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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 333-15627
8X8, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0142404
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2445 MISSION COLLEGE BLVD.
SANTA CLARA, CA 95054
(408) 727-1885
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR
VALUE $.001 PER SHARE
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. [ ]
Based on the closing sale price of the Registrant's common stock on the
NASDAQ National Market System on May 1, 1998, the aggregate market value of the
voting stock held by non-affiliates of the Registrant was $74,091,785.44. Shares
of the Registrant's common stock held by each officer and director and by each
person who owns 5% or more of the Registrant's outstanding common stock 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.
The number of shares of the Registrant's common stock outstanding as of May
1, 1998 was 15,293,614.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT LOCATION IN FORM 10-K
Proxy Statement for the 1998 Annual Meeting of Part III
Stockholders to be held on June 15, 1998
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8X8, INC.
INDEX
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 19
Item 3. Legal Proceedings........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 20
Item 6. Selected Financial Data..................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 8. Financial Statements and Supplementary Data................. 27
Consolidated Balance Sheets................................. 29
Consolidated Statements of Operations....................... 30
Consolidated Statements of Stockholders' Equity............. 31
Consolidated Statements of Cash Flows....................... 32
Notes to Consolidated Financial Statements.................. 33
Consolidated Quarterly Financial Data....................... 45
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 46
Item 13. Certain Relationships and Related Transactions.............. 46
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 46
Signatures............................................................ 47
Exhibit Index......................................................... 48
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This Report on Form 10-K contains forward-looking statements, including but
not limited to those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-K that are not
purely historical are forward-looking statements, including without limitation
statements regarding the Company's expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements included in this
Report on Form 10-K are based on information available to the Company on the
date hereof, and the Company assumes no obligation to update any such
forward-looking statements. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of a
number of factors, including, but not limited to, those set forth below under
the headings "Manufacturing," Competition" and "Factors That May Affect Future
Results" and elsewhere in this Report on Form 10-K.
PART I
ITEM 1. BUSINESS
8x8, Inc. ("8x8" or the "Company") designs, develops and markets highly
integrated, proprietary video communication semiconductors and associated
software to original equipment manufacturers (OEMs) of corporate video
communication systems. To address new opportunities, the Company has leveraged
its strengths in semiconductor design and related software to develop and market
low cost video communication systems (hereinafter referred to as its
"VideoCommunicators"). The Company began shipping the first product in its
planned family of VideoCommunicator products, ViaTV videophone model VC100, in
February 1997. Subsequently, the Company introduced the VC105, an upgraded
VC100, and added three new models, the VC50, VC55 and VC150, to the ViaTV
product line. The Company also has introduced versions of its ViaTV videophones
designed for European and Asian markets.
The Company's video communication semiconductors combine a reduced
instruction set computer (RISC) microprocessor, a digital signal processor
(DSP), specialized video processing circuitry, static random access memory
(SRAM) and proprietary software on a single chip. The Company's semiconductors
perform the real time compression and decompression (codec) of video and audio
information and establish and maintain network connections in a manner
consistent with international standards for video telephony. These
semiconductors are designed to provide video communication over a broad range of
network types including standard analog telephone lines (commonly known as plain
old telephone service or POTS), integrated services digital networks (ISDN),
local area networks (LAN) and digital subscriber lines (DSL). Customers for the
Company's video communication semiconductors include Mitsubishi, PictureTel,
Siemens, Sony, Tandberg, VideoServer, VCON and Vtel.
The Company's VideoCommunicators are based on its proprietary
semiconductor, software and systems technology. The ViaTV videophones are
designed to be compliant with the H.324 international standard for video
telephony over POTS and to be compatible with personal computer (PC) and non-PC
based systems that adhere to the H.324 standard. The ViaTV videophones are
designed to communicate with full duplex audio and video rates of up to 15
frames per second.
The VC105 ViaTV product connects to a television set and a standard
touch-tone telephone adding video to an otherwise normal telephone call, without
the need for a PC. The VC50 and VC55 are designed without a camera and utilize
an external camera device such as a camcorder or digital still camera in
addition to a television and a touch-tone telephone. In addition to video
communication capability, the VC55 includes an internet web browser developed by
PlanetWeb, Inc. The VC150 includes a built-in liquid crystal display (LCD) and
camera, thus requiring only the addition of a touch-tone telephone to permit
video communication.
INDUSTRY BACKGROUND
The continued expansion of the video communication market is dependent on
several factors including system cost, network bandwidth, the acceptance of
video telephony standards and compression technologies. Decreases in system
costs will expand the number of potential consumers and applications for video
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communication systems. Increases in available bandwidth improve the data
carrying capacity of networks, while improvements in compression technologies
utilize a given bandwidth more efficiently. Increased bandwidth and better
compression both permit the transmission of higher quality audio and video.
