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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, 1996 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NO. 0-26660
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ESS TECHNOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2928582
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on January
31, 1997 ($32.375) as reported on the Nasdaq National Market, was approximately
$868,886,000. Shares of Common Stock held by each officer and director and by
each person who owned 5% or more of the Registrant's outstanding Common Stock on
that date have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of January 31, 1997, Registrant had outstanding 38,307,036 shares of
Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 1997 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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ESS TECHNOLOGY, INC.
1996 FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................................... 2
Item 2. Properties.................................................................. 11
Item 3. Legal Proceedings........................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......................... 12
Item 4A. Executive Officers of the Registrant........................................ 12
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.... 14
Item 6. Selected Financial Data..................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................... 15
Item 8. Financial Statements and Supplementary Data................................. 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................................... 40
PART III
Item 10. Directors and Executive Officers of the Registrant.......................... 41
Item 11. Executive Compensation...................................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 41
Item 13. Certain Relationships and Related Transactions.............................. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............ 42
Signatures............................................................................... 45
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Statements contained in this filing that are not statements of historical
fact may be deemed to be forward-looking statements. A number of important
factors could cause actual events or the Company's actual results to differ
materially from those indicated by such forward-looking statements, including
dependence on continued growth in demand for PC audio, video and other
multimedia capabilities for notebook and desktop computers, as well as consumer
electronic products; the Company's ability to take advantage of new markets;
increased competition and pricing pressures, general economic conditions and
conditions specific to the semiconductor industry; the timing and market
acceptance of new product introductions; the timely development of new products;
continued availability of quality foundry capacity; and other risks set forth in
this filing and in the Company's filings from time to time with the Securities
and Exchange Commission.
PART I
ITEM 1. BUSINESS
ESS Technology, Inc. ("ESS" or the "Company"), a California corporation,
designs, markets and supports highly integrated mixed signal semiconductor and
software solutions for multimedia applications in the personal computer ("PC")
and consumer marketplaces. The Company offers comprehensive solutions for audio,
video, and fax/modem applications. ESS has established itself as a leading
supplier of mixed signal PC audio solutions that integrate all essential audio
components on a single chip. During 1996, ESS introduced a family of integrated
circuits that incorporate advanced decompression technology for digital video
products and began marketing a line of highly integrated V.34bis modem
solutions.
PRODUCTS
ESS leverages a leadership position in PC audio, its video and fax/modem
technology, a diverse customer base, recognized quality, and dependable on-time
delivery to provide high quality, cost effective, and highly integrated
multimedia solutions for the personal computer and consumer markets. The Company
has three major families of products: the AudioDRIVE(TM) family addressing the
PC digital audio device market; the VideoDRIVE(TM) family targeting MPEG-1 and
MPEG-2 decompression-based consumer products, such as Video Compact Disk ("VCD")
player, Digital Versatile Disk ("DVD") player and set-top box; and the
Tele(TM)DRIVE family, focusing on the integrated audio-fax/modem applications,
including full duplex speakerphone, digital simultaneous voice and data (DSVD)
and videoconferencing.
Audio Products
ESS' single chip AudioDRIVE products enable PC manufacturers to provide
audio capabilities 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
personal computers and sound cards among its customers.
ESS' single chip AudioDRIVE products provide comprehensive PC audio
solutions that offer higher performance and functionality, consume less power
and board space, and cost less than other commercially available PC audio
solutions.
Recently, demand for multimedia desktop and notebook computers with high
quality sound, graphics and video capabilities has increased due to three
dynamic factors: (1) advances in semiconductor technology; (2) growth in
interactive PC entertainment, educational and business software applications;
and (3) increases in use of on-line services. These factors have created market
opportunities for highly integrated multimedia semiconductor solutions that can
be placed on the PC motherboard and on multi-function sound cards.
The Company's AudioDRIVE products are based on ESS' proprietary audio
technologies, design methodologies, and software and firmware expertise. ESS has
developed a set of product solutions for desktop and notebook PCs and other
consumer electronics applications.
The AudioDRIVE product family integrates ESFM(TM), a proprietary FM sound
synthesis technology, that produces superior sound quality by enhancing
traditional FM synthesis techniques, with hardware, software
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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 part of its comprehensive solution and
consists of its AudioDRIVE device drivers for Microsoft(R) Windows(R) 3.1,
Windows NT(R) Windows 95(R), IBM OS/2(R) Warp(R), DirectX(TM)PC games, and audio
applications, including ESS AudioRack(TM) controller, an integrated graphical
controller for the entire PC audio system.
AudioDRIVE Products
ES688: a single mixed signal 16-bit stereo audio chip. The ES688
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip and, when coupled with the Yamaha OPL3 FM synthesizer
chip, provides a low cost solution for high performance multimedia PC audio. The
ES688 is PC games compatible in SB Pro mode with the Yamaha OPL3 and is
compatible with Microsoft Windows and other operating systems. The ES688
provides power management capability and is packaged in a 100 pin PQFP package.
ES1488: a single mixed signal 16-bit mono audio chip with integrated ESFM
synthesizer. The ES1488 integrates digital logic and a microcontroller with
audio CODEC and other analog functions onto one chip, and includes ESFM
synthesis. The ES1488 is PC games compatible in SB mode and is compatible with
Microsoft Windows and other operating systems. The ES1488 is socket compatible
with the ES488 and provides a single chip alternative for the combined solution
offered by the ES488 and the Yamaha OPL2 FM synthesis chip.
ES1688: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer. The ES1688 integrates digital logic and a microcontroller with
audio CODEC and other analog functions onto one chip, and includes ESFM
synthesis. The ES1688 is PC games compatible in SB and SB Pro modes and is
compatible with Microsoft Windows and other operating systems. The ES1688 is
socket compatible with the ES688 and provides a single chip alternative for the
combined solution offered by the ES688 and the Yamaha stereo OPL3 FM synthesis
chip.
ES1788: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer and game support. The ES1788 integrates digital logic and a
microcontroller with audio CODEC and other analog functions onto one chip, and
includes ESFM synthesis. The ES1788 is PC games compatible in SB and SB Pro
modes and is compatible with Microsoft Windows and other operating systems. The
ES1788 includes hardware volume control, 64 step volume control and dual
game/joystick port for game support.
ES1868: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation and game support. The ES1868
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip, and includes ESFM synthesis. The ES1868 is PC games
compatible in SB and SB Pro modes and is compatible with Microsoft Windows and
other operating systems. The ES1868 provides full ISA plug-and-play support and
includes hardware volume control, 64 step volume control and dual game/joystick
port for game support. The ES1868 also supports full-duplex operation with
simultaneous record and playback with two DMA channels.
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. The ES1869 integrates digital logic
and a microcontroller with audio CODEC and other analog functions onto one chip,
and includes ESFM synthesis. The ES1869 is PC games compatible in SB and SB Pro
modes and is compatible with Microsoft Windows and other operating systems. The
ES1869 provides full ISA plug-and - play support and includes hardware volume
control, 64 step volume control and dual game/joystick port for game support.
The ES1869 supports full-duplex operation with simultaneous record and playback
with two DMA channels and contains an I(2)S interface to support Zoom Video port
for MPEG audio. It also integrates circuitry to produce a three-dimensional
sound effect from two speakers. Currently sampling.
ES1878: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, Zoom Video support, and game support. The
ES1878 integrates digital logic and a microcontrol-
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ler with audio CODEC and other analog functions onto one chip, and includes ESFM
synthesis. The ES1878 is PC games compatible in SB and SB Pro modes and is
compatible with Microsoft Windows and other operating systems. The ES1878
includes hardware volume control, 64 step volume control and dual game/joystick
port for game support. The ES1878 provides full plug-and-play support. The
ES1878 also includes support for full-duplex operation with simultaneous record
and playback, and it contains an I(2)S interface to support the PCMCIA Zoom
Video port specification for MPEG input to PCs. The ES1878 provides full
plug-and-play support and provides interface to a docking station unit.
ES1879: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, Zoom Video support, telegaming and game
support and three-dimensional sound effect. The ES1879 also integrates hardware
volume control, 64 steps volume control, dual game port for game, I(2)S
interface for Zoom Video support, as well as circuitry to produce
three-dimensional sound effect from two speakers. The ES1879 provides full
plug-and-play support and provides interface to a docking station unit. Sampling
in Q2 1997.
ES1887: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, game support and plug-and-play through the
PC's BIOS. The ES1887 integrates digital logic and a microcontroller with audio
CODEC and other analog functions onto one chip, and includes ESFM synthesis. The
ES1887 is PC games compatible in SB and SB Pro modes and is compatible with
Microsoft Windows and other operating systems. The ES1887 includes hardware
volume control, 64 step volume control and dual game/joystick port for game
support. The ES1887 also includes support for full-duplex operation with
simultaneous stereo record and playback with two DMA channels. The ES1887
supports plug-and-play through the PC's BIOS.
ES1888: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer which supports full-duplex operation. The ES1888 integrates digital
logic and a microcontroller with audio CODEC and other analog functions onto one
chip, and includes ESFM synthesis. The ES1888 is PC games compatible in SB and
SB Pro modes and is compatible with Microsoft Windows and other operating
systems. The ES1888 includes hardware volume control, 64 step volume control and
dual game/joystick port for game support. The ES1888 also includes support for
full-duplex operation with simultaneous stereo record and playback with two DMA
channels.
