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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-26660
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ESS TECHNOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2928582
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
48401 FREMONT BLVD., FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(510) 492-1088
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant, based upon the closing sale price of
the Common Stock on February 22, 2001 ($7.44) as reported on the Nasdaq National
Market, was approximately $176,884,936. Shares of Common Stock held by each
officer and director and by each person who owned 5% or more of the registrant's
outstanding Common Stock on that date have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of February 22, 2001, registrant had outstanding 42,611,605 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2001 Annual Meeting of
Shareholders are incorporated by reference in Part III.
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ESS TECHNOLOGY, INC.
2000 FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 11
Item 3. Legal Proceedings........................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......... 12
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters......................................... 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 16
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 27
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosures....................................... 53
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 53
Item 11. Executive Compensation...................................... 53
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 53
Item 13. Certain Relationships and Related Transactions.............. 53
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 53
Signatures............................................................ 58
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The discussion in this report contains forward-looking statements that
involve risks and uncertainties. The statements contained in this report that
are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. The Company's
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in "Factors That May Affect Future Results," in the Management's
Discussion and Analysis Section and elsewhere in this report.
PART I
ITEM 1. BUSINESS
ESS Technology, Inc. and its subsidiaries ("ESS" or the "Company") designs,
markets and supports highly integrated mixed-signal semiconductor solutions for
multimedia applications in the Internet, personal computer ("PC") and consumer
marketplaces. The Company offers comprehensive solutions for networking and
Digital Versatile Disk ("DVD"), Internet-related semiconductor, Communications,
Video Compact Disk ("VCD")/Super Video Compact Disk ("SVCD"), and PC Audio
applications. ESS has established itself as a leading supplier for mixed-signal
PC audio solutions, which integrate all essential audio components on a single
chip and as a leading supplier of VCD solutions. During 1999, ESS introduced DVD
Chipsets for Motion Pictures Experts Group 2 ("MPEG-2"), DVD and MPEG Layer III
("MP3") player for consumer market. ESS has established itself as one of the
world's leading VCD, DVD and MP3 chip set supplier. During 2000, ESS began
shipping several V.90 modem products for data communications and announced a
single-chip controller that offers Modem/Local area network ("LAN") and home
networking solutions. For the Internet digital set-top box market, ESS also
introduced a single chip DVD and Internet set top box ("STB") processor
products. The Company was incorporated in California in 1984 and became a public
company in 1995. In April 1999, the Company established a subsidiary, Vialta,
Inc. ("Vialta"), which plans to introduce advanced, user-friendly products and
applications for the Internet. Vialta products will include multi-media
appliances, applications and contents for the Internet. The Vialta Internet
appliance is based on ESS's core technologies in digital video, telephony and
videophone. Their products are designed to address consumer demand for DVD and
MP3 players, videophone and Internet Connectivity in the living room
environment. In December 1999, Vialta established a wholly owned subsidiary Vcom
Canada Holdings, which operates a branch office in Toronto as a research and
development center for Vialta's portal development. As of December 31, 2000, the
Company owns 62.1% of Vialta.
In February 2000, the Company acquired all of the outstanding shares and
vested stock options of NetRidium and retained all its employees. At the time of
acquisition, NetRidium was a development stage company that develops broadband
communication products enabling high-speed networking over existing phone lines
in the home.
The Company and its subsidiaries operate in two reportable business
segments: the semiconductor segment and the Internet segment. In the
semiconductor segment, the Company designs, develops, supports and manufactures
highly integrated mixed-signal semiconductor solutions for multimedia
applications in the Internet and PC marketplace, among others. The semiconductor
segment offers comprehensive solutions for audio, video and modem applications.
There are five product lines in the Company's semiconductor segment: DVD,
Internet related semiconductor, Communications, VCD/SVCD, and PC Audio products.
In the Internet-segment, the Company plans to develop and market advanced,
user-friendly products and applications and content for the Internet.
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The following table summarizes product lines which counted for over 10% of
consolidated revenue for years 2000, 1999 and 1998, respectively:
PERCENTAGE OF
CONSOLIDATED REVENUES
FOR YEARS ENDED
DECEMBER 31,
-----------------------
2000 1999 1998
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PC Audio.................................................... 36% 48% 60%
VCD/SVCD.................................................... 40% 45% 35%
DVD......................................................... 15% -- --
SEMICONDUCTOR SEGMENT
DVD Products
The Company's DVD product provides original equipment manufactured ("OEMs")
of DVD players with a programmable single chip processor, which includes MPEG-2
audio/video/system, transport layer decoder and video post-processing. In
addition, the MPEG-2 decoder also integrates Dolby Digital, Decode Time Stamp
("DTS") Audio, and Navigation Software for DVD players. These chips are designed
for a variety of applications in consumer electronics such as MP3 players,
Internet set-top boxes, as well as DVD players.
ES4318: Single chip programmable DVD processor with integrated system
navigation software and direct DVD loader interface. ES4318 supports two channel
stereo down mix and MPEG-2 video decoding, and provides on-screen display and
transport layer compliance with DVD standard using the integrated system
navigation software and a direct DVD loader interface for a smaller form factor
and cost-effective design.
ES4408: Single chip programmable DVD processor with 5.1 channel Dolby
Digital outputs. ES4408 incorporates all the features of ES4318 with the support
of 5.1 channel Dolby Digital audio.
Internet Related Semiconductor Products
ES4228/ES4428: Single chip programmable SVCD/DVD and Internet set-top box
processor. ES4228/ ES4428 incorporates the ES4118/ES4318 features with a graphic
function and flicker filter algorithm to enhance viewing quality on the
television.
ES4227/ES4427: Analog companion chip. ES4227/ES4427 incorporates features
of echo, surround sound, 3-dimensional ("3-D") audio, Television ("TV") encoder
with clock generation, audio Digital Analog Converter ("DAC") functions with
Hyper Text Mark-up Language ("HTML"), hyperlink and a graphic user interface
with a programmable I/O interface to communicate with ES56V modem chipset.
Communication Products
Internet-related applications, such as voice e-mail, Internet radio, audio
home pages and news-on-demand, are increasing the demand for integrated audio
and computer fax/modem functions on the PC. ESS Communication Products enable PC
manufacturers to provide fax/modem capabilities to add-on cards and directly
onto the motherboards of desktops and notebook PCs.
ES56-PI, ES56T-PI: V.90 chipsets for data/fax/voice controllerless modem
solution. These chipsets are compliant with the V.90 (56 kbps) worldwide modem
standard via proprietary software. The ES56T-PI adds Telephone Answering Machine
functionality to the ES56-PI.
ES56CV-PI, ES56CVH-PI: V.90 modem chipset solution plus Pereferal Component
Interconnect ("PCI") accelerated 16 or 32 bit stereo audio. ES56CVH-PI combines
the ES2818 Modem Analog Front End ("AFE"), ES1918 Audio Coder-Decoder ("CODEC"),
and ES1978M/Maestro-2EM into an integrated Audio-Modem solution. ES56CV-PI adds
the ES2890 Modem Digital Signal Processor ("DSP") to add DSP acceleration to
ES56CVH-PI.
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ES2828 SuperLINK(TM)-M: a single-chip V.90 Modem CODEC (compliant to MC-97
specification) ("MC'97") based Host Signal Processor ("HSP") controllerless
modem solution for data/fax/voice applications. ES2828 uses the AC-Link to
interface directly with a motherboard corelogic chipset without the need for a
dedicated modem DSP.
ES2838/ES2839 SuperLINK(TM)-M: a single-chip PCI V.90 HSP controllerless
modem solution for data/fax/voice applications. ES2838 interfaces with a
conventional transformer Data Access Arrangement ("DAA") while ES2839 provides
the option to interface with a solid-state DAA.
ES2841/ES2842 SuperLINK(TM)-MLP: a single-chip PCI 10/100 Ethernet LAN plus
V.90 HSP modem controller for network/data/fax/voice applications. ES2841
interfaces with a solid-state DAA while ES2842 provides the option to interface
with a conventional transformer DAA.
ES2845/ES2846 SuperLINK(TM)-MLP10: a triple-technology single-chip PCI
controller device that offers Home Phone Line Networking Alliance ("HPNA") 2.0
home-network interoperability, 10/100 Ethernet LAN network capability, and V.90
HSP modem data/fax/voice connectivity. The ES2845 interfaces to a solid-state
DAA while the ES2846 provides the option to interface with a conventional
transformer DAA.
VCD/SVCD Products
The Company's VCD/SVCD products provide consumer OEMs of VCD and SVCD
players with flexible system solutions. The VideoDrive products provide OEMs of
VCD players with a single-chip processor, which includes MPEG-1 video, audio and
system decoder. They deliver full-screen, full-motion video at 30 frames per
second with selectable CD-quality audio that can be combined with memory and
video/audio DACs.
ES3210: Single chip programmable VCD processor which includes MPEG-1
audio/video/system decoder for use in standalone and portable VCD
players. ES3210 is a single chip that supports MPEG-1 video decoding and
incorporates on-screen display, Karaoke functions, programmable playback
control, trick play mode features, an integrated Static Random Access Memory
("SRAM") and remote control interface logic in a smaller form factor, allowing a
more compact design.
ES3880: Single chip programmable VCD processor. ES3880 incorporates ES3210
features and functions with improved video quality.
ES3883: Analog companion chip. ES3883 provides echo, surround sound, 3D
audio, TV encoder with clock generation, audio DAC functions with HTML,
hyperlink and a graphic user interface.
ES4118: Single chip programmable SVCD processor, which includes MPEG-2
video and MPEG-1 audio. The ES4118 incorporates on-screen display, Karaoke
functions, programmable playback control, trick play mode features, integrated
remote control interface logic and a direct CD loader interface for small form
factor and cost effective design.
PC Audio Products
The Company's PC Audio Products enable PC manufacturers to provide audio
capabilities on add-in sound cards and directly on the motherboards of desktop
and notebook computers. The Company has established itself as a leader in
integrated audio solutions and counts many of the leading OEMs of PCs and sound
cards among its customers. These Audio Products are based on its audio
technologies, design methodologies, software and firmware expertise. The Company
has developed a proven set of Industry Standard Architecture ("ISA") and PCI
product solutions for the PC desktop and notebook markets.