Finally, video telephony standards are key to widespread adoption as they are
designed to permit the interoperability between systems offered by different
vendors. The cost of video communication systems has decreased dramatically
since the introduction of the first video communication systems several decades
ago. Currently, corporate room video communication systems that operate over
ISDN and LAN networks are available for less than $10,000, while desktop ISDN
and POTS videophones are sold for less than $2,000.
Videophones that operate over POTS with the addition of a display screen
and a telephone, such as the Company's VC105 product, are now available for less
than $500. As a result, the market for video communication, formerly primarily
limited to the corporate boardroom, has expanded, with increasing corporate
applications as well as greater usage by small businesses and within the home.
Since the first video communication products were introduced in the late
1970's, users have faced a tradeoff between the cost and availability of network
bandwidth and the quality of video images that can be transmitted over the
network. High capacity connections, such as T1/E1 (1.5/2.0 megabits per second
(Mbps) and ISDN (128 kilobits per second (Kbps)) provide greater bandwidth, but
are significantly more costly and less available than analog POTS lines. The
POTS network now offers one-way data transmission rates of up to 56.6 Kbps but
remains limited to rates of up to 33.6 Kbps for the symmetrical data
transmission required for video communication. A number of technologies have
been deployed or are under development which aim to increase the bandwidth
available from existing copper telephone lines. These include faster POTS modems
and residential ISDN, DSL and cable transmission service.
The challenge faced by developers of video communication systems has been
to provide the best possible image quality through the efficient compression of
video and audio data for transmission over available network bandwidth. Because
video images contain a large amount of information, video communication systems
must compress the video and audio data to fit the available network bandwidth
while attempting to maintain the quality and synchronization of audio and video.
For example, a digitized normal television signal contains approximately 160
Mbps of information, which must be compressed by a factor of over 6000 to 1 to
permit symmetrical transmission over POTS at a rate of 25 Kbps. A video
bandwidth of 25 Kbps is typical in a 33.6 Kbps POTS connection, allowing for
audio, data and control overhead. The quality of transmitted video images is a
function of network bandwidth and the sophistication of the hardware and
software used to compress and decompress the data. By using sophisticated
compression algorithms and advanced DSP semiconductors, such as the Company's
video communication semiconductors, video communication system manufacturers can
achieve improved video quality over all network types, including POTS.
The proliferation of video communication equipment has been influenced by
the adoption of international video telephony standards. If complied with, the
standards permit interoperability between systems offered by different vendors.
Increased usage of video communication in the corporate market has been
facilitated by the adoption of the H.320 standard, which defined the video
telephony protocols used by systems connected over ISDN. The adoption of H.320
enabled interoperability between systems from different vendors, encouraged new
market entrants, and contributed to significantly lower system pricing and an
increased installed base. The Company believes that the H.320 standard expanded
the market for business video communication systems over ISDN. Similarly, the
H.324 standard for video telephony over POTS may result in expanded home use of
videophones.* Other standards, such as H.323, are being developed for
communication over packet-based networks, such as LANs and DSL and cable
networks.
Until recently, nearly all video communication products have been targeted
at corporate users with access to high bandwidth connections such as T1/E1 and
ISDN. However, the vast majority of consumers continue
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* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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to have limited access to bandwidth beyond that provided by standard analog POTS
lines. The Company believes that significant demand exists for inexpensive
videophone products that would allow users to transmit video images with audio
over normal telephone lines.* In addition, the Company believes that, as higher
bandwidth infrastructure, whether ISDN, DSL or cable networks, becomes more
available, a market for inexpensive videophones that operate over such networks
will develop.*
As a result of the availability of 33.6 Kbps POTS transmission rates, video
compression advances and the adoption of the H.324 standard, low cost POTS
videophones have been developed by the Company and a number of other suppliers.
These products may be introduced in a variety of product configurations and
physical forms (i.e., "form factors"), including those based on telephones and
using a television for display, such as the VC105, or using an LCD for display,
such as the VC150, and those based on the PC. An increasing number of PCs are
being shipped with pre-installed H.324 compliant software. Significant sales of
such H.324 products, if achieved, may increase the usefulness of and demand for
additional H.324 compliant videophones by providing potential videophone
purchasers with other parties to call.*
8X8 STRATEGY
Key elements of the Company's strategy include:
- Expand Upon Core Technology. The Company intends to further develop each
element of its video communication technology, including semiconductor,
software and systems technology. Certain of the Company's ongoing
development efforts are targeted at reducing overall system costs through
integration of additional functions onto the Company's semiconductors.*
At the same time, the Company is continuously developing technology to
improve video and audio quality at varying bandwidths, add video
communication features and ensure compliance with all current and
emerging video telephony standards to encourage proliferation of the
Company's and its OEM customers' system products.*
- Broaden and Enhance VideoCommunicator Family. The Company is currently
selling four models of the ViaTV videophone, all of which currently
operate over POTS and have been introduced since the beginning of 1997.