Wavetable Synthesizer Products
ES689: a wavetable music synthesizer chip. The ES689 is a high performance
wavetable music synthesizer chip that is General MIDI compatible and offers 32
note polyphony. It provides a serial interface to the ES1688 internal
digital-to-analog converter ("DAC") to provide an audio implementation that
includes both wavetable and ESFM synthesis, or external DAC for wavetable
synthesis. The ES689 interfaces to the ES981 or ES982 for one or two megabyte
sound sample sets, respectively.
ES690: a wavetable music synthesizer chip with chorus and reverb sound
effects. The ES690 is a high performance wavetable music synthesizer chip with
chorus and reverb sound effects for enriched sound. The ES690 is General MIDI
compatible and offers 32 note polyphony. It provides a serial interface to the
ES1688 internal DAC to provide an audio implementation that includes both
wavetable and ESFM synthesis, or external DAC for wavetable synthesis. The ES690
interfaces to the ES981 or ES982 for one or two megabyte sound sample sets,
respectively.
ES981: a 512K x 16 wavetable ROM. The ES981 is a 512K x 16 read only
memory ("ROM") with a General MIDI sound sample set for use with the ES689 and
ES690.
ES982: a 1M x 16 wavetable ROM. The ES982 is a 1M x 16 ROM with a General
MIDI sound sample set for use with the ES689 and ES690.
Multimedia System Chipsets
ES938: a sound effects processor. The ES938 provides enhanced sound
effects by expanding monophonic and stereo sound to 3-D spatial soundfields. The
ES938 also integrates bass and treble control.
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ES968: a multi-function chip for multimedia add-in cards. The ES968
integrates plug-and-play support, MPU401 interface, dual game/joystick port and
CD-ROM interface for Sony, Panasonic, Mitsumi and IDE drives in one chip.
ES978: a mixer expansion chip to support the ES1878 and ES1879 when
building a PC Notebook and Docking Station PC system. The ES978 is an analog
mixer chip which is placed in a docking station and interfaces directly with the
ES1878 and ES1879 located inside the notebook. This interface provides an
efficient structure for notebook and docking stations systems, requiring only
six pins of the notebook to connect with all communications paths to the docking
station.
Fax/modem 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 personal computer. ESS is using its
highly efficient fax/modem technology, in combination with its leadership in
audio technology, to provide high speed modem products integrated with audio
capabilities. The ESS V.34 TeleDRIVE modem solutions for PC and add-in card
manufacturers take advantage of this unique combination of technologies to
deliver a cost-effective, upgradable communications solution.
TeleDRIVE Products
ES336V: a V.34bis chipset data/fax/voice controller-less modem solution.
The ES336V provides base data, full duplex speaker phone, telephone answer
machine ("TAM") and V.80 support for H.324 video conferencing applications.
Currently sampling.
ES336D: a V.34bis chipset data/fax/voice controller-less modem solution
with ITU-T computable V.70 Digital Simultaneous Voice and Data ("DSVD"). The
ES336D is a superset of the ES336V and contains a programmable bus interface for
support of both ISA and PCI busses. Currently sampling.
ES336CV/ES336DV: a ES336V/ES336D modem solution with 16-bit full duplex
stereo. The ES336CV/ ES336CD combines a single mixed signal 16-bit stereo audio
chip with integrated ESFM synthesizer, plug-and-play full-duplex operation and
game support. Currently sampling.
Video Products
Multimedia applications are evolving at a rapid pace, primarily in response
to increasing acceptance and use of the Internet and the introduction of new
applications such as VCD, DVD, Digital set-top boxes and video conferencing. In
its VideoDRIVE(TM)video chips, ESS offers integrated solutions to consumer
electronics and PC manufacturers for use in a wide variety of next-generation
multimedia applications utilizing MPEG-1 and MPEG-2 technology.
ESS provides OEM manufactures of VCD players with a programmable
single-chip processor which includes MPEG-1 video, audio and system decoder. It
delivers full-screen, full-motion video at 30 frames per second with selectable
CD-quality audio and can be combined with memory and video/audio DACs.
ESS also provides a programmable single chip processor which includes
MPEG-2 audio/video/system and transport layer decoder, AC3 and video
post-processing. These chips are designed for a variety of applications in
consumer electronics such as set-top boxes and DVD player.
VideoDRIVE Products
ES3204: Single chip processor which includes MPEG-1 audio/video/system
decoder for use in VCD players. The ES3204 incorporates video standards
(NTSC/PAL) conversion, on-screen display, Karaoke functions, programmable
playback control for VCD 2.0 and trick play mode features.
ES3207: Analog companion chip to MPEG decoder chips. The ES3207 provides
echo, surround sound, 3D audio, TV encoder with clock generation and audio DAC
functions. Sampling in Q2 1997.
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ES3208: Single chip processor which includes MPEG-1 audio/video/system
decoder for use in VCD players with an integrated SRAM and remote control
interface logic. The ES3208 incorporates video standards (NTSC/PAL) conversion,
on-screen display, Karaoke functions, programmable playback control for VCD 2.0,
trick play mode features, an integrated SRAM and remote control interface logic.
Currently sampling.
ES3210: Single chip processor which includes MPEG-1 audio/video/system
decoder for use in portable VCD players. The ES3210 incorporates the ES3208
features of video standards (NTSC/PAL) conversion, on-screen display, Karaoke
functions, programmable playback control for VCD 2.0, trick play mode features,
an integrated SRAM and remote control interface logic in a smaller form factor
allowing a more compact portable designs. Currently sampling.
ES3308: Single chip processor which includes MPEG-2 audio/video/system
decoder for use in digital set-top boxes. The ES3308 incorporates video
standards (NTSC/PAL) conversion, on-screen display and transport layer compliant
with Digital Broadcast Signal standards. Currently sampling.
ES3309: Single chip processor which includes MPEG-2 audio/video/system
decoder for use in DVD players. The ES3309 incorporates Dolby AC-3 decoder,
video standards (NTSC/PAL) conversion, sub-picture unit, letter box conversion,
on-screen display, navigation 1.0 and is compliant with DVD specifications.
Sampling in Q2 1997.
Software and Support
ESS provides comprehensive support for its multimedia products including
software that can be bundled with products that incorporate ESS AudioDRIVE
chips. This software includes device drivers for Microsoft Windows 3.1, Windows
NT and Windows 95, IBM OS/2 Warp, Intel NSP and PC games. Other support software
that is available to customers includes localization software and installation
software that allows customers to tailor their products for specific
applications and needs.
Customer development support includes an Evaluation Kit that contains a
reference add-in card design with all the necessary information to incorporate
an ESS chip in the customer's product. To assist customers in further reducing
their time to market, ESS also provides a Manufacturing Kit that contains
manufacturing information, including a bill-of-materials, printed circuit board
layout and production test software.
CUSTOMERS
ESS sells its product principally to manufacturers of PCs and add-in
boards. The following table shows representative customers worldwide:
UNITED STATES TAIWAN JAPAN(1) REST OF THE WORLD
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AST Acer Fujitsu ICL
Compaq BTC Hitachi Eastbase
Dell ECS Matsushita JK Micro
Digital Equipment FIC NEC Samsung
Gateway 2000 GVC Seiko-Epson Trigem
Hewlett Packard Inventec Sony Xirlink
IBM Labway Toshiba
Texas Instruments Mitac
Quanta
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(1) Sales in Japan are made through a distributor.
A limited number of customers have historically accounted for a substantial
portion of the Company's net revenues. In 1994, 1995 and 1996, sales to the
Company's top five customers, including sales to the Company's international
distributor, accounted for approximately 51%, 48% and 40%, respectively, of the
Company's net revenues. In 1994, two customers, Compaq and Western Publishing,
accounted for approxi-
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mately 20% and 14%, respectively, of the Company's net revenues. In 1995, Compaq
and Universe Electron Corporation, the Company's Japanese distributor, each
accounted for approximately 17% of the Company's net revenues. The decline in
the percentage of net revenues attributable to Western Publishing was a result
of the Company's shift in product mix from toy and other consumer products to PC
audio products. In 1996, Compaq and Universe Electron Corporation each accounted
for approximately 12% and 13%, respectively, of the Company's net revenues. The
Company expects that a limited number of customers may continue to account for a
substantial portion of its net revenues for the foreseeable future. For example,
Compaq has been a significant customer of the Company since 1994. The Company
has experienced changes from year to year in the composition of its major
customer base and believes this will continue in the future.
SALES AND MARKETING
The Company sells and markets to leading PC and consumer OEM manufacturers
worldwide. In the United States, the Company markets its products through its
direct sales force and manufacturer representatives.
In 1994, 1995 and 1996, international sales comprised approximately 72%,
73% and 92% of the Company's net revenues, respectively. The majority of the
Company's international revenues in 1994, 1995 and 1996 have been derived from
Asian customers who manufacturer PCs and PC-related add-in boards. A large
percentage of the worldwide supply of these products is manufactured by
suppliers in Asia. ESS has direct sales personnel and technical staff located in
Taipei, Taiwan. To date, a significant portion of the Company's Asian sales have
been to customers located in Taiwan. See "Factors That May Affect Future
Results -- International Operations." The Company is continuing to expand its
Taiwan sales force and opened new customer and technical support centers in
Beijing and Tokyo in order to support its broadening customer base. The
Company's products are also sold internationally through a distributor located
in Japan and manufacturer representatives located in China, Taiwan, Singapore,
Korea, Hong Kong and Germany. To date, the Company has not had substantial sales
to customers located in Europe, and the Company is seeking to expand its sales
and distribution activities in Europe. The Company's manufacturer
representatives and distributor are not subject to minimum purchase requirements
and can discontinue marketing any of the Company's products at any time. In
addition, the Company's manufacturers' representatives, distributors and
customers typically are authorized certain rights of return for unsold product
or pricing allowances to compensate for rapid, unexpected prices changes. See
"Factor That May Effect Future Results -- Customer Concentration."