The PC Audio ISA and PCI product families integrate ESFM(TM), a proprietary
Frequency Modulation ("FM") sound synthesis technology that produces superior
sound quality by enhancing traditional FM synthesis techniques, with hardware,
software and music database technology. ESS also utilizes its proprietary
advanced analog and mixed-signal design methodologies, together with its library
of audio semiconductor designs, to produce highly integrated mixed-signal audio
chips. ESS software technology is bundled as a part of its comprehensive
solution and consists of its PC Audio device drivers for Microsoft(R) Windows
2000(R), Windows ME(R), Windows 98(R), Windows 98SE(R), Windows 95(R), Windows
NT(R), Windows 3.1(R), IBM OS/2(R)
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Warp(R), DirectX(TM) PC games, and audio applications, including the ESS
AudioRack(TM) controller, an integrated graphical controller for the entire PC
audio system.
ISA PC Audio Products
ES692: a wavetable music synthesizer chip. ES692 includes reverb special
effects without the need for external Random Access Memory ("RAM"). With its
embedded microcontroller, ES692 supports General MIDI, providing for 128 melodic
instruments with ability to play back 32 voices of 16-bit data at a sampling
rate of 44.1kHz. Music is produced in high fidelity with the realism of a live
symphony orchestra. ES692 includes a 1MB wavetable Read Only Memory ("ROM") to
provide a complete wavetable solution. This internal ROM provides digitally
recorded sound samples of musical instruments.
ES1869: a single mixed-signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation, Zoom Video support, game
support and three-dimensional sound effect. ES1869 integrates digital logic, a
microcontroller with audio CODEC that includes ESFM synthesis and other analog
functions onto one chip. ES1869 is PC games compatible in Sand Blaster ("SB")
and SB Pro modes and is compatible with Microsoft(R) Windows(R) and other
operating systems. ES1869 provides full ISA plug-and-play support and includes
hardware volume control, 64-step volume control and dual game/joystick port for
game support. ES1869 supports full-duplex operation with simultaneous record and
playback with two Direct Memory Access ("DMA") channels and contains an I2S
interface to support Zoomed Video port for MPEG audio. It also integrates
circuitry to produce a three-dimensional sound effect from two speakers.
ES1879: a single mixed-signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation, Zoomed Video support,
telegaming and game support and three-dimensional sound effect. ES1879 combines
the features of ES1878 with I2S interface for Zoomed Video support, as well as
circuitry to produce 3-D sound effect from two speakers. ES1879 provides full
plug-and-play support and provides an interface to a docking station unit.
PCI PC Audio Products
ES1918: PCI audio CODEC. ES1918 is a single mixed-signal AC '97 CODEC and
mixer for a digital audio controller. ES1918 meets PC '99 and Audio CODEC '97
Rev. 1.03 specifications.
ES1920: PCI audio CODEC. ES1920 is a single mixed-signal AC '97 CODEC and
mixer for a digital audio controller. ES1920 meets PC '99 and Audio CODEC '97
Rev. 2.0 specifications.
ES1921: PCI audio CODEC. ES1921 is a single mixed-signal AC '97 CODEC and
mixer for a digital audio controller. ES1921 meets PC '99 and Audio CODEC '97
Rev. 2.1 specifications.
ES1938: a PCI single mixed-signal audio chip. ES1938 provides a single chip
PCI audio solution providing high-quality audio processing while maintaining
full legacy Disk Operating System ("DOS") game compatibility. ES1938 has 16-bit
stereo with 7 channel record and playback mixers and an integrated 3-D sound
effects processor.
ES1946: a PCI single mixed-signal audio chip with I2S interface. ES1946
combines the features of ES1938 with I2S interface for Zoomed Video port audio
and 3.3 Volt digital supply operation.
ES1948: a PCI digital audio accelerator. ES1948 provides enhanced audio,
utilizing the additional bandwidth provided by the PCI bus and taking advantage
of the Intel AC-97 architecture. ES1948 implements positional 3-D and 64 channel
hardware wavetable using system memory to dramatically improve the multimedia
gaming experience. ES1948 uses ESS proprietary technology called Time Division
Multiplex Access to provide legacy compatibility for DOS games, which is a
requirement for multimedia PCs.
ES1968: a PCI digital audio accelerator. ES1968 provides enhanced audio,
utilizing the additional bandwidth provided by the PCI bus and taking advantage
of the Intel AC-97 architecture. ES1968 implements positional 3-D using CRL's
Digital Ear(TM) and Sensaura(TM) 3-D audio technology to dramatically improve
the multimedia gaming experience. ES1968 implements 64 channel hardware
wavetable using system memory to reduce size, cost and host utilization while
increasing sound quality for Music Instrument Digital
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Interface ("MIDI"). ES1968 utilizes ACPI and small form factor to enable low
power designs for notebooks and motherboards. ES1968 also uses ESS proprietary
technology, Transparent Direct Memory Access to provide legacy compatibility for
DOS games, a requirement for multimedia PCs.
ES1968M: a PCI audio/modem combo solution. ES1968M provides the features of
ES1968 with a parallel modem interface to a modem DSP processor.
ES1978: a PCI digital audio accelerator. ES1978 provides the features of
ES1968 with an Electronically Erasable Programmable Read Only Memory ("EEPROM")
interface for system configuration and Sony/Phillips Digital Interface
("S/PDIF") output for interface to consumer stereo equipment.
ES1978M: a PCI audio/modem combo solution. ES1978M provides the features of
ES1978 in a 144-pin Thin Quad Flat Pack ("TQPF") package with a parallel modem
interface to a modem DSP processor.
ES1980: ES1980 takes ES1978 design, eliminates the internal Wave Processor
block (which transfers the wavetable music synthesis to the host
microprocessor), implements a faster internal DSP processor, and adds a second
AC link interface for audio-modem combination solutions.
ES1983: ES1983 provides the features of ES1980, plus adds a bi-directional
S/PDIF port for consumer electronics interface and Notebook/Docking Station
interface.
ES1989: a PCI single mixed-signal audio chip. ES1989 provides a single-chip
PCI audio solution, containing ES1980 digital audio processor plus an integrated
16-bit audio CODEC, and provides legacy compatibility for DOS games.
ES1988: a PCI single mixed-signal audio chip. ES1988 provides the features
of ES1989, plus I2S, input port for Zoomed Video port plus a second AC link for
Notebook/Docking interface.
ES1930: a PCI single mixed-signal audio chip. ES1930 provides the features
of ES1989 less joystick interface and less AC-link.
Canyon3D(TM): a high-performance audio chipset for multi-speaker PC Audio
configurations, especially for 4.1-speaker game audio and 5.1-speaker DVD audio
configurations. Canyon3D consists of ES1970-3D and ES1921 ESS products, plus
associated support chips supplied by third parties.
Canyon3D(TM)2: a single-chip high-performance audio accelerator for
multispeaker PC Audio configurations, such as 4.1-speaker game audio and
5.1-speaker DVD audio configurations. Canyon3D(TM)2 uses ES1992 chip with an
integrated quad-DAC AC-97 CODEC to immerse the listener in an extreme 3-D-audio
experience.
INTERNET SEGMENT
Vialta Internet Products
Vialta intends for its products to include home entertainment appliances,
media content portal, and Internet services. Vialta intends for its products to
provide an Internet experience that is personal, entertaining and user-friendly.
These products are currently in their development stage.
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CUSTOMERS
The Company sells its products principally to OEMs of PCs, PC-related
add-in boards and consumer electronics systems. The Company sells its product
through a direct sales force, distributors and manufacturer representatives. The
following table shows representative customers worldwide:
HONG KONG UNITED STATES TAIWAN JAPAN(1) ROW
--------- ------------- ------ -------- ---
Digital AV(3) Broadxent Acer Aiwa Daewoo
Dynax(2) Compaq Alpha-top Fujitsu Jabil Circuit
Pineview Hewlett-Packard Asustek Hitachi LG Electronics
Vnet IBM Clevo Kenwood Netgem
Solectron Compal Matsushita Pace
Tatung Telecom FIC NEC Philips
GVC Sanyo Samsung
Inventec Sharp
Labway Sony
Mitac Toshiba
Quanta
Twinhead
Weikeng(2)
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(1) Sales in Japan are made through a distributor.
(2) Distributors of the Company.
(3) Formerly Shinco.
A limited number of customers have accounted for a substantial portion of
the Company's net revenues. In 2000, 1999 and 1998 sales to the Company's top
five customers, including sales to distributors, accounted for approximately
56%, 53% and 54% respectively, of the Company's net revenues. In 2000, Dynax and
Digital AV accounted for approximately 34% and 10% respectively of the Company's
net revenues. In 1999, Dynax and Shinco accounted for approximately 22% and 13%
of the Company's net revenues. In 1998, Dynax and Shinco accounted for
approximately 16% and 15% of the Company's net revenues. The Company expects
that a limited number of customers may account for a substantial portion of the
net revenues for the foreseeable future.
SALES AND MARKETING
The Company sells and markets to leading PC and consumer OEM's worldwide.
The Company markets its products through its direct sales force, distributors
and manufacturer representatives.
International sales comprised approximately 93%, 95% and 92% in 2000, 1999
and 1998, respectively of the Company's net revenues. The Company's
international revenues in 2000, 1999 and 1998 have been derived primarily from
Asian customers who manufacture PCs, PC-related add-on boards and OEM's of VCD,
SVCD and DVD players. Suppliers in Asia manufacture a large percentage of the
worldwide supply of these products. ESS has direct sales personnel and technical
staff located in Hong Kong and Taiwan. A significant portion of the Company's
Asian sales has been to customers located in Hong Kong and Taiwan. See "Factors
That May Affect Future Results -- International Operations." The Company's
products are also sold internationally through distributors and manufacturer
representatives located in Japan, China, Korea, Singapore, Germany and India.
The Company's manufacturer representatives and distributors are not subject to
minimum purchase requirements and can discontinue marketing any of the Company's
products at any time. In addition, certain of the Company's manufacturer
representatives, distributors and customers typically have certain rights of
return for unsold product and rights to pricing allowances to compensate for
rapid, unexpected prices changes. See "Factors That May Affect Future Results --
Customer Concentration."
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The Company believes that customer service and technical support are
important competitive factors in selling to major customers. The Company
provides technical support to its customers. Manufacturer representatives and
distributors supplement the Company's efforts by providing additional customer
service at the local level. The Company believes that close contact with its
customers not only improves the customers' level of satisfaction, but also
provides important insight into future market direction.
