, which could impair our
ability to sustain profitability. In addition, as we plan to hire additional
personnel throughout various departments of our company, we expect selling,
general and administrative and other expenses to increase. If we fail to
attract qualified personnel with relevant experience, our ability to meet
competitive challenges and create new products and technology to meet the
demands of our customers will be adversely affected. Other risks associated
with our business described elsewhere in this section could also affect our
ability to sustain profitability, including the possibility that the end-
markets for our products may not grow at the same rate as they did in fiscal
2003 and the first three quarters of fiscal 2004. 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, if 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 be issued 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, on August 21, 2002 we
initiated a patent infringement action in Taiwan, R.O.C. against IC Media
Corporation of San Jose, California for infringement of Taiwan patent NI-139439
that had been issued to us. 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, which
decision was upheld by the Taiwan Ministry of Economic Affairs in November
2003. We intend to file an action with the High Administrative Court of Taiwan
to reverse the grant of cancellation. 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.
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
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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 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 Proceeding" on
----------------
page 43. 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 outcome, 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 attention.
We may experience integration or other problems with potential acquisitions,
---------------------------------------------------------------------------
which could have an adverse effect on our business or results of operations.
---------------------------------------------------------------------------
New acquisitions could dilute the interests of existing stockholders, and
-------------------------------------------------------------------------
the announcement of new acquisitions could result in a decline in the price
---------------------------------------------------------------------------
of our common stock.
-------------------
We may in the future make acquisitions of or large investments in
businesses that offer products, services and technologies that we believe would
complement our products, including other CMOS image sensor manufacturers. We
may also make acquisitions of or investments in businesses that we believe
could expand our distribution channels. Even if we were to announce an
acquisition, we may not be able to complete it. Additionally, any future
acquisition or substantial investment would present numerous risks, including:
o difficulty in integrating the technology, operations or work force of the
acquired business with our existing business;
o disruption of our ongoing business;
o difficulty in realizing the potential financial or strategic benefits of
the transaction;
o difficulty in maintaining uniform standards, controls, procedures and
policies;
o possible impairment of relationships with employees, customers, suppliers
and strategic partners as a result of integration of new businesses and
management personnel, and
o impairment of assets related to resulting goodwill, and reductions in our
future operating results from amortization of intangible assets.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We expect that any future acquisitions could provide for consideration to
be paid in cash, shares of our common stock or a combination of cash and our
common stock. If consideration for a transaction is paid in common stock, this
would further dilute our existing stockholders.
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, net, and, at
times, an increase in our days of sales outstanding, primarily as a result of
our revenue growth in fiscal 2003 and the first half of fiscal 2004. Our
failure to effectively manage our inventory levels could either result in
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 nine
months ended January 31, 2004 our accounts receivables increased while days
sales outstanding decreased. If we do not manage effectively our accounts
receivable, our cash balance and operating results will be adversely affected.
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
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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 will result in an increase in our effective
rate in fiscal 2004 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.
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 nine months ended January 31, 2004,
approximately 32% and 28%, 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
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o monitor the financial condition and creditworthiness of our distributors.
Any failure to manage these challenges could cause us to inaccurately
forecast sales and carry excess or insufficient 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 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 and innovative 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. 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.
--------
The production of 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 availability of production capacities at the semiconductor foundries
that manufacture our products or components of our products;
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
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o the announcement and introduction of products and technologies by our
competitors.
In addition, our introduction of new products and our product mix have
affected and may continue to affect our quarterly operating results. Changes in
our product mix could adversely affect our operating results because some
products provide higher margins than others. 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 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 joint venture with TSMC, 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.
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.
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, ceramic and plastic packaging service providers
and our foreign distributors, most of whom are located in Asia. Potential
political and economic instability in Asia may have an adverse impact on
foreign exchange rates and could cause service disruptions for our vendors and
distributors.
Sales outside of the United States accounted for approximately 94% and 74%
of our revenues for fiscal 2003 and fiscal 2002, respectively, for
approximately 98% and 95% of our revenues for the three months ended January
31, 2004 and 2003, respectively, and for approximately 99% and 93% of our
revenues for the nine months ended January 31, 2004 and 2003, 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.
We may not achieve the anticipated benefits of our alliances with, and
----------------------------------------------------------------------
strategic investments in, third parties.
---------------------------------------
We expect to develop our business partly 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 another
packaging service company. In addition, we entered into an agreement with TSMC
in October 2003 to form a joint venture in Taiwan which will provide
manufacturing services and automated final testing services. We expect to
continue to utilize partnerships, strategic alliances and investments,
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
particularly those that enhance our manufacturing capacity and those that
provide manufacturing services and testing capability. These investments and
partnering arrangements are crucial to our ability to grow our business and
meet the increasing demands of our customers. However, we cannot 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. In addition,
certain of these investments or partnering relationships may place restrictions
on the scope of our business, the geographic areas in which we can sell our
products and the types of products that we can manufacture and sell. For
example, our agreement with TSMC provides that we may not engage in any
business that will directly compete with the business of VisEra. This type of
non-competition provision may impact our ability to grow our business and to
meet the demands of our customers. 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 losses on a quarterly and annual basis.
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. 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.
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 into the 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
--------------------------------------------------------------------------
could 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, personal computer cameras and cameras for toys and games,
are consumer electronics goods. These mass market camera devices generally have
particular seasonal cycles. For example, sales of our CameraChips for use in
digital still cameras tend to increase in the second quarter of our fiscal year
in anticipation of the holiday sales cycle and in the third quarter of our
fiscal year in anticipation of the Chinese New Year. 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 these key periods, 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
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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, Raymond Wu, our Executive Vice
President, John T. Rossi, our Vice President of Finance and Chief Financial
Officer and certain 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 sales, marketing, finance, management and technical personnel,
particularly analog or mixed signal design engineers. 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.