The Company believes that customer service and technical support are
important competitive factors in selling to major customers. The Company
provides technical support to its customers worldwide. Manufacturers'
representatives and distributors supplement the Company's efforts by providing
additional customer service at the local level. The Company believes that close
contact with its customers not only improves the customers' level of
satisfaction, but also provides important insight into future market direction.
Sales of the Company's products are generally made pursuant to standard
purchase orders, which are frequently revised to reflect changes in the
customer's requirements. Product deliveries are scheduled upon the Company's
receipt of purchase orders. Generally, these purchase orders allow customers to
reschedule delivery dates and cancel purchase orders without significant
penalties. For these reasons, the Company believes that its backlog, while
useful for scheduling production, is not necessarily a reliable indicator of
future revenues.
RESEARCH AND DEVELOPMENT
In order to compete successfully, the Company believes that it must
continually design, develop and introduce new products that take advantage of
market opportunities and address emerging standards. The Company's strategy is
to leverage its substantial base of audio technology and design expertise,
analog, digital and mixed signal design and process technologies, and software
and systems expertise to develop new PC audio solutions as well as other new
products targeting opportunities in the multimedia PC and consumer market. The
Company is currently engaged in the development of new PC audio products that
provide
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advanced sound effects. ESS has also developed new multimedia products for
video, and fax/modem/voice applications. The Company intends to continue to
provide comprehensive solutions for its customers by developing state of the art
semiconductor chips, device drivers, firmware and application software.
ESS utilizes a design environment based on workstations, dedicated product
simulators, system simulation with hardware and software modeling, and a high
level design description language. The Company invests regularly in new advanced
equipment and software tools and intends to maintain and enhance its library of
core cells. In addition, the Company opened a new design center in Austin, Texas
in order to gain access to additional talented design engineers.
At December 31, 1996, ESS had a staff of 114 research and development
personnel, 76 of which were involved in semiconductor design and process
development and 38 of which were involved in software development. In addition,
ESS has, on occasion, engaged outside developers to develop certain technologies
to the Company's specifications and intends to increase its reliance on outside
developers in the future. During 1994, 1995 and 1996, the Company spent
approximately $3.7 million, $8.7 million and $20.3 million, respectively, on
research and development activities, excluding a one-time pre and post-tax
charge of $30.4 million related to acquired research and development in-process
from the acquisition of VideoCore Technology, Inc. ("VideoCore") and OSEE
Technology, Inc. ("OSEE") in the first quarter of 1996.
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. In January 1996, the Company completed its
acquisition of VideoCore pursuant to which the Company acquired all of the
outstanding capital stock of VideoCore in exchange for approximately 525,000
shares of the Company's Common Stock and $5.7 million in cash. VideoCore, now a
wholly owned subsidiary of the Company, is developing integrated circuits which
will incorporate advanced compression technology for digital video products. In
March 1996, the Company completed its acquisition of OSEE pursuant to which the
Company acquired all of the outstanding capital stock of OSEE in exchange for
approximately 217,000 shares of the Company's Common Stock and $3.6 million in
cash. OSEE, now a wholly owned subsidiary of the Company, is developing an
advanced fax/modem V.34 and V.34bis algorithm technology which will enable the
Company to offer fax/modem applications to its customers. The Company may
continue to utilize cash and equity to acquire or invest in complementary
businesses or products or to obtain the right to use complementary technologies.
From time to time, in the ordinary course of business, the Company may evaluate
potential acquisitions of or investments in such businesses, products or
technologies owned by third parties.
MANUFACTURING
The Company contracts with independent foundries to manufacture all of its
products. 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. The Company's products are currently
manufactured by four independent foundries, all of which utilize advanced
manufacturing technologies. A substantial majority of the Company's products are
manufactured by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC"), which
has manufactured certain of the Company's products since 1989. The Company also
has foundry arrangements with United Microelectronics Corporation ("UMC") in
Taiwan, Sharp Corporation ("Sharp") in Japan and IC Works ("ICW") in California.
Most of the Company's devices are currently fabricated using a mixed signal CMOS
0.6 and 0.5 micron process technology. The Company is currently developing new
products and converting some existing products which will be manufactured
utilizing a 0.35 micron process technology.
The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs and to
produce products of acceptable quality and with acceptable manufacturing yields
in a timely manner. These foundries fabricate products for other companies and,
with the exception of TSMC, manufacture products of their own design. In
November 1995, the Company entered into long-term agreements with two of its
foundries, TSMC and UMC. The Company intends to continue to work with its other
foundries and to qualify new foundries to obtain additional
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manufacturing capacity. There can be no assurance, however, that the Company
will be able to obtain additional capacity when necessary.
Under the Company's agreement with TSMC, in exchange for TSMC's wafer
capacity commitments for the years 1996 through 1999, the Company is obligated
to pay approximately $32 million in two installments in 1996 and 1997. The
Company also obtained an option to expand the TSMC wafer capacity commitments
further for years 1997 through 2000. If the Company exercises its option, it
would be obligated to pay an additional $31 million in two installments in 1997
and 1998. The Company is obligated to make payments whether or not it takes the
wafers.
Under the Company's agreement with UMC, the Company entered into a joint
venture arrangement with UMC and other U.S. semiconductor companies to build a
separate semiconductor manufacturing facility to be located in Taiwan at an
estimated cost of $1 billion. The Company will invest approximately $26.4
million in three installments over the projected eighteen month period required
to build the facility. Under the terms of the agreement, the Company will
receive a 5% equity ownership in the joint venture company and capacity rights.
The new fabrication facility is currently projected to commence production of
8-inch wafers in 1997.
All of the Company's semiconductor products are assembled and tested by
third-party vendors, primarily Amkor ANAM in Korea, Advanced Semiconductor
Engineering in Taiwan, ASAT in Hong Kong, Astra Microtronics in Indonesia and
OSE in Taiwan. The Company has internally designed and developed its own test
software and certain test equipment, which is provided to the Company's test
vendors. Shortages of raw materials or disruptions in the provision of services
by the Company's assembly vendors could lead to supply constraints or delays in
the delivery of the Company's products. Such constraints or delays might result
in the loss of customers, limitations or reductions in the Company's revenues or
other material adverse effects on the Company's business, financial condition
and results of operations. The Company's reliance on third-party assembly and
testing vendors involves a number of other risks, including reduced control over
delivery schedules, quality assurance and costs. The inability of such third
parties to deliver products of acceptable quality and in a timely manner could
have a material adverse effect on the Company's business, financial condition
and results of operations.
COMPETITION
The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, price declines and rapid product
obsolescence. The Company currently competes with add-in card suppliers and
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
price ("ASPs") and margins of the Company's products. In general, product prices
in the semiconductor industry have decreased over the life of a particular
product. The markets for most of the applications for the Company's products,
particularly the PC market, are characterized by intense price competition. The
willingness of prospective customers to design the Company's products into their
products depends to a significant extent upon the ability of the Company to sell
its products at a price that is cost-effective for such customers. As the
markets for the Company's products mature and competition increases, the Company
anticipates that prices for its products will continue to decline. If the
Company is unable to reduce its costs sufficiently to offset declines in product
prices or is unable to introduce more advanced products with higher product
prices, the Company's business, financial condition and results of operations
would be materially adversely affected.
The Company's existing and potential competitors consist principally of
large domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources, greater intellectual property rights, broader product lines and
longer-standing relationships with customers than the Company. The Company's
competitors also include a number of smaller and
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emerging companies. The Company's principal audio competitors include Cirrus
Logic, Creative Technology, OPTi and Yamaha. The Company's principal video
competitors include C-Cube, Hyundai, LSI Logic and SGS Thompson. The Company's
principal fax/modem competitors include Cirrus Logic, Lucent, Rockwell and Texas
Instruments. Certain of the Company's current and potential competitors maintain
their own semiconductor foundries and may therefore benefit from certain
capacity, cost and technical advantages. The Company believes that its ability
to compete successfully depends on a number of factors, both within and outside
of its control, including the price, quality and performance of the Company's
and its competitors' products, the timing and success of new product
introductions by the Company, its customers and its competitors, the emergence
of new multimedia standards, the development of technical innovations, the
ability to obtain adequate foundry capacity and sources of raw materials, the
efficiency of production, the rate at which the Company's customers design the
Company's products into their products, the number and nature of the Company's
competitors in a given market, the assertion of intellectual property rights and
general market and economic conditions. There can be no assurance that the
Company will be able to compete successfully in the future.
Each successive generation of microprocessors has provided increased
performance, which could in the future result in a microprocessor capable of
performing multimedia functions. In this regard, Intel Corporation has developed
Native Signal Processing ("NSP") capability and an extended multimedia system
architecture ("MMX") for use in conjunction with its Pentium microprocessor, and
is promoting the processing power of the Pentium for data and signal intensive
functions such as graphics acceleration and other multimedia functions. There
can be no assurance that the increased capabilities of microprocessors will not
adversely affect demand for the Company's products.
PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trademarks, copyrights,
trade secret laws and confidentiality procedures to protect its intellectual
property rights. As of December 31, 1996, the Company had 10 patents granted in
the United States, which expire over time, commencing in 1997 and ending in
2011, and 9 corresponding foreign patents. In addition, the Company intends to
seek further United States and international patents on its technology. There
can be no assurance that patents will be issued from any of the Company's
pending applications or applications in preparation or that any claims allowed
from pending applications or applications in preparation will be of sufficient
scope or strength, or be issued in all countries where the Company's products
can be sold, to provide meaningful protection or any commercial advantage to the
Company. Also, competitors of the Company may be able to design around the
Company's patents. The laws of certain foreign countries in which the Company's
products are or may be manufactured or sold, including various countries in
Asia, may not protect the Company's products or intellectual property rights to
the same extent as do the laws of the United States and thus make the
possibility of piracy of the Company's technology and products more likely.
Although the Company is not aware of the development, distribution or sales of
any illegal copies of the Company's hardware or software, any infringements of
its patents, copyrights or trademarks, or any violation of its trade secrets,
confidentiality 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. There is no pending
intellectual property litigation against the Company. However, the Company or
its foundries may from time to time receive notice of claims that the Company
has infringed patents or other intellectual property rights owned by others. The
Company may seek licenses under such patents or other intellectual property
rights. However, there can be no assurance that licenses will be offered or that
the terms of any offered licenses will be acceptable to the Company. The failure
to obtain a license from a third party for technology used by the Company could
cause the Company to incur substantial liabilities and to suspend the
manufacture of products or the use by the Company's foundries of processes
requiring the technology. Furthermore, the Company may initiate claims or
litigation against third parties for infringement of the
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Company's proprietary rights or to establish the validity of the Company's
proprietary rights. Litigation by or against the Company could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation results in a
favorable determination for the Company. In the event of an adverse result in
any such litigation, the Company could be required to pay substantial damages,
cease the manufacture, use and sale of infringing products, expend significant
resources to develop non-infringing technology, discontinue the use of certain
processes or obtain licenses for the infringing technology. There can be no
assurance that the Company would be successful in such development or that such
licenses would be available on reasonable terms, or at all, and any such
development or license could require expenditures by the Company of substantial
time and other resources. Although patent disputes in the semiconductor industry
have often been settled through cross-licensing arrangements, there can be no
assurance that, in the event that any third party makes a successful claim
against the Company or its customers, a cross-licensing arrangement could be
reached. 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 no current plans to grant licenses with respect to its products or
technology; however, it may become necessary for the Company to enter into
product licenses in the future in order, among other things, to secure foundry
capacity. Although the Company has in the past granted licenses to certain of
its technology, some of which have expired, such licenses have been limited and
the Company has not derived material revenues from such licenses in recent
periods.
EMPLOYEES
As of December 31, 1996, the Company had 253 full-time employees, including
114 in research and development, 60 in marketing, sales and support and 79 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.
ITEM 2. PROPERTIES
Prior to October 1996, the Company leased two facilities in Fremont,
California. The leases for such facilities expired on June 30 and October 31,
1996. The facilities consisted of two buildings comprising approximately 62,000
square feet, which were used as the Company's headquarters. In October 1995, the
Company purchased approximately 16 acres of land near its previous Fremont
headquarters and constructed a new headquarters facility of 93,000 square feet.
The Company relocated its operations from the leased facility to the new
facility in September 1996. The Company anticipates that it will begin
construction of additional buildings on the existing land in the spring of 1997.
ITEM 3. LEGAL PROCEEDINGS
In March 1995, Yamaha filed a lawsuit against the Company alleging that the
Company's FM synthesis products infringe two of Yamaha's patents, U.S. Patent
No. 4,249,447 and U.S. Patent No. 4,813,326 (the "Yamaha Patents"). Yamaha
initiated suit with a motion for a temporary restraining order and a request for
a preliminary injunction. In addition, in its complaint, Yamaha sought a
permanent injunction against future infringement, damages for past infringement,
attorneys' fees and costs. Yamaha's lawsuit alleged infringement by all of the
Company's FM synthesis chips, consisting at that time of the ES1488, ES1688,
ES1788, ES1868 and ES1888. For 1995, the Company had revenues of approximately
$52.9 million attributable to sales of these products, constituting
approximately 50% of net revenues. Further, a substantial majority of the
Company's revenues for the foreseeable future was, and still is expected to be
dependent upon sales of these and future products incorporating FM synthesis.
The lawsuit, entitled Yamaha Corporation vs. ESS
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Technology, Inc., was filed in the U.S. District Court for the Central District
of California in Los Angeles, California.
Yamaha's requests for a temporary restraining order and preliminary
injunction were denied on March 17, 1995 and May 1, 1995, respectively. In its
order denying the request for preliminary injunction, the District Court stated
that its decision was based on an assessment of the likelihood of Yamaha's
success on the merits, as well as a balance of the relative hardships that would
be suffered by ESS or Yamaha as a result of the granting or denial of the
preliminary injunction. Yamaha appealed the District Court's denial of the
request for preliminary injunction to the U.S. Court of Appeals for the Federal
Circuit. The hearing at the Federal Circuit took place on January 8, 1996, and
on March 29, 1996 that Court confirmed the denial of the request for preliminary
injunction.
On August 18, 1995 the District Court granted in part and denied in part a
motion for summary judgment which had been filed by the Company. The District
Court held that the Company's FM synthesis products did not literally infringe
Yamaha's U.S. Patent No. 4,249,447, but held that there was a triable issue of
fact as to the infringement of such patent on another basis. The Court also
found triable issues of fact and, therefore, denied the Company's motion for
summary judgment with regard to U.S. Patent No. 4,813,326.
On May 17, 1996, the Company and Yamaha settled all patent infringement
litigation between the two companies. The settlement agreement did not have a
material adverse affect on the Company's financial position or results of
operations or on the Company's ability to sell its products or conduct its
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1996.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the Company's
current executive officers:
NAME AGE POSITION
- ------------------------------------------- --- -------------------------------------------
Fred S.L. Chan............................. 50 President, Chief Executive Officer and
Chairman of the Board of Directors
John H. Barnet............................. 61 Vice President, Chief Financial Officer and
Secretary
Chi-Shin Wang.............................. 50 Chief Technical Officer
Robert L. Blair............................ 49 Executive Vice President, Operations
Bo Ericsson................................ 39 Vice President, Marketing
Nicholas A. Aretakis....................... 35 Vice President, Sales
Mr. Chan joined the Company in November 1985 as President and has been a
director since January 1986. He was appointed Chairman of the Board of Directors
in October 1992 and Chief Executive Officer in June 1994. Mr. Chan has been
serving as President since February 1997. Mr. Chan served as Secretary from
October 1992 to August 1995 and 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. Barnet joined the Company in September 1996 as Vice President, Finance,
Chief Financial Officer and Secretary. Prior to joining the Company, he was
Executive Vice President, Finance and Chief Financial Officer of Trimble
Navigation Limited from 1993. From mid 1992 to mid 1993 he served as Senior Vice
President, Finance and Chief Financial Officer of Centex Telemanagement, Inc., a
telecommunications management company. From 1988 to 1992, he was Vice President,
Finance and Chief Financial Officer of Acurex Corporation, a conglomerate
engaged in military and commercial aerospace, environmental systems,
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and industrial process controls. Previously he held executive positions at
BankAmerica Corporation, Signetic Corporation and Teledyne, Inc. Mr. Barnet
received a BS degree in Industrial Engineering from Stanford University in 1957
and an MBA degree from Columbia University Graduate Business School in 1961.
Dr. Wang has been Chief Technical Officer of the Company since December
1995. Prior to joining the Company he was a co-founder of Integrated Information
Technology, a semiconductor company, and served as President and Chief Executive
Officer from 1987 to December 1995. From 1981 to 1986, he was a co-founder of
Weitek Corporation and served as Vice President of Engineering. Dr. Wang was a
member of the technical staff of Hughes Aircraft Company from 1973 to 1976 and a
project manager of Hewlett Packard from 1976 to 1981. He holds a M.S. degree in
Physics from the California Institute of Technology and a Ph.D.E.E. from
Stanford University.
Mr. Blair has been Executive Vice President, Operations of the Company
since February 1997. From December 1994 to January 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. Ericsson joined the Company in November 1996 as Vice President of
Marketing. Prior to joining the Company, he held various engineering and
management positions with Cirrus Logic between 1990 and 1996. Mr. Ericsson's
most recent position at Cirrus Logic was Vice President, Desktop PC Marketing,
Planning and Business Development. From May 1995 to March 1996, Mr. Ericsson was
Director of Strategic Marketing, Visual and Systems Interface Division. Mr.