Sales of the Company's products are generally made pursuant to standard
purchase orders, which are frequently revised to reflect changes in the
customer's requirements. Product deliveries are scheduled upon the Company's
receipt of purchase orders. Generally, these purchase orders allow customers to
reschedule delivery dates and cancel purchase orders without significant
penalties. For these reasons, the Company believes that its backlog, while
useful for scheduling production, is not necessarily a reliable indicator of
future revenues. See "Factors That May Affect Future Results -- Potential
Fluctuations in Operating Results."
RESEARCH AND DEVELOPMENT
In order to compete successfully, the Company believes that it must
continually design, develop and introduce new products that take advantage of
market opportunities and address emerging technical standards. The Company's
strategy is to leverage its base of design expertise, analog, digital and
mixed-signal design capabilities and process technologies, and software and
systems expertise to develop audio, communication and video solutions for the
Internet, PC and consumer marketplace. ESS has in the past acquired and in the
future will consider acquiring technology and product lines to enhance its own
product offerings and to accelerate its time-to-market. The Company intends to
continue to provide comprehensive multimedia solutions for its customers by
developing state-of-the-art semiconductor chips, device drivers, firmware, and
application software in its chosen markets.
The Company utilizes a design environment based on workstations, dedicated
product simulators, system simulation with hardware and software modeling, and a
high level design description language. The Company invests regularly in new
advanced equipment and software tools and intends to maintain and enhance its
library of core cells.
At February 22, 2001, ESS including its subsidiary, Vialta, had a staff of
approximately 296 research and development personnel, 196 in the United States,
21 in Asia and 79 in Canada. In addition, ESS has engaged outside developers to
develop certain technologies to the Company's specifications and intends to
continue to utilize outside developers in the future. During 2000, 1999 and 1998
the Company spent approximately $47.2 million, $37.4 million and $30.5 million
respectively, on research and development activities, excluding a one-time pre
and post-tax charge of $2.6 million related to acquired research and development
in-process from the acquisition of NetRidium Communications, Inc. ("NetRidium")
in the first quarter of 2000. In February 2000, the Company acquired all of the
outstanding shares and vested stock options of NetRidium and retained all its
employees. At the time of acquisition, NetRidium was a development stage company
that develops broadband communication products enabling high-speed networking
over existing phone lines in the home.
In April 1999, the Company established a subsidiary, Vialta, that develops
and plans to market advanced, user-friendly products and applications for the
Internet. The Company currently owns 62.1% of Vialta. At February 22, 2001,
Vialta had a staff of 131 in research and development, including 53 in the
United States, 71 in Canada and 7 in Hong Kong. During 2000, and 1999 Vialta
spent approximately $19.6 million and $1.4 million respectively, on research and
development activities. In October 1999, Vialta entered into an agreement with
EnReach Technology for the acquisition of EnReach website software. As part of
the agreement, eight contract engineers were transferred from EnReach's Canadian
office to Vialta as regular fulltime employees. In December 1999, Vialta
established a wholly owned subsidiary Vcom Canada Holdings, which operates a
branch office in Toronto as a research and development center for Vialta portal
development.
The Company may continue to use cash and equity to acquire or invest in
complementary businesses or products or to obtain the right to use complementary
technologies. From time to time, in the ordinary course of business, the Company
may evaluate potential acquisitions of or investments in such businesses,
products or technologies owned by third parties.
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MANUFACTURING
The Company contracts with independent foundries and assembly and test
service providers to manufacture all of its products. This manufacturing
strategy enables the Company to focus on its design strengths, minimize fixed
costs and capital expenditures and gain access to advanced manufacturing
capabilities. Semiconductor manufacturing consists of foundry activity where
wafer fabrication takes place, and assembly and test activities. Two independent
foundries that use advanced manufacturing technologies perform wafer
fabrication. A substantial majority of the Company's products are manufactured
by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC"), which has
manufactured certain of the Company's products since 1989. The Company also has
a foundry arrangement with United Microelectronics Corporation ("UMC") in
Taiwan. Most of the Company's devices are currently fabricated using both
mixed-signal and logic CMOS 0.35 to 0.25 micron process technologies.
The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs and to
produce products of acceptable quality and with acceptable manufacturing yields
in a timely manner. These foundries fabricate products for other companies and
manufacture products of their own design. In November 1995, the Company entered
into long-term agreements with TSMC and UMC. Under the TSMC Agreement, in
exchange for TSMC's increased wafer capacity commitments, the Company committed
to pay approximately $32 million during 1996 and 1997 as deposits for wafers
through 1999. The cash requirements associated with this agreement were two $16
million payments due June 30, 1996 and 1997. The Company issued two promissory
notes totaling $32 million securing these payments, which were cancelled
subsequent to the payments in 1996 and 1997. The payments were applied in full
to offset wafers purchased from 1996 to 1999. In December 2000, the Company
secured wafer capacity that it believes will be adequate to meet its forecast
for the next 12 months.
Under the Company's agreement with UMC, the Company entered into a joint
venture arrangement with UMC and other U.S. semiconductor companies to build a
separate semiconductor manufacturing facility to be located in Taiwan at an
estimated cost of $1 billion. The Company has invested approximately $24.6
million in this joint venture. Under the terms of the agreement, the Company
received approximately a 5% equity ownership in the joint venture company and
capacity rights. On October 17, 1998, the Company entered into an agreement with
UMC to sell UMC approximately 63.8 million shares of the joint venture for a
purchase price of $22.4 million dollars. On April 8, 1999, the Company sold its
remaining 6 million shares of stock of the joint venture at book value for a
purchase price of $2.2 million. The Company received the cash on April 30, 1999.
All of the Company's semiconductor products are assembled and tested by
third-party vendors, primarily Advanced Semiconductor Engineering, OSE, and
Sampo Semiconductor in Taiwan. The Company has internally designed and developed
its own test software and certain test equipment, which are provided to the
Company's test vendors. Shortages of raw materials or disruptions in the
provision of services by the Company's assembly vendors could lead to supply
constraints or delays in the delivery of the Company's products. Such
constraints or delays might result in the loss of customers, limitations or
reductions in the Company's revenues or other material adverse effects on the
Company's business, financial condition and results of operations. The Company's
reliance on third-party assembly and testing vendors involves a number of other
risks, including reduced control over delivery schedules, quality assurance and
costs. The inability of such third parties to deliver products of acceptable
quality and in a timely manner could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Factors
That May Affect Future Results -- Dependence on TSMC and Other Third Parties"
and "-- International Operations."
BACKLOG
Sales are made primarily pursuant to standard short-term purchase orders
for delivery of standard products. The quantity actually ordered by the
customer, as well as the shipment schedules, are frequently revised to reflect
changes in the customer's needs. Accordingly, while the dollar amount of backlog
orders is not firm, we believe that our backlog at any given time is not a
meaningful indicator of future revenues.
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COMPETITION
The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, price reductions and rapid product
obsolescence. Competition typically occurs at the design stage, where the
customer evaluates alternative design approaches that require integrated
circuits. Because of shortened product life cycles and even shorter design-in
cycles, the Company's competitors have more frequent opportunities to achieve
design wins in next-generation systems. The Company currently competes with
add-on card suppliers and other semiconductor manufacturers. The Company expects
competition to increase in the future from existing competitors and from other
companies that may enter the Company's existing or future markets with products
that may be at lower costs or provide higher levels of integration, higher
performance or additional features. The Company is unable to predict the timing
and nature of any such competitive product offerings. The announcement and
commercial shipment of competitive products could adversely affect sales of the
Company's products and may result in increased price competition that would
adversely affect the average selling prices ("ASPs") and margins of the
Company's products. In general, product prices in the semiconductor industry
have decreased over the life of a particular product. The markets for most of
the applications for the Company's products are characterized by intense price
competition. The willingness of prospective customers to design the Company's
products into their products depends to a significant extent upon the ability of
the Company to sell its products at a price that is cost-effective for such
customers. As the markets for the Company's products mature and competition
increases, the Company anticipates that prices for its products will continue to
decline. If the Company is unable to reduce its costs sufficiently to offset
declines in product prices or is unable to introduce more advanced products with
higher product prices, the Company's business, financial condition and results
of operations would be materially adversely affected. See "Factors That May
Affect Future Results -- Potential Fluctuations in Operating Results."
The Company's existing and potential competitors consist principally of
large domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources, greater intellectual property rights, broader product lines and
longer-standing relationships with customers than the Company. The Company's
competitors also include a number of smaller and emerging companies. The
Company's principal PC audio competitors include Cirrus Logic, Creative
Technology and Yamaha. The Company's principal video (including VCD/SVCD and
DVD) competitors include C-Cube Microsystems, Winbond, LSI Logic, National
Semiconductor, Zoran and SGS Thomson. The Company's principal communication
competitors include Lucent Technologies, PC-Tel, Conexant, 3Com and Texas
Instruments. The Company's principal Internet-related semiconductor competitors
include National Semiconductor, Zoran and LuxSonor.
Certain of the Company's current and potential competitors maintain their
own semiconductor fabrication facilities and may therefore benefit from certain
capacity, cost and technical advantages. The Company believes that its ability
to compete successfully depends on a number of factors, both within and outside
of its control, including the price, quality and performance of the Company's
and its competitors' products, the timing and success of new product
introductions by the Company, its customers and its competitors, the emergence
of new multimedia standards, the development of technical innovations, the
ability to obtain adequate foundry capacity and sources of raw materials, the
efficiency of production, the rate at which the Company's customers design the
Company's products into their products, the number and nature of the Company's
competitors in a given market, the assertion of intellectual property rights and
general market and economic conditions. There can be no assurance that the
Company will be able to compete successfully in the future.
Each successive generation of microprocessors has provided increased
performance, which could result in microprocessors capable of performing
multimedia functions. In this regard, Intel Corporation includes MMX
Instructions (Multimedia Extensions) in its current generation of
microprocessors, which improve the microprocessor's performance for graphics,
image processing and data computation applications. Intel is promoting the
processing power of the Pentium-III processor for data and signal intensive
functions such as graphics acceleration and other multimedia functions. The
microprocessor still requires analog and mixed-signal interface chips, such as
ESS-supplied IC products, to complete a multimedia subsystem, however there
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can be no assurance that the increased capabilities of microprocessors will not
adversely affect demand for the Company's products. See "Factors That May Affect
Future Results -- Importance of New Products and Technological Changes."
The markets in which Vialta will compete are intensely competitive and are
characterized by rapid technological change. The consumer electronics markets in
which Vialta expects to compete are often marked by price reductions and rapid
product obsolescence. The principal competitive factors in our primary markets
are product performance, ease of use and functionality, availability and quality
of content, name recognition and pricing.
PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trademarks, copyrights,
trade secret laws and confidentiality procedures to protect its intellectual
property rights. As of December 31, 2000, the Company had 14 patents granted in
the United States, two patents expired in the year 2000, and the rest are going
to expire over time commencing in 2001 and ending in 2019. In addition the
Company has 13 corresponding foreign patents, two of which expired in the year
2000. The Company has several patent applications pending and has a continuous
program and intent to seek further United States and international patents on
its technology whenever possible. However, there can be no assurance that
patents will be issued from any of the Company's pending applications or
applications in preparation or that any claims allowed from pending applications
or applications in preparation will be of sufficient scope or strength, or be
issued in all countries where the Company's products can be sold, to provide
meaningful protection or any commercial advantage to the Company. Also,
competitors of the Company may be able to design around the Company's patents.
The laws of certain foreign countries in which the Company's products are or may
be designed, manufactured or sold, including various countries in Asia, may not
protect the Company's products or intellectual property rights to the same
extent as do the laws of the United States and thus make the possibility of
piracy of the Company's technology and products more likely. Although the
Company is not aware of the development, distribution or sales of any illegal
copies of the Company's hardware or software, any infringements of its patents,
copyrights or trademarks, or any violation of its trade secrets, confidentiality
procedures or licensing agreements to date, there can be no assurance that the
steps taken by the Company to protect its proprietary information will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which have resulted in
significant and often protracted and expensive litigation. As of December 31,
2000, there were several pending intellectual property litigation against the
Company for which the Company believes it has adequate reserves. (See Item 3.
Legal Proceedings) However, the Company or the independent foundries used by the
Company may from time to time receive notice of claims that the Company has
infringed patents or other intellectual property rights owned by others. The
Company may seek licenses under such patents or other intellectual property
rights. However, there can be no assurance that licenses will be offered or that
the terms of any offered licenses will be acceptable to the Company. The failure
to obtain a license from a third party for technology used by the Company could
cause the Company to incur substantial liabilities and to suspend the
manufacture of products or the use by the independent foundries used by the
Company of processes requiring the technology. Furthermore, the Company may
initiate claims or litigation against third parties for infringement of the
Company's proprietary rights or to establish the validity of the Company's
proprietary rights. Litigation by or against the Company could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation results in a
favorable determination for the Company. In the event of an adverse result in
any such litigation, the Company could be required to pay substantial damages,
cease the manufacture, use and sale of infringing products, expend significant
resources to develop non-infringing technology, discontinue the use of certain
processes or obtain licenses for the infringing technology. There can be no
assurance that the Company would be successful in such development or that such
licenses would be available on reasonable terms, or at all, and any such
development or license could require expenditures by the Company of
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substantial time and other resources. Although patent disputes in the
semiconductor industry have often been settled through cross-licensing
arrangements, there can be no assurance that in the event that any third party
makes a successful claim against the Company or its customers, a cross-licensing
arrangement could be reached. In such a case, if a license is not made available
to the Company on commercially reasonable terms, the Company's business,
financial condition and results of operations could be materially adversely
affected.
The Company currently licenses certain of the technology utilized by the
Company in its products, and expects to continue to do so in the future. The
Company has in the past granted licenses to certain of its technology, some of
which have expired, such licenses have been limited and the Company has not
derived material revenues from such licenses in recent periods. See "Factors
That May Affect Future Results -- Uncertainty Regarding Patents and Protection
of Proprietary Rights."
EMPLOYEES
As of February 22, 2001, the Company excluding its subsidiary Vialta had
approximately 436 full-time employees, including 165 in research and
development, 151 in marketing, sales and support, and 120 in operations, finance
and administration. The Company's subsidiary Vialta had approximately 213
employees, including 131 in research and development, 30 in marketing, sales and
support, and 31 in operations, finance and administration. The Company's future
success will depend, in part, on its ability to continue to attract, retain and
motivate highly qualified technical and management personnel, particularly
highly skilled semiconductor design personnel and software engineers involved in
new product development, for whom competition is intense. The Company's
employees are not represented by any collective bargaining unit, and the Company
has never experienced a work stoppage.
The loss of the services of key personnel could have a material adverse
effect on the Company's business. The Company is currently seeking certain
additional engineering, marketing and management personnel. The Company's
success in the future will depend in part on the successful retention of
existing key personnel and the successful assimilation of new personnel. The
Company also obtains assistance from customers whose engineers participate in
development programs with the Company. The continuing availability of such
support is dependent upon a number of factors, including relationships with
customers and the ability of such engineers, many of who are foreign residents,
to obtain immigration visas. The competition for key personnel, particularly
engineering personnel, is intense and the loss of such personnel could have a
material adverse effect on the Company. See "Factors That May Affect Future
Results -- Dependence on Key Personnel."
ITEM 2. PROPERTIES
At the end of 1995 ESS purchased 16 acres of land in Fremont, California.
By the end of 1996, the Company completed and occupied a two-story, 93,000
square-foot headquarters. In 1998, the Company completed construction of a
77,000 square-foot building to support headcount growth, which is now being
occupied by Vialta. In addition an 11,000 square-foot dormitory was completed in
1998 to house visitors and guest workers. In October 2000, the Company sold 4.32
acres of un-used land in Fremont, California. The Company also maintains leased
office space in various locations. The Company believes that its existing
facilities and equipment are adequate to meet its current requirements. See
"Notes to Consolidated Financial Statements -- 9. Commitments and
Contingencies."
ITEM 3. LEGAL PROCEEDINGS
On April 27, 1999, Dollinger-Fremont Associates named the Company and one
other defendant in a complaint in the Superior Court of California, County of
Alameda, Case No. H206962-7. The complaint alleges breach of contract in
connection with a contract for the sale of certain property to the plaintiff and
seeks specific performance requiring the Company to convey the property, as well
as damages for lost profits, expenses arising from delay and attorney's fees. On
April 21, 2000, the parties reached a settlement of the case, which includes the
sale of the land to the plaintiff. The sale of the land resulted in a one-time
gain for the Company. The parties finalized the settlement agreement in October
of 2000.
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On April 9, 1999, the Company filed a complaint in the United States
District Court for the Northern District of California, No. C-99 20292 RMW,
against PC-Tel, Inc., alleging violations of the antitrust laws and other claims
relating to PC-Tel's failure to provide a license to the Company covering
certain patents that PC-Tel maintains are essential to the manufacture and sale
of modems. Among other things, the complaint alleges that through its
relationship with an industry standards organization, PC-Tel has an obligation
to offer such patents for license to anyone on a reasonable and
non-discriminating basis, and that it has failed to do this with respect to ESS.
On August 7, 2000, PC-Tel filed an answer and cross-complaint alleging
infringement of such patents, and in an amended cross-complaint filed October 4,
2000 it has asserted infringement of three additional patents. The
cross-complaints seek unspecified damages and include claims of willful
infringement. The Company believes that it has adequate defenses to the PC-Tel
counterclaims. The case is in the early discovery stage and has not been set for
trial.
On September 15, 2000, the Company was named, along with another
respondent, in a complaint filed by PC-Tel with the International Trade
Commission, requesting exclusion orders and other relief directed at products
imported into the United States which contain the Company's modem products
alleged to infringe two of the patents which also have been asserted in the
district court action, but which are described by PC-Tel as not essential to the
manufactured and sale of modems pursuant to industry standards. On October 18,
2000, the International Trade Commission initiated an investigation into the
matter. The action is in the final stages of discovery, there is a third
Settlement Conference scheduled for May 18, 2001, and a trial date set for May
30, 2001. The Company believes that it does not infringe any valid claim of
either of the patents asserted by PC-Tel.
In October of 1999, Gateway, Inc. filed suit against the Company in United
States District Court for the Northern District of California, alleging that the
name "SOLO" designating one of the Companies computer chips infringed on a
Gateway registered trademark used for their laptop computers. Prior to the suit
being filed, the Company voluntarily removed from all of its products and
materials any references to the trademark, however Gateway proceeded with filing
the action. The complaint filed by Gateway asserted claims for federal and state
trademark infringement and trademark dilution against the Company. The parties
attended a non-binding mediation in June 2000 however no settlement was reached.
This matter is in pretrial discovery with a trial date set for October 2001. The
Company believes no infringement has occurred and will vigorously defend the
litigation. The Company is engaged in settlement negotiations.
On December 8, 1999, the Company filed an action against Grubb & Ellis
Company, David Fukuda, and Thomas B. Taylor in the Superior Court for the County
of Alameda, State of California, Case Number H210698-6, asserting claims for
negligence, breach of fiduciary duty, and equitable indemnity in connection with
the defendants' conduct as real estate brokers for the Company. On April 5,
2000, Grubb & Ellis filed a counterclaim for breach of contract, contribution,
indemnity and declaratory relief, seeking payment of real estate commissions. In
December of 2000, the parties negotiated and entered into a comprehensive
settlement agreement providing for payment of reduced commissions to Grubb &
Ellis and mutual releases of the other parties. Performance of the settlement
agreement has been completed by all parties, and dismissals to the complaint and
counterclaim were filed on January 25, 2001.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2000.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the Company's
current executive officers:
NAME AGE POSITION
---- --- --------
Fred S.L. Chan............................ 54 Chairman of the Board of Directors of the Company,
President, Chief Executive Officer and Chairman of
the Board of Directors of Vialta
Robert L. Blair........................... 53 President, Chief Executive Officer and Director
James B. Boyd............................. 48 Chief Financial Officer, Chief Accounting Officer
and Assistant Secretary
Frank Effler Jr. ......................... 54 Vice President of Worldwide Sales
William K. Wong........................... 53 Vice President of Marketing
The following provides certain additional information regarding the
Company's current executive officers:
Mr. Chan has been Chairman of the Board of Directors of the Company since
October 1992 and has been President, Chief Executive Office and Chairman of the
Board of Directors for Vialta since September 1999. Mr. Chan joined the Company
in November 1985 as President and served as such until October 1996 and then
began to serve as President again from February 1997 to September 1999. Mr. Chan
has been a director since January 1986. He was appointed Chairman of the Board
of Directors in October 1992 and Chief Executive Officer in June 1994 and served
as Chief Executive Officer until September 1999. Mr. Chan served as Secretary of
the Company from October 1992 to August 1995 and its Chief Financial Officer
from October 1992 to May 1995. From 1984 to 1985, Mr. Chan was founder,
President and Chief Executive Officer of AC Design, Inc., a VLSI chip design
center providing CAD, engineering and design services. From 1982 to 1984, he was
co-founder, President and Chief Executive Officer of CADCAM Technology, Inc., a
company in the business of CAE systems development. Mr. Chan holds B.S.E.E. and
M.S.C. degrees from the University of Hawaii. Mr. Chan is the husband of Annie
M. H. Chan, a director of the Company.
Mr. Blair has been President and Chief Executive Officer since September
1999. Mr. Blair was elected as director in October 1999. Mr. Blair served as
Executive Vice President, Operations of the Company from April 1997 to September
1999. From December 1994 to March 1997, he was Vice President of Operations of
the Company. From December 1991 to November 1994, he was Senior Vice President
Operations (Software Packaging & Printing Division) of Logistix Corporation, a
software turnkey company, and from 1989 to November 1991, he was Vice President
and co-owner of Rock Canyon Investments, a real estate development-planning firm
in California. From 1986 to 1989, he held various positions at Xidex
Corporation, a computer diskette manufacturer, including President/General
Manager, at XEMAG, a division of Xidex Corporation. From 1973 to 1986 he was
Vice President, High Reliability Operations at Precision Monolithics, Inc.