Our operations may be impaired as a result of disasters, business
-----------------------------------------------------------------
interruptions or similar events.
------------------------------
Disasters such as earthquakes, water, fire, electrical failure, accidents
and epidemics affecting our operating activities, major facilities, and
employees' and customers' health could materially and adversely affect our
operating results and financial condition. In particular, our Asian operations
and most of our third party manufacturers and service providers involved in the
manufacturing of our products are located within relative close proximity.
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.
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 in
locations such as the Korean Peninsula, Taiwan and China. 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 our
----------------------------------------------------------------------------
company 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
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
right entitles the registered holder to purchase from us one one-thousandth of
a share of Series A Preferred at an exercise price of $20.00 (reflecting the
stock split that took effect on February 17, 2004), subject to adjustment. The
exercise of the rights could have the effect of delaying, deferring or
preventing a change of control of our company, 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 are
---------------------------------------------------------------------------
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 $33.83 per share to a low of $1.18 per share. The closing sales price
of our common stock on March 11, 2004 was $26.52. 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 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
------------------------------
We sell our products globally, in particular, to branded customers,
contract manufacturers, VARs and distributors in China, Hong Kong, Japan, Korea
and Taiwan.
All of our transactions with our vendors and customers are carried out in
U.S. dollars. The only expenses the Company incurs in currencies other than
U.S. dollars are certain costs affecting gross profits, selling, general and
administrative and research and development expenses, which are primarily
incurred in China, where renminbi ("RMB") is the local currency. Historically,
the Chinese government has benchmarked the RMB exchange ratio against the U.S.
dollar, thereby mitigating the associated foreign currency exchange rate
fluctuation risk. These certain expenses that are denominated in currencies
other than U.S. dollars have not historically been a material percentage of our
revenues.
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
We do not believe that our foreign currency exchange rate fluctuation risk
is significant, especially if the Chinese government continues to benchmark the
RMB against the U.S. dollar. Moreover, given that the only expenses that we
incur in denominations other than U.S. dollars are certain cost affecting gross
profits, selling, general and administrative and research and development
expenses (which historically have not been a significant percentage of our
revenues), we do not believe that a 10% change in foreign currency exchange
rates would have a significant effect on our future net income or cash flows.
We have not hedged exposures denominated in foreign currencies or used any
other derivative financial instruments as we do not believe that we currently
have any significant direct foreign currency exchange rate risk. 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, and results of
operations.
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
provide us with a reasonable level of assurance that the information required
to be disclosed in our 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. 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 in providing us with a
reasonable level of assurance that our control objectives, as discussed above
in the first sentence of this paragraph, were met.
(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
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.
42
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. Claims against our directors and officers have
been dismissed without prejudice pursuant to a stipulation. On February 19,
2003, the Court issued an order dismissing 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 our Company. 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.
We believe that the settlement will not have any material adverse affect on our
financial condition, results of operations or cash flows.
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 that had been issued to us related to the integration of
certain computer interfacing technology in system designs. The patent
infringement action seeks damages and injunctive relief from IC Media
Corporation. In response to our patent infringement action, on October 2, 2002,
IC Media Corporation initiated a cancellation proceeding 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, which
decision was upheld by the Taiwan Ministry of Economic Affairs on November 21,
2003. On January 20, 2004, we filed an action with the High Administrative
Court of Taiwan to reverse the grant of cancellation.
On October 11, 2002, we filed a complaint against IC Media Corporation in
Superior Court of California, Santa Clara County (Case No. CV 811866). In our
complaint, we allege misappropriation of trade secrets, unfair competition and
other business torts, and seek damages and injunctive relief. IC Media
Corporation has answered the complaint by denying the allegations and raising
various defenses. In accordance with the Alternative Dispute Resolution
practices of the Court, this matter was submitted for non-binding arbitration.
On February 19, 2004, the Court issued a notice reflecting the parties'
agreement to withdraw from arbitration and to submit the matter to non-binding
mediation.
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. Mr. Ku never served the complaint on us. On January 29, 2004, the
Court dismissed the complaint on its own motion due to Mr. Ku's failure to make
any appearance in the case, failure to show cause in writing why the dismissal
should not be entered, or otherwise pursue the case after filing the complaint.
On July 14, 2003, Sunex, Inc. filed a complaint against us 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 us in the fiscal quarters
ended January 31, 2003 and April 30, 2003 and our cancellation in that quarter
of additional purchase orders we had previously placed with Sunex. In October
2003, the Superior Court granted Sunex's request for a prejudgment writ of
attachment. The parties stipulated to the filing of a bond, in lieu of an
attachment, which we posted with the Superior Court in the approximate amount
of $1.1 million. The attachment order and subsequent filing of the bond are not
reflective of the merits of the case and are expressly prohibited from being
referred to at the time of trial. We intend to defend ourselves vigorously and
43
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 January 31, 2004 will not have a material adverse affect
on our financial condition, results of operations or cash flows.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
------ ------------------------------------------------------------------
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 furnished a Current Report on Form 8-K on November 19, 2003 announcing
our financial results for our second fiscal quarter ended October 31, 2003.
Such report was "furnished," but not "filed."
44
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: March 16, 2004
By: /s/ SHAW HONG
------------------------------------
Shaw Hong
Chief Executive Officer, President and Director
(Principal Executive Officer)
Dated: March 16, 2004
By: /s/ JOHN T. ROSSI
------------------------------------
John T. Rossi
Vice President of Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
45