Ericsson held the position of Director of Marketing, Personal Systems Division
between 1993 and 1995. From 1992 to 1993, Mr. Ericsson was Director of
Multimedia, Strategic Planning. In 1990, Mr. Ericsson joined Cirrus Logic as
Director of Software and Systems Architecture. Prior to joining Cirrus Logic,
Mr. Ericsson was Software Engineering Manager at Chips and Technologies, a
company he joined in 1987 as Senior Software Engineer. In 1984, Mr. Ericsson
founded Micro Systemation AB, a communications software company in Stockholm,
Sweden. From 1977 to 1981, Mr. Ericsson attended the Stockholm School of
Economics. Between 1989 and 1994, Mr. Ericsson served in various functions
within the Video Electronics Standards Association, including the position of
Vice Chairman in 1991-92.
Mr. Aretakis has been Vice President, Sales of the Company since August
1994. Prior to joining the Company, he held sales positions in various
semiconductor companies, including Director of OEM Sales at Media Vision, a
computer peripherals manufacturer, from March 1993 to July 1994 and Director of
Sales at SEEQ from 1988 to January 1993. From 1984 through 1988, Mr. Aretakis
held various marketing positions at Microchip Technology Inc. Mr. Aretakis holds
a B.S.E.E. degree from Columbia University and a B.A. degree in Mathematics from
Hobart College.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock has been trading on the Nasdaq National Market
under the symbol "ESST" since October 6, 1995. The following table sets forth
the high and low last reported sales prices for the Common Stock as reported by
the Nasdaq National Market during the period indicated.
HIGH LOW
---- ---
FISCAL 1995:
Fourth Quarter (since October 6, 1995)........................ $ 39 $14 /16
FISCAL 1996:
First Quarter................................................. $ 24 $16
Second Quarter................................................ 25 1/4 16 1/4
Third Quarter................................................. 18 1/2 9 1/4
Fourth Quarter................................................ 30 15 1/8
As of January 31, 1997, there were approximately 126 record holders of the
Company's Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues........................... $23,675 $15,218 $33,435 $105,744 $226,455
Cost of revenues....................... 9,588 6,733 12,047 39,584 106,818
------- ------- ------- -------- --------
Gross profit......................... 14,087 8,485 21,388 66,160 119,637
Operating expenses:
Research and development............. 3,529 2,915 3,711 8,665 20,270
Research and development
in-process........................ -- -- -- -- 30,355
Selling, general and
administrative.................... 2,799 3,005 3,233 9,758 16,814
------- ------- ------- -------- --------
Operating income....................... 7,759 2,565 14,444 47,737 52,198
Nonoperating income (expense), net..... (266) 598 283 2,694 3,241
------- ------- ------- -------- --------
Income before income taxes............. 7,493 3,163 14,727 50,431 55,439
Provision for income taxes............. (2,654) (2,880) (6,346) (20,545) (33,813)
------- ------- ------- -------- --------
Net income............................. $ 4,839 $ 283 $ 8,381 $ 29,886 $ 21,626
======= ======= ======= ======== ========
Net income per share................... $ 0.08 $ 0.01 $ 0.22 $ 0.79 $ 0.52
======= ======= ======= ======== ========
Weighted average common and common
equivalent shares(1)................. 57,220 35,849 37,413 37,775 41,588
======= ======= ======= ======== ========
DECEMBER 31,
---------------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.......................... $10,964 $ 8,114 $10,860 $ 78,124 $ 69,204
Working capital........................ 3,924 2,940 11,135 70,602 65,207
Total assets........................... 19,949 15,108 24,014 162,703 211,985
Long-term debt, less current portion... 3,220 -- -- 15,960 --
Total shareholders' equity............. 517 5,889 14,458 105,208 143,176
- ---------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of weighted average common and common equivalent shares used to compute net
income per share.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
ESS designs, develops and markets highly integrated mixed signal
semiconductor multimedia solutions for sale to desktop and notebook personal
computer manufacturers and consumer product companies. In 1996, ESS experienced
four quarters of strong sequential growth, with revenues totaling a record
$226.5 million, a 114% increase from the 1995 total of $105.7 million and
seven-times revenues in 1994 of $33.4 million. Similarly, net income rose to
$52.0 million excluding a one-time pre and post-tax charge of $30.4 million
related to acquired research and development in-process for the VideoCore and
OSEE acquisitions, a 74% increase over 1995 net income of $29.9 million and
six-times 1994 net income of $8.4 million. The gross margin for 1996 was 53%,
declining from 63% in 1995 primarily due to price competition in the audio
segment offset in part by manufacturing cost reductions.
The Company is a leader in single-chip audio solutions for both personal
computers and consumer electronics products. Having established itself as a
leading supplier of mixed signal PC audio components on a single chip, ESS
entered both the video and fax/modem markets. In January 1996, the Company
completed its acquisition of VideoCore pursuant to which the Company acquired
all of the outstanding capital stock of VideoCore in exchange for approximately
525,000 shares of the Company's Common Stock and $5.7 million in cash. VideoCore
develops integrated circuits which incorporate advanced compression technology
in digital video products under the trade-name VideoDRIVE. In March 1996, the
Company completed its acquisition of OSEE pursuant to which the Company acquired
all of the outstanding capital stock of OSEE in exchange for approximately
217,000 shares of the Company's Common Stock and $3.6 million in cash. OSEE
develops advanced fax/modem V.34 and V.34bis algorithm technology which will
enable the Company to provide modem and computer fax/modem products under the
trade-name TeleDRIVE. Both acquisitions were accounted for as a purchase, and
the portion of the purchase prices attributable to research and development
in-process was expensed in the first quarter of 1996.
After completing development of its first video product, the Company
introduced its first VideoDRIVE product, a single-chip MPEG-1 video/audio/system
decorder that provides full-screen, full-motion video and selectable CD-quality
audio for a variety of digital video playback applications, such as karaoke
players, VCD players, PC MPEG playback cards, and CD-XA video playback systems.
Shipments of these chips to the VCD player market began in the second quarter of
1996. The Company also announced 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 set-top boxes, multimedia
personal computers and home entertainment units. By year-end 1996, ESS had sold
approximately 800,000 chips in the VideoDRIVE product line, comprising 7% of the
Company's revenues for 1996.
The TeleDRIVE products for the Internet and other modem markets followed
the Company's first quarter acquisition of OSEE. The Company introduced its
integrated V.34bis modem solutions, the Company's first modem digital signal
processor which is scheduled for production volumes in the first half of 1997.
As the Company expanded during 1996, the number of employees increased to
253 from 158, and it became increasingly important to invest in the Company's
infrastructure to broaden and deepen the Company's management team. New senior
executives have been hired whose skills and experience will help to continue
ESS' growth.
1996 also marked significant physical expansion for the Company. At the end
of 1995, ESS purchased 16 acres of land in Fremont, California, near ESS'
previous facilities. By the end of 1996, the Company completed and occupied a
two-story, 93,000-square-foot, world headquarters. The site has expansion
capacity for three additional buildings, and the Company plans to begin
construction of two of these buildings in the spring of 1997 to house additional
engineering capacity and other needs.
With the Company's growth focused on the rapidly expanding Asia/Pacific
region, ESS supplemented its existing sales and technical support centers with
new centers in Beijing and Tokyo. The new centers are supporting the Company's
new MPEG video products for VCD player, DVD player and set-top box products.
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In addition, the Company opened a new design center in Austin, Texas, in order
to gain access to additional talented design engineers.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated statement of operations as a percentage of net revenues for the
periods indicated.
YEARS ENDED DECEMBER 31,
-------------------------
1994 1995 1996
----- ----- -----
Net revenues................................................ 100.0% 100.0% 100.0%
Cost of revenues............................................ 36.0 37.4 47.2
------ ------ ------
Gross margin.............................................. 64.0 62.6 52.8
Operating expenses:
Research and development.................................. 11.1 8.2 9.0
Research and development in-process....................... -- -- 13.4
Selling, general and administrative....................... 9.7 9.2 7.4
------ ------ ------
Operating income............................................ 43.2 45.2 23.0
Nonoperating income, net.................................... 0.8 2.5 1.5
------ ------ ------
Income before income taxes.................................. 44.0 47.7 24.5
Income taxes................................................ (19.0) (19.4) (14.9)
------ ------ ------
Net income.................................................. 25.0% 28.3% 9.6%*
====== ====== ======
- ---------------
* Includes a one-time pre and post-tax charge of 13.4% related to acquired
research and development in-process.
Net Revenues. Net revenues were $33.4 million, $105.7 million and $226.5
million in 1994, 1995 and 1996, respectively. Net revenues for 1996 increased
114% from 1995 primarily as a result of the increased sales growth of the
Company's existing PC audio products as well as from the introduction of new PC
audio and video semiconductor products. The Company's PC audio semiconductor
products accounted for 92% of the Company's net revenues for 1996. Net revenues
for 1995 increased 216% from 1994 primarily as a result of the sales growth of
the Company's PC audio semiconductor products. The increase in PC audio
semiconductor product sales was partially offset by a continued decrease in
sales of the Company's consumer speech/sound semiconductors. International
revenues accounted for approximately 72%, 73% and 92% of net revenues for 1994,
1995 and 1996, respectively. The increase in international sales as a percentage
of net revenues between 1995 and 1996 primarily reflects the transfer of
production by U.S. based PC customers from U.S. to Asia and growth in the sales
of video products which are sold in Asian markets.