Mr. Boyd was appointed Chief Financial Officer and Chief Accounting Officer
in August 2000. Mr. Boyd was also elected as Assistant Secretary in August 2000.
Prior to joining ESS, Mr. Boyd served from March 1998 until July 2000 as Chief
Financial Officer of Gatefield Corporation, a Fremont-based manufacturer of
field programmable electronic circuits used in PC's and consumer electronics.
From August of 1997 until January of 1998 he was Chief Financial Officer of
AirMedia, a developer of wireless communications software and from March of 1996
until August of 1997 he was Corporate Controller at Farallon Communications. He
has also held senior management positions with Fritz Companies, GTE Sprint
Communications and Southern Pacific Companies. Mr. Boyd holds a B.S. degree in
accounting and an MBA in finance from the University of Wisconsin -- Madison,
and a J.D. from Golden Gate University.
Mr. Effler Jr. was promoted to Vice President of Worldwide Sales in January
2001. Mr. Effler Jr. was Vice President, Sales and Marketing -- PC Products of
the Company from April 1998 until January 2001. From October 1993 to March 1998,
he was Director of Sales and Marketing, Flat Panel Display Division at Hitachi
America, Ltd. From April 1992 to September 1993, he was Area Sales Manager of
the western United States at Hitachi America Ltd. From 1988 to 1992, he was a
regional sales manager for Toshiba
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America Electronic Components. Mr. Effler holds a B.A. degree from California
State University at Northridge.
Mr. Wong was appointed Vice President of Marketing in January 2001. From
April 2000 to January 2001, he was Vice President of Marketing at Synaptics.
From April 1998 to April 2000, he was the Vice President of Marketing at Sigma
Designs. From April 1995 to April 1998, he served as Director of Asia Pacific
Business Development at National Semiconductor. From April 1993 to April 1995,
he was the Vice President of Marketing at Diamond Multimedia Systems. From April
1975 to April 1993, Mr. Wong held senior engineering, marketing and management
positions with Intel Corporation. Mr. Wong holds a B.S. degree in Electrical
Engineering and Computer Science from University of California-Berkeley, and a
M.S. in Electrical Engineering and Computer Science as well as an MBA from Santa
Clara University.
The information concerning compliance with Section 16 of the Securities
Exchange Act of 1934 is incorporated by reference to the section in the
Company's proxy statement entitled "Compliance under Section 16(a) of the
Securities Exchange Act of 1934."
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's Common Stock has been trading on the Nasdaq National Market
under the symbol "ESST" since October 6, 1995. The following table sets forth
the high and low last reported sales prices for the Common Stock as reported by
the Nasdaq National Market during the period indicated.
HIGH LOW
---- ---
FISCAL 1999:
First Quarter ended March 31, 1999........................ 8 1/16 4 15/16
Second Quarter ended June 30, 1999........................ 13 7/16 5 3/32
Third Quarter ended September 30, 1999.................... 15 7/8 11 1/8
Fourth Quarter ended December 31, 1999.................... 23 1/16 12 1/8
FISCAL 2000:
First Quarter ended March 31, 2000........................ 25 15
Second Quarter ended June 30, 2000........................ 16 7/8 10 3/4
Third Quarter ended September 30, 2000.................... 18 5/16 13 3/16
Fourth Quarter ended December 31, 2000.................... 16 1/2 4 31/32
As of February 22, 2001, there were approximately 218 record holders of the
Company's Common Stock. Since most shareholders are listed under their brokerage
firm's names, the actual number of shareholders is higher.
The issuance of securities in this Item 5 was deemed to be exempt from
registration under the Securities Act of 1933, as amended (the "Act"), in
reliance on Section 4(2) of the Act as a transaction by an issuer not involving
any public offering. The recipients of the securities in such transaction
represented their intention to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and
appropriate legends were affixed to the securities issued in such transaction.
The recipients were given adequate access to information about the Company.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues................................ $303,436 $310,651 $218,252 $249,517 $226,455
Cost of revenues............................ 192,452 191,529 182,417 171,859 106,818
-------- -------- -------- -------- --------
Gross profit.............................. 110,984 119,122 35,835 77,658 119,637
Operating expenses:
Research and development.................. 47,229 37,383 30,529 29,471 20,270
In-process research and development....... 2,625 -- -- 22,200 30,355
Selling, general and administrative....... 46,123 39,735 36,289 25,198 16,814
-------- -------- -------- -------- --------
Operating income (loss)..................... 15,007 42,004 (30,983) 789 52,198
Nonoperating income, net.................... 47,816 5,178 1,478 2,183 3,241
-------- -------- -------- -------- --------
Income (loss) before income taxes........... 62,823 47,182 (29,505) 2,972 55,439
Provision for (benefit from) income taxes... 22,946 7,077 (1,489) 13,838 33,813
-------- -------- -------- -------- --------
Net income (loss) before minority
interest.................................. 39,877 40,105 (28,016) (10,866) 21,626
Loss attributable to minority interest...... (8,429) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss)........................... $ 48,306 $ 40,105 $(28,016) $(10,866) $ 21,626
======== ======== ======== ======== ========
Net income (loss) per share:
Basic..................................... $ 1.14 $ 0.99 $ (0.68) $ (0.27) $ 0.57
======== ======== ======== ======== ========
Diluted(1)................................ $ 1.05 $ 0.88 $ (0.68) $ (0.27) $ 0.52
======== ======== ======== ======== ========
Shares used in calculating net income (loss)
per share:
Basic..................................... 42,548 40,640 40,955 39,593 37,702
======== ======== ======== ======== ========
Diluted(1)................................ 45,943 45,625 40,955 39,593 41,588
======== ======== ======== ======== ========
DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA(2):
Cash, cash equivalents and short-term
investments -- ESS........................ $ 58,838 $ 68,687 $ 82,471 $ 42,284 $ 69,204
Cash, cash equivalents and short-term
investments -- Vialta..................... 136,490 112,844 -- -- --
Working capital............................. 248,015 197,148 81,124 74,238 65,207
Total assets................................ 400,964 320,513 214,645 231,654 211,985
Long-term debt, less current portion........ -- -- -- -- --
Minority interest in Vialta................. 73,629 52,860 -- -- --
Total shareholders' equity.................. $211,429 $183,579 $142,072 $171,107 $143,176
- ---------------
(1) See Note 6 of Notes to Consolidated Financial Statements for an explanation
of shares used in calculating net income (loss) per share -- diluted.
(2) Certain reclassifications have been made in prior year balance sheets to
conform to the 2000 presentation.
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ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this report contains forward-looking statements that
involve risks and uncertainties. The statements contained in this report that
are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. The Company's
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in "Factors That May Affect Future Results," as well as those
discussed in this section and elsewhere in this Report, and the risks discussed
in the Company's Securities and Exchange Commission filings.
OVERVIEW
ESS designs, develops, manufactures and markets highly integrated
mixed-signal semiconductor products including digital video, audio and
communications chips for sale to the Internet, PC and consumer marketplace. In
April 1999, the Company established a subsidiary, Vialta, which designs and
plans to manufacture and market advanced, user-friendly products and
applications for the living room environment. ESS holds 62.1% of the outstanding
capital stock of Vialta on a fully diluted basis as of December 31, 2000. In
2000, ESS had revenues totaling $303.4 million, a 2% decrease from the 1999
total of $310.7 million and a 39% increase from the 1998 total of $218.3
million. Net income (including $35.0 million pretax gain on sale of investments)
increased to $48.3 million in 2000 from a net income of $40.1 million in 1999,
which compares to a net loss of $28.0 million in 1998. The gross margin for 2000
was 36.6%. The decrease in gross margin compared to 1999 was primarily due to an
increase in ESS's inventory reserves. The gross margin for 1999 was 38.3%,
reflecting favorable product mix and manufacturing cost reductions, offset in
part by decreased average selling price due to price competition. The gross
margin in 1998 was 16.4%.
In February 2000, the Company acquired all of the outstanding shares and
vested stock options of NetRidium for $5.3 million in cash. NetRidium is a
development stage company, which develops broadband communication products
enabling high-speed networking over existing phone lines in the home. The
acquisition was recorded using the purchase method of accounting and
accordingly, the results of operations and cash flows of such acquisition have
been included from date of acquisition. See "Notes to Consolidated Financial
Statements -- Note 11 Acquisitions and Related Charges."
The Company is one of the leaders in semiconductor products for the VCD,
DVD and MP3 player marketplace. In 1997, the Company introduced its first MPEG-2
video chip solution, a fully programmable, single-chip processor that
incorporates the additional features needed for consumer electronics
applications such as DVD players, set-top boxes, multimedia PCs and home
entertainment units.
The Company is a strong competitor in semiconductor products for the
communications marketplace. The Communication Products for the Internet and
other modem markets were developed following the Company's first quarter of 1996
acquisition of OSEE. In 1997, the Company began shipment of V.34bis modem
solutions and introduced the V.90 56K modem solutions. The Company is currently
shipping both V.34bis and V.90 56K modem solutions.
The Company is one of the leaders in semiconductor audio products for the
PC marketplace. ESS' PC Audio Products enable PC manufacturers to provide audio
capabilities on add-on sound cards and directly on the motherboards of desktop
and notebook computers. The Company has established itself as a leader in
integrated audio solutions and counts many of the leading manufacturers of PCs
and sound cards among its customers.