Gross Margin. Gross profit was $21.4 million, $66.2 million and $119.6
million in 1994, 1995 and 1996, respectively, representing 64.0%, 62.6% and
52.8% of net revenues for such years. Gross margin declined from 1995 to 1996 as
a result of lower ASPs on existing products arising from highly competitive
market conditions and manufacturing startup costs associated with the Company's
new PC audio, video, and fax/modem products. Lower ASPs were partially offset by
manufacturing cost reductions on existing products and higher ASPs associated
with the introduction of new PC audio and video products. Gross margins declined
from 1994 to 1995 as a result of a decrease in ASPs of the Company's PC audio
products and manufacturing startup costs associated with the Company's new PC
audio products. The Company's overall gross profit and margin are 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. The Company has encountered increased
competition from other suppliers who are offering competitive single chip
products and new features. In addition, the Company expects the overall average
selling prices for its existing products to decline significantly over the life
of the products. The Company believes that in order to maintain or increase
gross profit, it must achieve higher unit volume shipments, cost reductions, new
features and
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product introductions. 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 gain market acceptance.
Research and Development Expenses. Research and development expenses were
$3.7 million, $8.7 million and $20.3 million, or 11.1%, 8.2% and 9.0% of net
revenues, in 1994, 1995 and 1996, respectively, excluding a one-time pre and
post-tax charge of $30.4 million related to acquired research and development
in-process from the acquisition of VideoCore and OSEE in the first quarter of
1996. The increase in absolute dollars was primarily due to the increase in the
Company's engineering staff, engineering test runs, masks, internal and external
consulting expenses and one-time licensing fees associated with the research and
development efforts to support the introduction of new multimedia products. The
increase in absolute dollars in research and development expenses from 1994 to
1995 primarily reflected increases in the Company's engineering staff and
internal and outside consulting expenses associated with increased research and
development efforts to support the introduction of new PC audio products and
multimedia products. The Company expects to incur higher absolute research and
development expenses in 1997, although these expenses are expected to remain
relatively constant as a percentage of net revenues. There can be no assurance,
however, that revenues will grow at the same rate as the anticipated research
and development expenses.
Selling, General and Administration Expenses. Selling, general and
administrative expenses were $3.2 million, $9.8 million and $16.8 million, or
9.7%, 9.2% and 7.4% of net revenues, in 1994, 1995 and 1996, respectively. The
increase in absolute dollars in selling, general and administration expenses
from 1995 to 1996 was primarily due to increase in commissions and bonuses on
higher sales volumes, increased personnel and related expenses resulting from
Company's status as a public company. The increase in absolute dollars in
selling, general and administrative expenses from 1994 to 1995 was primarily due
to legal expenses associated with the Company's litigation with Yamaha. See
"Item 3. Legal Proceedings" and Note 8 of Notes to Consolidated Financial
Statements. The increase in these expenses was also due to commissions on higher
sales levels, added personnel and related expenses and, to a lesser extent,
promotional expenses and costs associated with the expansion of the Company's
sales activities. The Company expects to incur higher selling, general and
administrative expenses due to increased selling activities and reporting and
other requirements of a public company, although these expenses are expected to
remain relatively constant as a percentage of net revenues. There can be no
assurance, however, that revenues will grow at the same rate as the anticipated
selling, general and administrative expenses.
Non-Operating Income (Expense), Net. Non-operating income, net was
$283,000, $2,694,000 and $3,241,000 in 1994, 1995 and 1996, respectively. In
1994, 1995 and 1996 non-operating income (expense), net consisted of interest
income net of interest expense and gains on sale of securities.
Provision for Income Taxes. The Company's effective tax rate was 43%, 41%
and 61% for 1994, 1995 and 1996. The Company's tax rate for 1994 was higher than
the combined federal and state statutory rate of 41% as a result of federal
taxes provided on foreign earnings. The Company's tax rate for 1995 was at the
combined federal and state statutory rate of 41%. The tax rate for 1996 of 61%
includes the one-time pre and post-tax charge of $30.4 million related to
acquired research and development in-process from the acquisition of VideoCore
and OSEE in the first quarter 1996. Pro forma tax rate excluding this one-time
pre and post-tax charge of $30.4 million was 39%. The Company's pro forma tax
rate for 1996 was lower than the combined federal and state statutory rate of
41% as a result of tax exempt interest income and research and development
credits. See Note 4 of Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements from
cash generated by operations, the sale of equity securities, bank lines of
credit and short-term and long-term debt. At December 31, 1996, ESS had cash and
cash equivalents and short-term investments of $69.2 million and working capital
of $65.2 million. As of December 31, 1996, the Company had two $10.0 million
bank lines of credit expiring on March 31, 1997 and May 1, 1997. These lines of
credit require the Company to achieve certain financial ratios and operating
results. There were no borrowing under these lines of credit as of December 31,
1996.
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In 1996, the Company generated net cash from operating activities of $36.4
million. This resulted from net income of $21.6 million, a one-time non-cash
charge for research and development in-process of $30.4 million and depreciation
and amortization of $3.2 million, less a gain on sale of short-term investments
of $1.0 million and investment in working capital of $17.8 million. The Company
received net proceeds of $7.1 million from sale of marketable equity securities,
$3.8 million from the issuance of common stock from exercise of stock options
and employee stock purchase plan, and $8.9 million in income tax credits from
disqualifying disposition of common stock options. The Company invested $14.0
million in property and equipment, repurchased stock for $19.7 million, paid
$16.0 million on capacity commitments and $9.3 million for acquisition of
VideoCore and OSEE. For the year, cash and cash equivalents declined $2.8
million.
In 1995, the Company generated net cash from operating activities of $13.5
million. This resulted from net income of $29.9 million, depreciation and
amortization of $0.9 million less a gain on sale of marketable equity securities
of $1.3 million and investments in working capital of $16.0 million. The Company
received net proceeds of $60.8 million from the issuance of common stock related
to its initial public offering. The Company purchased $24.9 million in
short-term investments and invested $8.4 million in property and equipment. For
the year, cash and cash equivalents increased $41.0 million.
In 1994, the Company generated net cash from operating activities of $5.1
million. This resulted from net income of $8.4 million, depreciation or
amortization of $0.6 million less investments in working capital of $3.8
million. The Company received $1.3 million from the sale of marketable equity
securities. The Company paid $2.7 million in short-term debt and invested $1.1
million in property and equipment. For the year, cash and cash equivalents
increased $2.7 million.
The Company believes that its existing cash and cash equivalents as of
December 31, 1996, together with the cash generated from operations and
available borrowings under its line of credit, will be sufficient to fund
acquisitions of property and equipment and provide adequate working capital
through at least the next twelve months. Capital expenditures for the next
twelve months are anticipated to be approximately $17 million of which
approximately $7 million will be used to fund construction of additional
facilities and approximately $10 million will be used to acquire capital
equipment. In addition, the Company is obligated to pay approximately $16
million over the next 6 months to TSMC in exchange for certain wafer capacity
commitments and will invest approximately $20 million in 2 installments over the
next 6 months in exchange for equity ownership in a joint venture with UMC. 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. The Company also has bank lines of credit which may be
utilized to provide additional cash.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for the historical information contained in this Annual Report on
Form 10-K, the matters discussed in this report are forward looking statements
which involve risks and uncertainties that could cause actual results to differ
from those indicated by such forward looking statements. Such risks and
uncertainties include but are not limited to those set forth below. In any
event, the matters set forth below should be carefully considered when
evaluating the Company's business and prospects.
Potential Fluctuations in Operating Results. The Company's operating
results are subject to quarterly and other fluctuations due to a variety of
factors, including the gain or loss of significant customers, increased
competitive pressures, changes in pricing policies by the Company, its
competitors or its suppliers, including decreases in unit ASPs of the Company's
products, the timing of new product announcements and introductions by the
Company or its competitors and market acceptance of new or enhanced versions of
the Company's and its customers' products. Other factors include the
availability of foundry capacity, fluctuations in manufacturing yields,
availability and cost of raw materials, changes in the mix of products sold, the
cyclical nature of both the semiconductor industry and the market for PCs,
seasonal customer demand, the timing of significant orders and significant
increases in expenses associated with the expansion of operations. The Company's
operating results could also be adversely affected by economic conditions
generally in various
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geographic areas where the Company or its customers do business, or order
cancellations or rescheduling. These factors are difficult to forecast, and
these or other factors could materially affect the Company's quarterly or annual
operating results. There can be no assurance as to the level of sales or
earnings that may be attained by the Company in any given period in the future.
See "Management Discussion and Analysis of Financial Condition and Results of
Operations."
Competition; Pricing Pressures. The markets in which the Company competes
are intensely competitive and are characterized by rapid technological change,
price declines and rapid product obsolescence. See "Item 1.
Business -- Competition."
Dependence on Single Product Line and PC Industry. In 1995 and 1996, sales
of PC audio semiconductors accounted for approximately 98% and 92%,
respectively, of the Company's net revenues, and the Company expects that sales
of audio semiconductors will continue to account for a majority of its net
revenues for the foreseeable future. Any reduction in ASPs for audio products or
demand for the Company's audio semiconductors, whether because of a reduction in
demand for PCs in general or PC audio, increased competition or otherwise, would
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company is currently engaged in the development and introduction of new
PC audio products as well as new multimedia products for the PC and consumer
markets that provide capabilities such as video and fax/ modem/voice
applications. There can be no assurance that the Company will be able to
identify market trends or new product opportunities, develop and market new
products, achieve design wins or respond effectively to new technological
changes or product announcements by others. A failure in any of these areas
would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's audio products are sold for incorporation into multimedia
desktop and notebook computers. ESS audio semiconductors are incorporated into
motherboards by multimedia PC original equipment manufacturers ("OEMs") or in
add-in sound cards. Therefore, the Company is heavily dependent on the continued
growth of the markets for multimedia desktop and notebook computers and
multimedia applications utilizing high quality audio. There can be no assurance
that these markets will be able to sustain continued growth. A slowing in unit
volume and a decrease in ASPs could result in a decline in market revenues in
the PC industry which could result in a corresponding decline in demand for the
Company's products, which would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1.
Business -- Products."
Importance of New Products and Technological Change. The markets for the
Company's products are characterized by evolving industry standards, rapid
technological change and product obsolescence. The Company's success is highly
dependent upon the successful development and timely introduction of new
products at competitive price and performance levels. The success of new
products depends on a number of factors, including timely completion of product
development, market acceptance of the Company's and its customers' new products,
securing sufficient foundry capacity for volume manufacturing of wafers,
achievement of acceptable wafer fabrication yields by the Company's independent
foundries and the Company's ability to offer new products at competitive prices.
In order to succeed in having the Company's products incorporated into new
products being designed by desktop and notebook computer manufacturers, the
Company must anticipate market trends and performance and functionality
requirements of such manufacturers and must successfully develop and manufacture
products that meet these requirements. In addition, the Company must meet the
timing and price requirements of such manufacturers and must make such products
available in sufficient quantities. Accordingly, in selling to OEMs, the Company
can often incur significant expenditures prior to volume sales of new products,
if any. In order to help accomplish these goals, the Company has in the past and
will continue to consider in the future the acquisition of other companies or
the products and technologies of other companies. Such acquisitions carry
additional risks such as a lack of integration with existing products and
corporate culture, the potential for large write-offs and the diversion of
management attention. The Company is currently engaged in the development of new
PC audio products as well as new multimedia products that provide telephony
capabilities such as fax/modem/voice and video applications. There can be no
assurance that the Company will be able to identify market trends or new
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product opportunities, develop and market new products, achieve design wins or
respond effectively to new technological changes or product announcements by
others. A failure in any of these areas would have a material adverse effect on
the Company's business, financial condition and results of operations. See "Item
I. Business -- Research and Development."
Dependence on TSMC and Other Third Parties. The Company relies on
independent foundries to manufacture all of its products. A substantial majority
of the Company's products are currently manufactured by TSMC, which has
manufactured certain of the Company's products since 1989. The Company also has
foundry arrangements with Sharp, ICW, and UMC, which have been manufacturing
certain of the Company's products since 1986, 1991 and 1995, respectively. TSMC,
in particular, provides the Company with access to advanced process technology
necessary for the manufacture of the Company's products. These foundries
fabricate products for other companies and, with the exception of TSMC,
manufacture products of their own design. In November 1995, the Company entered
into long-term agreements with TSMC and UMC in which the Company has secured
access to additional capacity and to leading edge technology. See "Item I.
Business -- Manufacturing."
While the Company has entered into long-term agreements with two of its
foundries, the Company's reliance on these and other independent foundries
involves a number of risks, including the absence of adequate capacity, the
unavailability of, or interruption in access to, certain process technologies
and reduced control over delivery schedules, manufacturing yields and costs, and
the international risks more fully described below. The Company expects to rely
upon TSMC and UMC to manufacture a substantial majority of the Company's
products for the foreseeable future. In the event that TSMC and UMC are unable
to continue to manufacture the Company's key products in required volumes, the
Company will have to identify and secure additional foundry capacity. In such an
event, the Company may be unable to identify or secure additional foundry
capacity from another manufacturer, particularly at the levels that the Company
currently expects TSMC and UMC to provide. Even if such capacity is available
from another manufacturer, the qualification process could take six months or
longer. The loss of any of its foundries as a supplier, the inability of the
Company to acquire additional capacity at its current suppliers or qualify other
wafer manufacturers for additional foundry capacity should additional capacity
be necessary, or any other circumstances causing a significant interruption in
the supply of semiconductors to the Company would have a material adverse effect
on the Company's business, financial condition and results of operations.
To address potential foundry capacity constraints in the future, ESS will
continue to consider and may be required to enter into additional arrangements,
including equity investments in or loans to independent wafer manufacturers in
exchange for guaranteed production capacity, joint ventures to own and operate
foundries, or "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods. Any such arrangements
could require the Company to commit substantial capital and grant licenses to
its technology. The need to commit substantial capital may require the Company
to obtain additional debt or equity financing, which could result in dilution to
the Company's shareholders. There can be no assurance that such additional
financing, if required, will be available when needed or, if available, will be
obtained on terms acceptable to the Company.
Customer Concentration. A limited number of customers have accounted for a
substantial portion of the Company's net revenues. In 1994, 1995 and 1996, sales
to the Company's top five customers, including sales to the Company's
international distributor, accounted for approximately 51%, 48% and 40%
respectively, of the Company's net revenues. In 1994, two customers, Compaq and
Western Publishing, accounted for approximately 20% and 14%, respectively, of
the Company's net revenues. In 1995, Compaq and Universe Electron Corporation,
the Company's Japanese distributor, each accounted for approximately 17% of the
Company's net revenues. The decline in the percentage of sales attributable to
Western Publishing reflects the Company's shift in product mix from toy and
other consumer products to PC audio products. In 1996, Compaq and Universe
Electron Corporation each accounted for approximately 12% and 13%, respectively,
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. While the Company has not experienced returns and allowances
in excess of the Company's reserves, 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
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22
Company expects that a limited number of customers may account for a substantial
portion of its net revenues for the foreseeable future. The Company has
experienced changes from year to year in the composition of its major customer
base and believes this pattern may continue. For example, Compaq has been a
significant customer of the Company since 1994. The Company does not have
long-term purchase agreements with any of its customers. The reduction, delay or
cancellation of orders from one or more major customers for any reason or the
loss of one or more of such major customers could materially and adversely
affect the Company's business, financial condition and results of operations. In
addition, since the Company's products are often sole sourced to its customers,
the Company's operating results could be materially and adversely affected if
one or more of its major customers were to develop other sources of supply.
There can be no assurance that the Company's current customers will continue to
place orders with the Company, that orders by existing customers will not be
canceled or will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers. The Company currently places
noncancelable orders to purchase its products from independent foundries on an
approximately three month rolling basis, while its customers generally place
purchase orders with the Company less than four weeks prior to delivery that may
be canceled without significant penalty. Consequently, if anticipated sales and
shipments in any quarter are canceled or do not occur as quickly as expected,
expense and inventory levels could be disproportionately high and the Company's
business, financial condition and results of operations could be materially
adversely affected.
Management of Growth. The Company has recently experienced significant
growth in revenues 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 continue to improve its
operational, financial and management information systems, implement additional
systems and controls, and hire, train, motivate, manage and retain its
employees. There can be no assurance that the Company will be able to manage
such growth effectively, and the failure to do so could have a material adverse
effect on the Company's business, financial condition and results of operations.
International Operations. During 1994, 1995 and 1996, international sales,
accounted for approximately 72%, 73% and 92% of the Company's net revenues,
respectively. Substantially all of the Company's international sales were to
customers in Taiwan, Japan, Hong Kong and Singapore. The Company expects that
international sales will continue to represent a significant portion of its net
revenues for the foreseeable future. In addition, substantially all of the
Company's products are manufactured, assembled and tested by independent third
parties in Asia. Due to its reliance on international sales and foreign
third-party manufacturing, assembly and testing operations, the Company is
subject to the risks of conducting business outside of the United States. These
risks include unexpected changes in, or impositions of legislative or regulatory
requirements, delays resulting from difficulty in obtaining export licenses for
certain technology, tariffs, quotas and other trade barriers and restrictions,
longer payment cycles, greater difficulty in accounts receivable collection,
potentially adverse taxes, the burdens of complying with a variety of foreign
laws and other factors beyond the Company's control. The Company is also subject
to general geopolitical risks in connection with its international trade
relationships. In particular, mainland China, which represents a large potential
market for the Company's products, has recently experienced the death of its
leader Deng Xiaoping. Should the death of Deng Xiaoping result in instability in
the government, it is possible that sales to mainland China will be impeded.
Such instability could also lead to disruption in the Company's ability to trade
with Taiwan, which represents a majority of the Company's sales and is the
location of its major foundries and two test facilities. Should such disruption
occur, it is possible that purchases by Taiwanese customers will decline and
semiconductor manufacturing in Taiwan will be impeded, cutting off the Company's
main supply of guaranteed wafer production. This could also lead to capacity
constraints at non-Taiwanese foundries. Although the Company has not to date
experienced any material adverse effect on its business, financial condition or
results of operations as a result of such regulatory, geopolitical and other
factors, there can be no assurance that such factors will not have a material
adverse effect on the Company's business, financial condition and results of
operations in the future or require the Company to modify its current business
practices.
In addition, the laws of certain foreign countries in which the Company's
products are or may be manufactured or sold, including various countries in
Asia, may not protect the Company's products or
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intellectual property rights to the same extent as do the laws of the United
States and thus make the possibility of piracy of the Company's technology and
products more likely. Currently, all of the Company's product sales and all of
its arrangements with foundries and assembly and test vendors, other than its
foundry arrangement with Sharp Corporation, provide for pricing and payment in
U.S. dollars. To date, although the effect of currency fluctuations have been
insignificant, there can be no assurance that fluctuations in currency exchange
rates will not have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, to date the Company
has not engaged in any currency hedging activities, although the Company may do
so in the future. Further, there can be no assurance that one or more of the
foregoing factors will not have a material adverse effect on the Company's
business, financial condition and results of operations or require the Company
to modify its current business practices.