The Company has not experienced any material impact of inflation in the
past. There can be no assurance, however, that any future inflation would not
have any adverse impact on its net sales, revenue and income from operations.
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At the end of 1995, the Company purchased 16 acres of land in Fremont,
California. By the end of 1996, the Company completed and occupied a two-story,
93,000 square-foot headquarters. In 1998, the Company completed construction of
a 77,000 square-foot building to support headcount growth, which is now being
occupied by the Company's majority owned subsidiary Vialta. An 11,000
square-foot dormitory was also completed during 1998. In October 2000, the
Company sold 4.32 acres of un-used land in Fremont, California.
During the fourth quarter of 1997, the Company established a wholly owned
foreign subsidiary in the Cayman Islands, British West Indies and transferred a
substantial portion of its business operations to it. In April 1999, the Company
established a subsidiary, Vialta, that plans to introduce advanced,
user-friendly products and applications for the Internet. Vialta completed its
equity financing generating a total of $144.2 million. ESS contributed $62.1
million cash in the Vialta equity offering and acquired a 62.1% ownership in
Vialta as of December 31, 2000.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data as a percentage of net revenues for the periods indicated:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
------ ------ ------
Net revenues................................................ 100.0% 100.0% 100.0%
Cost of revenues............................................ 63.4 61.7 83.6
----- ----- -----
Gross margin.............................................. 36.6 38.3 16.4
Operating expenses:
Research and development.................................. 15.6 12.0 14.0
In-process research and development....................... 0.9 0.0 0.0
Selling, general and administrative....................... 15.2 12.8 16.6
----- ----- -----
Operating income (loss)..................................... 4.9 13.5 (14.2)
Nonoperating income, net.................................... 15.8 1.7 0.7
----- ----- -----
Income (loss) before income taxes........................... 20.7 15.2 (13.5)
Provision for (benefit from) income taxes................... 7.6 2.3 (0.7)
----- ----- -----
Net income (loss) before minority interest.................. 13.1 12.9 (12.8)
Loss attributable to minority interest...................... (2.8) 0.0 0.0
----- ----- -----
Net income (loss)........................................... 15.9% 12.9% (12.8)%
===== ===== =====
Net Revenues. Net revenues were $303.4 million, $310.7 million and $218.3
million in 2000, 1999 and 1998, respectively. Net revenues decreased 2% between
2000 and 1999 primarily due to the softness in the PC marketplace and a decrease
in ASP in the audio markets. In 2000, the Company's communication and video
business grew while PC audio business declined; the Company expects these trends
to continue. Company's majority owned subsidiary Vialta did not record any
revenue in 2000, since its products are still in the development stage. Net
revenues increased 42% between 1999 and 1998 primarily from increased video
sales. The Company's video sales accounted for a majority and the Company's PC
audio sales accounted for a significant portion of the Company's net revenue in
2000. The Company's video sales and PC audio sales accounted for a significant
portion of the Company's net revenues in 1999. The Company's PC audio products
accounted for a majority of the Company's net revenues in 1998. International
revenues accounted for approximately 93%, 95%, and 92% of net revenues for 2000,
1999 and 1998, respectively. The Company's net revenues are denominated in U.S.
dollars. The Company expects that its percentage of international sales will
remain high in the future.
For the first time, the Company had a stronger third quarter than fourth
quarter in the digital video products. The shift resulted from many of the
Company's China OEMs (The Company's products are sold through Company's
distributors.) now building the majority of their products for export, and thus
the worldwide Christmas season demand has made the third quarter the Company's
largest revenue quarter as opposed to the later demand typical in China based on
the Chinese New Year season during the fourth
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quarter. The Company expects this trend to continue as more of its products are
exported out of China to worldwide customers.
Gross Margin. Gross profit was $111.0 million, $119.1 million and $35.8
million in 2000, 1999 and 1998, respectively, representing corresponding gross
margins of 36.6%, 38.3% and 16.4% of net revenues for such years. The decrease
in gross margin from 1999 to 2000 was primarily due to an increase of $8.9
million in inventory reserves in 2000. During the quarters ended September 30,
2000 and December 31, 2000, the Company purchased inventory based on the
Company's original sales forecast and the Company's intent to build up inventory
on key products from its foundries due to a forecasted tight wafer capacity.
However, during the quarter ended December 31, 2000, the overall market for PC
Audio products declined significantly, and, as a result, the demand for these
products did not meet the Company's forecasts. On a pro-forma basis, before
recognition of the additional $8.9 million inventory reserve, the gross margin
would have been 39.5% for 2000 compared to 38.3% for 1999. On the pro-forma
basis, the increase in gross margin from 1999 to 2000 was primarily due to
favorable product mix partially offset by reduced ASPs. The increase in gross
margin from 1998 to 1999 was the result of favorable product mix and reduced
manufacturing cost partially offset by reduced ASPs. The Company's overall gross
margin is subject to change due to various factors, including among others,
competitive product pricing, unit volumes shipped, new product introductions,
yields, wafer costs, assembly costs, and product mix as well as the Company's
ability to forecast demand accurately. The Company has encountered increased
competition from other suppliers who are offering competitive products and new
features. In addition, the Company expects the overall ASPs for its existing
products to decline significantly over the life of the products. The Company
believes that in order to maintain or increase gross margin, it must achieve
higher unit volume shipments, reduce costs, add new features and introduce new
products. However, no assurance can be given that the Company will be able to
ship higher volumes, reduce costs, add new features or introduce new products
that will gain market acceptance.
Research and Development Expenses. On-going research and development
expenses were $47.2 million, $37.4 million and $30.5 million or 15.6%, 12.0% and
14.0% of net revenues, in 2000, 1999 and 1998, respectively. Year 2000 operating
expenses included an additional $2.6 million for in-process research and
development due to the purchase of NetRidium. The increase in research and
development expenses from 1999 to 2000 was primarily due to Vialta's growth.
Vialta incurred $19.6 million of the above research and development expenses in
2000, compared to $1.4 million in 1999. Vialta's increase was primarily due to
increased headcount and expenses relating to the business completing a full year
of operations and ramping up for product expected to be released in 2001.
Excluding its Vialta subsidiary ESS's research and development expenses
decreased by $8.3 million to $27.7 million in 2000 from $36.0 million in 1999.
The decrease was primarily due to a decrease in internal projects, consulting,
and outside services. The increase in research and development expenses from
1998 to 1999 was primarily due to increased payroll related expenses, software
maintenance and depreciation and amortization. The Company expects that research
and development expenses will remain relatively constant as a percentage of net
revenues. There can be no assurance, however, that revenues will grow at the
same rate as the anticipated research and development expenses.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $46.1 million, $39.7 million and $36.3 million or
15.2%, 12.8% and 16.6% of net revenues, in 2000, 1999 and 1998, respectively.
The increase in selling, general and administrative expenses from 1999 to 2000
was primarily due to Vialta's growth. Vialta incurred $9.6 million of the above
selling, general and administrative expenses in 2000, compared to $1.2 million
in 1999. Vialta's increase in these expenses was primarily due to increased
headcount and expenses relating to a full year of operation and ramping up for
products expected to be released in 2001. ESS, excluding its subsidiary Vialta,
decreased selling, general and administrative expenses by $2.0 million in 2000
from $38.5 million in 1999 to $36.5 million in 2000. The decrease was primarily
due to the reduction in legal and payroll related expenses. The increase in
selling, general and administrative expense from 1998 to 1999 was primarily due
to increased marketing expenses and legal expenses partially offset by decreases
in expenses relating to reserves for accounts receivable. The Company expects
selling, general and administrative expenses will remain relatively constant as
a percentage of net revenues. There can be no assurance, however, that revenues
will grow at the same rate as the anticipated selling, general and
administrative expenses.
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Non-Operating Income. Net non-operating income was $47.8 million, $5.2
million and $1.5 million in 2000, 1999, and 1998, respectively. In 2000,
non-operating income consisted primarily of a pretax gain of $35.0 million on
the Company's disposition of its preferred stock in Komodo Technology in
exchange for shares of common stock of Cisco Systems in September 2000, $10.0
million net interest income on cash and short-term investments, $2.9 million
gain from the sale of property, plant and equipment. In 1998 and 1999,
non-operating income consisted primarily of interest income.
In early 1999, the Company provided start-up capital to Komodo Technology
and in turn received a 23% equity interest and a license of Komodo's
Voice-over-Internet Protocol ("VoIP") technology. Komodo was a leading developer
of VoIP appliances that allow analog telephones to place low cost calls over
IP-based networks. Cisco Systems acquired ESS equity interest's in Komodo
Technology in September 2000 in exchange for shares of common stock of Cisco
Systems. In conjunction with this transaction, the Company recognized a $35.0
million pretax gain, or a $21.0 million net gain.
Net interest income increased primarily due to higher cash, cash equivalent
and short term investments in Vialta which accounted for approximately $7.7
million of net interest income.
Provision for Income Taxes. The Company's effective tax rate was 37%, 15%
and (5%) for 2000, 1999 and 1998, respectively. The Company's effective tax rate
excluding the provision taken on the gain from investment was 17% for 2000. The
Company used an estimated 40% tax rate on the gain from investment, which netted
a $21.0 million gain after tax. The tax rate for 2000 of 17% was lower than the
combined federal and state statutory rate of 40% as a result of the lower
foreign tax rate on earnings from the Company's foreign subsidiary that was
considered to be permanently reinvested. The reported tax provision for 1999 of
15% of pre-tax income is below the combined federal and state statutory rate of
41% as a result of the lower foreign tax rate on earnings from the Company's
foreign subsidiary that was considered to be permanently reinvested. See Note 5
of Notes to Consolidated Financial Statements. The reported tax benefit for 1998
of 5% of pre-tax losses is below the combined federal and state statutory rate
of 41% since a majority of the losses was incurred by a foreign subsidiary and
was not deductible in the United States.
Net income (loss). Net income (loss) was $48.3 million, $40.1 million and
($28.0) million in 2000, 1999 and 1998, respectively. The results for 2000
include $47.1 million of nonoperating income resulting primarily from the gain
on investment and interest income; this gain was partially offset by an increase
of operating expenses due to the development of Vialta, and an increase of
inventory reserves. The increase of net income during 1999 compared to 1998
primarily due to significant increase in revenues and gross margin as a result
of favorable product mix in 1999.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements from
cash generated by operations, the sale of equity securities, bank lines of
credit and short-term and long-term debt. At December 31, 2000, the Company had
cash and cash equivalents and short-term investments of $195.3 million, of which
$136.5 million belonged to Vialta, and working capital of $248.0 million, of
which $109.6 million belonged to Vialta. At December 31, 2000, the Company had a
$15.0 million unsecured line of credit, which expires on October 1, 2001. The
line of credit requires the Company to maintain certain financial ratios and
operating results. On December 31, 2000, the Company was in compliance with its
borrowing criteria. There were no borrowings under the line of credit at
December 31, 2000.