Semiconductor Industry. The semiconductor industry has historically been
characterized by rapid technological change, cyclical market patterns,
significant price erosion, periods of over-capacity and production shortages,
variations in manufacturing costs and yields and significant expenditures for
capital equipment and product development. In addition, the industry has
experienced significant economic downturns at various times, characterized by
diminished product demand and accelerated erosion of product prices. Although
the semiconductor industry in recent periods has experienced increased demand,
it is uncertain how long these conditions will continue. The Company may
experience substantial period-to-period fluctuations in operating results due to
general semiconductor industry conditions.
Patents and Proprietary Rights. The Company relies on a combination of
patents, trademarks, copyrights, trade secret laws and confidentiality
procedures to protect its intellectual property rights. See "Item 1.
Business -- Patents and Proprietary Rights."
Dependence on Key Personnel. The Company's success depends to a
significant degree upon the continued contributions of Fred S.L. Chan, the
Company's Chief Executive Officer and Chairman of the Board of Directors. As of
January 31, 1997, Mr. Chan, together with his spouse, Annie M.H. Chan, a
director of the Company and certain trusts for the benefit of the Chan's
children and certain charities beneficially own, in the aggregate, approximately
41% of the Company's Common Stock. The future success of the Company depends on
its ability to continue to attract, retain and motivate qualified senior
management, sales and technical personnel, particularly highly skilled
semiconductor design personnel and software engineers, for whom competition is
intense. Recently, the Company has hired a number of key executives and
management personnel. The loss of Mr. Chan, other key executive officers, key
design personnel or software engineers or the inability to hire and retain
sufficient qualified personnel could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the Company will be able to retain these employees. The
Company currently does not maintain any key man life insurance on the life of
any of its key employees.
Control by Existing Shareholders. As of January 31, 1997, Fred S.L. Chan,
the Company's Chief Executive Officer and Chairman of the Board of Directors,
together with his spouse, Annie M. H. Chan, a director of the Company, and
certain other shareholders related to Mr. and Mrs. Chan owned, in the aggregate,
41% of the Company's outstanding Common Stock. As a result, these shareholders,
acting together, possess significant voting power over the Company, giving them
the ability among other things to influence significantly the election of the
Company's Board of Directors and approve significant corporate transactions.
Such control could delay, defer or prevent a change in control of the Company,
impede a merger, consolidation, takeover or other business combination involving
the Company, or discourage a potential acquiror from making a tender offer or
otherwise attempting to obtain control of the Company.
Shares Eligible for Future Sale. As of January 31, 1997, the Company had
approximately 38,307,036 shares of Common Stock outstanding. Of such shares,
22,406,639 shares are freely tradable and the remaining 15,900,397 shares are
restricted shares ("Restricted Shares") under the Securities Act of 1933, as
amended (the "Securities Act") and are eligible for sale in the public market,
subject to certain volume and resale restrictions pursuant to Rule 144.
Possible Volatility of Stock Price. The price of the Company's Common
Stock has in the past and may continue in the future to fluctuate widely. Future
announcements concerning the Company, its competitors or
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its principal customers, including quarterly operating results, changes in
earnings estimates by analysts, technological innovations, new product
introductions, governmental regulations or litigation may cause the market price
of the Common Stock to continue to fluctuate substantially. Further, in recent
years the stock market has experienced extreme price and volume fluctuations
that have particularly affected the market prices of equity securities of many
high technology companies and that often have been unrelated or disproportionate
to the operating performance of such companies. These fluctuations, as well as
general economic, political and market conditions such as recessions or
international currency fluctuations, may materially adversely affect the market
price of the Common Stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the years ended December 31,
1996, 1995 and 1994
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995 and 1994
Notes to Consolidated Financial Statements
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
ESS Technology, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity and cash
flows present fairly, in all material respects, the financial position of ESS
Technology, Inc. and its subsidiaries at December 31, 1995 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Price Waterhouse LLP
San Jose, California
January 17, 1997
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ESS TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
DECEMBER 31,
-------------------------
1995 1996
-------- --------
ASSETS
Current assets:
Cash and cash equivalents...................................... $ 51,881 $ 49,055
Short-term investments......................................... 26,243 20,149
Accounts receivable, net....................................... 10,236 22,054
Inventories.................................................... 19,169 33,150
Deferred income taxes.......................................... 2,337 3,270
Prepaid expenses and other assets.............................. 2,271 6,338
------- -------
Total current assets................................... 112,137 134,016
Property and equipment, net...................................... 10,371 22,366
Other assets..................................................... 40,195 55,603
------- -------
$162,703 $211,985
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.......................... $ 33,744 $ 58,433
Income taxes payable........................................... 3,722 4,964
Deferred income taxes.......................................... 4,069 5,412
------- -------
Total current liabilities.............................. 41,535 68,809
------- -------
Long-term advances payable to foundries.......................... 15,960 --
------- -------
Total liabilities...................................... 57,495 68,809
------- -------
Commitments and contingencies
(Notes 8 and 9)
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding................................. -- --
Common stock, no par value, 100,000 shares authorized;
35,473 and 38,127 shares issued and outstanding at
December 31, 1995 and 1996, respectively.................... 66,891 98,655
Deferred compensation related to stock options................. (60) --
Retained earnings.............................................. 38,377 44,521
------- -------
Total shareholders' equity............................. 105,208 143,176
------- -------
Total liabilities and shareholders' equity....................... $162,703 $211,985
======= =======
The accompanying notes are an integral part of these financial statements.
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ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1995 1996
------- -------- --------
Net revenues................................................ $33,435 $105,744 $226,455
Cost of revenues............................................ 12,047 39,584 106,818
------- ------- --------
Gross profit.............................................. 21,388 66,160 119,637
Operating expenses:
Research and development.................................. 3,711 8,665 20,270
Research and development in-process....................... -- -- 30,355
Selling, general and administrative....................... 3,233 9,758 16,814
------- ------- --------
Operating income............................................ 14,444 47,737 52,198
Interest expense............................................ (164) -- --
Interest income............................................. 305 1,348 2,276
Gain on short-term investments.............................. 142 1,346 965
------- ------- --------
Income before provision for income taxes.................... 14,727 50,431 55,439
Provision for income taxes.................................. (6,346) (20,545) (33,813)
------- ------- --------
Net income.................................................. $ 8,381 $ 29,886 $ 21,626
======= ======= ========
Net income per share........................................ $ 0.22 $ 0.79 $ 0.52
======= ======= ========
Weighted average common and common equivalent shares........ 37,413 37,775 41,588
======= ======= ========
The accompanying notes are an integral part of these financial statements.
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ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
COMMON STOCK
----------------- DEFERRED RETAINED
SHARES AMOUNT COMPOSITION EARNINGS TOTAL
------ ------- ------------ -------- --------
Balance at December 31, 1993.................... 29,126 $ 5,959 $ (180) $ 110 $ 5,889
Issuance of common stock upon exercise of
options.................................... 1,122 128 -- -- 128
Amortization of deferred compensation......... -- -- 60 -- 60
Net income.................................... -- -- -- 8,381 8,381
------ -------- ----- ------- --------
Balance at December 31, 1994.................... 30,248 6,087 (120) 8,491 14,458
Issuance of common stock in initial public
offering, net of issuance costs of
$1,081..................................... 4,428 60,682 -- -- 60,682
Issuance of common stock upon exercise of
options.................................... 797 122 -- -- 122
Amortization of deferred compensation......... -- -- 60 -- 60
Net income.................................... -- -- -- 29,886 29,886
------ -------- ----- ------- --------
Balance at December 31, 1995.................... 35,473 66,891 (60) 38,377 105,208
Issuance of common stock upon exercise of
options.................................... 3,667 3,152 -- -- 3,152
Issuance of common stock for acquisitions..... 743 23,352 -- -- 23,352
Issuance of common stock for employee stock
purchase plan.............................. 47 621 -- -- 621
Amortization of deferred compensation......... -- -- 60 -- 60
Repurchase of common stock.................... (1,803) (4,249) -- (15,482) (19,731)
Income tax benefit on disqualifying
disposition of common stock options........ -- 8,888 -- 8,888
Net income.................................... -- -- -- 21,626 21,626
------ -------- ----- ------- --------
Balance at December 31, 1996.................... 38,127 $98,655 -- $ 44,521 $143,176
====== ======== ===== ======= ========
The accompanying notes are an integral part of these financial statements.
27
29
ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1995 1996
------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 8,381 $ 29,886 $ 21,626
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 656 934 3,234
Charges for research and development in-process........ -- -- 30,355
Gain on sale of short-term investments................. (142) (1,346) (965)
Deemed compensation expense and compensation related
to stock options..................................... 60 60 60
Change in assets and liabilities (net of effect of
VideoCore and OSEE acquisitions):
Accounts receivable.................................. (2,889) (5,935) (11,818)
Inventories.......................................... (2,970) (15,140) (13,969)
Deferred income taxes................................ (654) (1,061) (1,430)
Prepaid expenses and other assets ................... (45) (41,837) (15,969)