In 2000, the Company used $8.6 million cash in operating activities. This
amount resulted primarily from increase in the Company's current assets of $87.2
million, offset by the in flows from current year net income, increase in a
notes payable to related party of $30.0 million and income tax related
liabilities of $15.7 million. The Company generated $1.3 million cash from
investing activities, which mainly resulted from the Company's net sales of
short-term investments, partially offset by acquisition of property, plant and
equipment and NetRidium. The Company generated $11.5 million cash from financing
activities, which resulted primarily from cash received from Vialta's minority
investors of $29.2 million, issuance of common stock under employee stock option
plan, partially offset by repurchase of the Company's common stock of $27.8
million.
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In 1999, the Company generated $61.3 million cash from operating
activities. This amount resulted from current year net income of $40.1 million,
increase in accounts payable and accrued expenses of $14.4 million, decrease in
prepaid expenses and other assets, partially offset by increase in inventories
of $19.5 million and decrease in income tax related liabilities. The Company
used $48.0 million cash in investing activities, which resulted primarily from
purchase of short term investment and property, plant and equipment. The Company
generated $51.8 million cash from financing activities, which is primarily from
cash received from Vialta's minority investors of $52.9 million.
In 1998, the Company generated $31.9 million cash from operating
activities. This is primarily due to the decrease in current assets of $37.7
million, increase in current liabilities, offset by the current year operating
loss of $8.0 million. The Company generated $7.9 million cash from investing
activities as a result of cash from sale of joint venture investment. The
Company used $1.8 million cash in financing activities mainly due to the
repurchase of the Company's common stock.
The Company believes that its existing cash and cash equivalents as of
December 31, 2000 together with the cash generated from operations, available
borrowings under its line of credit and other financing options, will be
sufficient to fund acquisitions of property and equipment and provide adequate
working capital through at least the next twelve months. Capital expenditures
for the next twelve months are anticipated to be approximately $20.5 million of
which $3.6 million is to be used by ESS and $16.9 million is to be used by
Vialta primarily for the acquisition of capital equipment. The Company may also
utilize cash to acquire or invest in complementary businesses or products or to
obtain the right to use complementary technologies. From time to time, in the
ordinary course of business, the Company may evaluate potential acquisitions of
or investment in such businesses, products or technologies owned by third
parties.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards of derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. In July 1999, the Financial Accounting
Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133"
("SFAS 137"). SFAS 137 deferred the effective date until fiscal year beginning
after June 15, 2000. The Company's adoption of SFAS 133 as of January 1, 2001
didn't have a significant effect on its financial position and results of
operations.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No. 101
"Revenue Recognition in Financial Statements" which provides guidance on the
recognition, presentation and disclosure of revenue in financial statements
filed with the SEC ("SAB 101"). SAB 101 outlines the basic criteria that must be
met to recognize revenue and provides guidance for disclosures related to
revenue recognition policies. The Company's adoption of SAB 101 did not have a
significant effect on its financial position and results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation" an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
establishes guidance for the accounting for stock option grants made after June
30, 2000. FIN 44 also establishes guidance for the repricing of stock options
and determining whether a grantee is an employee, for which guidance was
effective after December 15, 1998 and modifying a fixed option to add a reload
feature, for which guidance was effective after January 12, 2000. The Company's
adoption of FIN 44 did not have a significant effect on its financial position
and results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains certain forward-looking statements that are subject to
risk and uncertainties. For such statements, the Company desires to take
advantage of the "Safe Harbor" provisions of the Private Securities Litigation
Reform Act of 1995 and of Section 21E of and Rule 3b-6 under the Securities
Exchange
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Act of 1934. Such forward-looking statements include, without limitation,
statements regarding the Company's expectations, intentions or future strategies
and involve known and unknown risks, uncertainties and other factors. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update such forward-looking statements.
Potential Fluctuations in Operating Results. The Company's operating
results are subject to quarterly and other fluctuations due to a variety of
factors, including the gain or loss of significant customers, increased
competitive pressures, changes in pricing policies by the Company, its
competitors or its suppliers, including decreases in ASP of the Company's
products, the timing of new product announcements and introductions by the
Company or its competitors and market acceptance of new or enhanced versions of
the Company's and its customers' products. Other factors include the
availability of foundry capacity, fluctuations in manufacturing yields,
availability and cost of raw materials, changes in the mix of products sold, the
cyclical nature of both the semiconductor industry and the market for PCs,
seasonal customer demand, the timing of significant orders and significant
increases in expenses associated with the expansion of operations. The Company's
operating results could also be adversely affected by economic conditions in
various geographic areas where the Company or its customers do business, or
order cancellations or rescheduling. Also, a significant portion of the
Company's expenses is fixed in the short term, and the timing of increases in
expenses is based in large part on the Company's forecast of future revenues. As
a result, if revenues do not meet the Company's expectations, it may be unable
to quickly adjust expenses to levels appropriate to actual revenues, which could
have a material adverse effect on the Company's business and results of
operations. These factors are difficult to forecast, and these or other factors
could materially affect the Company's quarterly or annual operating results.
There can be no assurance as to the level of sales or earnings that may be
attained by the Company in any given period in the future. The Company currently
places non-cancelable orders to purchase its products from independent foundries
on an approximately three-month rolling basis, while its customers generally
place purchase orders with the Company less than four weeks prior to delivery
that may be canceled without significant penalty. Consequently, if anticipated
sales and shipments in any quarter are canceled or do not occur as quickly as
expected or forecasted sales levels are not realized, expense and inventory
levels could be disproportionately high and the Company's business, financial
condition and results of operations could be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Competition and Pricing Pressures. The markets in which the Company
competes are intensely competitive and are characterized by rapid technological
change, price declines and rapid product obsolescence. See "Item 1. Business --
Competition."
Dependence on the PC and Consumer Markets. In 2000 Sales of video
semiconductor chips to the VCD/SVCD and DVD player market accounted for a
majority of the Company's revenues. The Company expects that sales will continue
to account for a significant portion of its net revenues for the foreseeable
future. Sales of video semiconductor chips to the VCD, SVCD and DVD player
market accounted for a significant of the Company's revenues in 1999 and a
significant portion of its net revenues in 1998. In 1998, sales of PC audio
semiconductor chips accounted for a majority of the Company's net revenues.
Any reduction in ASPs or demand for the Company's semiconductor chips,
whether because of a reduction in demand for PCs, DVD or VCD players in general,
increased competition or otherwise, would have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company is currently engaged in the development and introduction of new
PC audio, video and modem semiconductor devices for the Internet, PC and
consumer markets. There can be no assurance that the Company will be able to
identify market trends or new product opportunities, develop and market new
products, achieve design wins or respond effectively to new technological
changes or product announcements by others. A failure in any of these areas
would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's products are sold for incorporation into desktop and notebook
computers and VCD, SVCD and DVD players. Therefore, the Company is heavily
dependent on the growth of the markets and the
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cost requirements for desktop and notebook computers and VCD and DVD players.
There can be no assurance that these markets will be able to grow. A slowing in
unit volume and a decrease in ASPs could result in a decline in revenues, which
would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1. Business -- PC Audio
Products," "-- Communication Products" "-- VCD/SVCD Products" and "DVD
Products."
Some of the Company's products are sold for incorporation into PCs. The
recent economic downturn has reduced PC demand. Additionally, as the PC industry
and its customers place more reliance on the Internet, an increasing number of
Internet devices that are smaller and simpler than traditional PCs may reduce
the overall PC industry's demand for the Company's existing products. Thus, the
Company's future operating results and financial condition may be affected by
general customer preferences for one platform over another or one set of product
features over another and by the overall demand for PCs.
Importance of New Products and Technological Changes. The markets for the
Company's products are characterized by evolving industry standards, rapid
technological change and product obsolescence. The Company's success is highly
dependent upon the successful development and timely introduction of new
products at competitive price and performance levels. The success of new
products depends on a number of factors, including timely completion of product
development, market acceptance of the Company's and its customers' new products,
securing sufficient foundry capacity for volume manufacturing of wafers,
achievement of acceptable wafer fabrication yields by the Company's independent
foundries and the Company's ability to offer new products at competitive prices.
In order to succeed in having the Company's products incorporated into new
products being designed by its customers and OEMs, the Company must anticipate
market trends and meet performance, quality and functionality requirements of
such customers and OEMs and must successfully develop and manufacture products
that adhere to these requirements. In addition, the Company must meet the timing
and price requirements of such manufacturers and must make such products
available in sufficient quantities. Accordingly, in selling to OEMs, the Company
can often incur significant expenditures prior to volume sales of new products,
if any. In order to help accomplish these goals, the Company has in the past and
will continue to consider in the future the acquisition of other companies or
the products and technologies of other companies. Such acquisitions carry
additional risks, such as an ineffective integration with existing products and
corporate culture, the potential for large write-offs and the diversion of
management attention. There can be no assurance that the Company will be able to
identify market trends or new product opportunities, develop and market new
products, achieve design wins or respond effectively to new technological
changes or product announcements by others. A failure in any of these areas
would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1. Business -- Research and
Development."
The greater integration of functions and complexity of operations of the
Company products increase the risk that the Company's customers or end users
could discover latent defects or subtle faults after volumes of product have
been shipped. This could result in material recall and replacement costs for
product warranty and support. The recurrence of significant defects, delay in
recognition or loss of revenues, loss of market share or failure to achieve
market acceptance and diversion of the attention of the Company engineering
personnel from our product development efforts could also adversely impact the
Company's customer relationships.
New Business Venture. In 1999, the Company incorporated Vialta, originally
as a wholly owned subsidiary of the Company, to develop and market new products
and applications for the Internet. As of December 31, 2000, the Company had
contributed a total of $62.1 million in cash to Vialta and acquired 40 million
shares of Vialta's Series A Preferred Stock, 20 million shares of Vialta's
Series B Preferred Stock and 400,000 shares of Vialta's common stock. As of
December 2000, 8 million shares of Vialta's Series B Preferred Stock and 4
million shares of Vialta's Common Stock were issued to Fred S.L. Chan, the
Company's Chairman of the Board, and an entity controlled by Fred S.L. Chan and
Annie M.H. Chan, a director of the Company and spouse of Mr. Chan for $20.8
million and $1.0 million, respectively. In addition, Vialta received a total of
$60.3 million from third party investors and certain employees in exchange for
shares of Vialta's Series B Preferred Stock and Common Stock. The Company's
investment in Vialta involves all of the risks normally associated with
investments in development stage companies. In order for Vialta to begin earning
revenues and ultimately achieve profitability, it must successfully develop and
market new products
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and applications on a cost effective basis. There can be no assurance that
Vialta will be able to do so, since, among other things, the Company has limited
experience in starting new business ventures and there is intense competition in
the marketplace for Internet products and applications generally. In addition,
the Company's investment in Vialta may adversely affect the Company's existing
business, financial position and results of operations by diverting management's
attention, working capital and other resources from the Company to Vialta.
Dependence on TSMC and Other Third Parties. The Company relies on
independent foundries to manufacture all of its products. A substantial majority
of the Company's products are currently manufactured by TSMC, which has
manufactured certain of the Company's products since 1989. The Company also has
foundry arrangements with UMC, which has manufactured certain of the Company's
products since 1995. These relationships provide the Company with access to
advanced process technology necessary for the manufacture of the Company's
products. These foundries fabricate products for other companies and, in certain
cases, manufacture products of their own design. In December 2000, the Company
secured wafer capacity that it believes will be adequate to meet its forecast
for the next 12 months. In November 1999, the Company secured wafer capacity
that met its year 2000 needs. In September 1999, Taiwan experienced a series of
earthquakes. While the Company did not experience any material effects from
these earthquakes, there can be no assurance that any future earthquakes or any
future natural disaster will not have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1.
Business -- Manufacturing."
While the Company has entered into agreements with these two foundries, the
Company's reliance on these independent foundries involves a number of risks,
including the absence of adequate capacity, the unavailability of, or
interruption in access to, certain process technologies and reduced control over
delivery schedules, manufacturing yields and costs, and the international risks
more fully described below. In addition, the Company has pre-negotiated certain
of its purchase orders and could be unable to benefit from enhanced yields
realized by its vendors. The Company expects to rely upon TSMC and UMC to
manufacture substantially all of the Company's products for the foreseeable
future. In the event that TSMC and UMC are unable to continue to manufacture the
Company's key products in required volumes, the Company will have to identify
and secure additional foundry capacity. In such an event, the Company may be
unable to identify or secure additional foundry capacity from another
manufacturer. Even if such capacity is available from another manufacturer, the
qualification process could take six months or longer. The loss of any of its
foundries as a supplier, the inability of the Company to acquire additional
capacity at its current suppliers or qualify other wafer manufacturers for
additional foundry capacity should additional capacity be necessary, or any
other circumstances causing a significant interruption in the supply of
semiconductors to the Company would have a material adverse effect on the
Company's business, financial condition and results of operations.
To address potential foundry capacity constraints in the future, ESS will
continue to consider and may be required to enter into additional arrangements,
including equity investments in or loans to independent wafer manufacturers in
exchange for guaranteed production capacity, joint ventures to own and operate
foundries, or "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods. Any such arrangements
could require the Company to commit substantial capital and grant licenses to
its technology. The need to commit substantial capital may require the Company
to obtain additional debt or equity financing, which could result in dilution to
the Company's shareholders. There can be no assurance that such additional
financing, if required, will be available when needed or, if available, will be
obtained on terms acceptable to the Company.
The company obtains foundry capacity through forecasts that are generated
in advance of expected delivery dates. The Company's ability to obtain the
foundry capacity necessary to meet the future demand for its products is based
on its ability to accurately forecast such future demand. If the Company fails
to accurately forecast such future demand, the Company may be unable to timely
obtain an adequate supply of wafers necessary to manufacture the number of
products required to satisfy the actual demand. There can be no assurance that
the Company will continue to accurately forecast the future demand for its
products and obtain sufficient foundry capacity in the future.
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ESS has from time-to-time experienced disruptions in supply, although none
of those disruptions have to date materially adversely affected results. There
can be no assurance that manufacturing or assembly problems will not occur in
the future or that any such disruptions will not have a material adverse effect
upon the Company's results of operations. Further, there can be no assurance
that suppliers who have committed to provide product will do so, or that the
Company will meet all conditions imposed by such suppliers. Failure to obtain an
adequate supply of products on a timely basis would delay product delivery to
ESS's customers, which would have a material adverse effect on the Company's
business and results of operations. In addition, ESS's business could also be
materially and adversely affected if the operations of any supplier are
interrupted for a substantial period of time, or if the Company is required, as
a result of capacity constraints in the semiconductor industry or otherwise, to
increase the proportion of wafers or finished goods purchased from higher cost
suppliers in order to obtain adequate product volumes.
The markets into which ESS sells its products are subject to extreme price
competition. Thus, the Company expects to continue to experience declines in the
selling prices of its products over the life cycle of each product. In order to
offset or partially offset declines in the selling prices of is products, ESS
must continue to reduce the costs of products through product design changes,
manufacturing process changes, volume discounts, yield improvements and other
savings negotiated with its manufacturing subcontractors. Since the Company does
not operate its own manufacturing facilities and must make volume commitments to
subcontractors at prices that remain fixed over certain periods of time, it may
not be able to reduce its costs as rapidly as its competitors who perform their
own manufacturing. The Failure of the Company to design and introduce, in a
timely manner, lower cost versions of existing products or new products with
higher gross margins, or to successfully manage its manufacturing subcontractor
relationships would have a material adverse effect on ESS's gross margin.
Indirect Channels of Distribution. The Company utilizes indirect channels
of distribution over which the Company exercises limited control. The Company
derives a material percentage of product revenues from distributor channels. The
Company financial results could be adversely affected if the relationship with
these distributors were to deteriorate or if the financial condition of these
resellers or distributors were to decline. In addition, as the Company business
grows, the Company may have an increased reliance on indirect channels of
distribution. There can be no assurance that the Company will be successful in
maintaining or expanding these indirect channels of distribution. This could
result in the loss of certain sales opportunities. Furthermore, the partial
reliance on indirect channels of distribution may reduce the Company visibility
with respect to future business, thereby making it more difficult to accurately
forecast orders.
Customer Concentration. A limited number of customers have accounted for a
substantial portion of the Company's net revenues. In 2000, 1999 and 1998 sales
to the Company's top five customers, including sales to distributors, accounted
for approximately 56%, 53% and 54% respectively, of the Company's net revenues.
In 2000, Dynax, a Hong Kong distributor, and Digital AV each accounted for
approximately 34% and 10% of the Company's net revenues. In 1999, Dynax and
Shinco accounted for approximately 22% and 13% of the Company's net revenues. In
1998, Dynax and Shinco accounted for approximately 16% and 15% of the Company's
net revenues. Sales to distributors are generally subject to agreements allowing
limited rights of return and price protection with respect to unsold products.
Returns and allowances in excess of reserves could have a material adverse
impact on the Company's business, financial condition and results of operation.
The Company expects that a limited number of customers may account for a
substantial portion of the net revenues for the foreseeable future. The Company
has experienced changes from year to year in the composition of its major
customer base and believes this pattern may continue. The Company does not have
long-term purchase agreements with any of its customers. The reduction, delay or
cancellation of orders from one or more major customers for any reason or the
loss of one or more of such major customers could materially and adversely
affect the Company's business, financial condition and results of operations. In
addition, since the Company's products are often the sole sourced to its
customers, the Company's operating results could be materially and adversely
affected if one or more of its major customers were to develop other sources of
supply. There can be no assurance that the Company's current customers will
continue to place orders with the Company, that orders by existing customers
will not be canceled or will continue at the levels of previous periods or that
the Company will be able to obtain orders from new customers.
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Management of Growth. The Company has experienced significant growth in
unit shipments and the addition of multiple product lines that require
additional management systems and processes. To manage its future operations and
growth effectively, the Company will need to hire and retain management, hire,
train, motivate, manage and retain its employees, continue to improve its
operational, financial and management information systems and implement
additional systems and controls. The competition for highly skilled worker is
intense, especially in Silicon Valley. There can be no assurance that the
Company will be able to manage such growth effectively, and the failure to do so
could have a material adverse effect on the Company's business, financial
condition and results of operations.
International Operations. During 2000, 1999 and 1998, international sales
accounted for a substantial majority of the Company's net revenues.
Substantially all of the Company's international sales were to customers in Hong
Kong, Taiwan, Japan, China, Korea, Singapore, Germany and India. The Company
expects that international sales will continue to represent a significant
portion of its net revenues for the foreseeable future. In addition,
substantially all of the Company's products are manufactured, assembled and
tested by independent third parties in Asia. Due to its reliance on
international sales and foreign third-party manufacturing, assembly and testing
operations, the Company is subject to the risks of conducting business outside
of the United States. These risks include unexpected changes in, or impositions
of legislative or regulatory requirements, delays resulting from difficulty in
obtaining export licenses for certain technologies, tariffs, quotas and other
trade barriers and restrictions, longer payment cycles, greater difficulty in
accounts receivable collection, potentially adverse taxes, the burdens of
complying with a variety of foreign laws and other factors beyond the Company's
control. The Company is also subject to general geopolitical risks in connection
with its international trade relationships. Although the Company has not to date
experienced any material adverse effect on its business, financial condition or
results of operations as a result of such regulatory, geopolitical and other
factors, there can be no assurance that such factors will not have a material
adverse effect on the Company's business, financial condition and results of
operations in the future or require the Company to modify its current business
practices.
In addition, the laws of certain foreign countries in which the Company's
products are or may be manufactured or sold, including various countries in
Asia, may not protect the Company's products or intellectual property rights to
the same extent as do the laws of the United States and thus make the
possibility of piracy of the Company's technology and products more likely.
Currently, all of the Company's product sales and all of its arrangements with
foundries and assembly and test vendors provide for pricing and payment in U.S.
dollars. With respect to international sales that are denominated in U.S.
dollars, increases in the value of the U.S. dollar relative to foreign
currencies can increase the effective price of, and reduce demand for, the
Company's products relative to competitive products priced in the local
currency. Since a significant number of ESS's current and prospective customers
and suppliers are located overseas, protective trade legislation in either the
United States or foreign countri