In addition to the introduction of these products, the Company also has
made available software upgrades to its installed base, adding features
such as pan/tilt/zoom, snapshot mode, auto-answer and picture and audio
quality enhancements. The Company plans to extend its VideoCommunicator
product line in the future by developing products in new form factors and
with new features.* The Company further intends to differentiate its
current products in the future by adding features and providing further
picture and audio quality enhancements.*
- Extend Marketing Channels. The Company currently sells its video
communication semiconductor and software products to OEMs and
distributors. The Company sells its VideoCommunicators to OEMs, retail
stores, distributors and directly to end-users. The Company's
semiconductor and system products are sold in a number of countries
throughout North America, Asia and Europe. The Company continues to work
to broaden the marketing and distribution of its products.*
- Enhance and Increase Capabilities Over Network Infrastructures. The
Company's semiconductor, software and systems technologies currently
enable, to varying degrees, video communication over the POTS, ISDN, LAN,
DSL and cable networks. The Company's current VideoCommunicator products
operate on the POTS network. The Company intends to further enhance the
capabilities to permit operation of the products of its OEM customers and
its VideoCommunicators on additional networks, including those listed
above and those that may emerge in the future.*
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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PRODUCTS
VideoCommunicator Products
The Company develops, markets and sells its VideoCommunicator products and
a variety of video communication semiconductors and related software and
reference boards. The table below describes the Company's VideoCommunicator
products:
- ------------------------------------------------------------------------------------------------------------------
PRODUCT DESCRIPTION FEATURES
- ------------------------------------------------------------------------------------------------------------------
ViaTV Model VC50 Modular H.324 modular videophone with built-in 33.6 Kbps - 3 camera inputs
Videophone modem requiring connection to a television, a digital - Accessory port input
video camera and a touch-tone telephone.
- ------------------------------------------------------------------------------------------------------------------
ViaTV Model VC55 Modular H.324 modular videophone with built-in 33.6 Kbps - 3 camera inputs
Videophone modem requiring connection to a television, a digital - Accessory port input
video camera and a touch-tone telephone; internet - Web browsing
access device with email. - Email
- ------------------------------------------------------------------------------------------------------------------
ViaTV Model VC105 Set-top H.324 set-top videophone/built-in 33.6 Kbps modem - Built-in video camera
Videophone requiring connection to a television and touch-tone - Accessory port input
phone.
- ------------------------------------------------------------------------------------------------------------------
ViaTV Model VC150 Desktop H.324 videophone requiring connection to a touch-tone - Built-in video camera
Videophone telephone. - Built-in 4" LCD display
- Accessory port input
- ------------------------------------------------------------------------------------------------------------------
The Company's VideoCommunicators, the VC50, VC55, VC105 and VC150 models,
all connect to a standard touch-tone telephone and add video to an otherwise
normal telephone call, without the need for a PC. These ViaTV videophones are
designed to be compliant with the H.324 international standard for video
telephony over POTS and to be compatible with PC and non-PC based systems that
adhere to the H.324 standard. In addition, the ViaTV videophones are designed to
communicate with full duplex audio and video rates of up to 15 frames per
second. The ViaTV products, which are based on the Company's proprietary
semiconductor and software technology, include a V.34 modem and display video on
the display screen in several sizes, as well as in a simultaneous remote and
self-view mode. Additional features include caller ID, electronic pan/tilt/zoom,
snapshot mode, video privacy mode and an auto-answer feature with an optional
security password. The ViaTV videophones are controlled through the touch-tone
keypad of the user's telephone and menu driven instructions that appear on the
video display screen.
The VC50, VC55 and VC105 require the use of a television as the display,
while the VC150 includes a built-in four-inch LCD video display. Further, while
the VC105 and VC150 each contain a built-in video camera, the VC50 and VC55 are
designed to be connected to a camcorder, digital snapshot camera or other
composite video source. Particular aspects of each product are as follows:
- VC50 Modular Videophone. The VC50 Modular Videophone requires the use of
a television as a display. In addition, because the VC50 model does not
include a built-in video camera, it requires connection to a composite
video source, such as a camcorder, a digital camera or a video cassette
recorder. The VC50 videophone has three separate video inputs so that it
can be connected to multiple cameras, which may be remotely selected for
viewing. As a result of this and the auto-answer feature present in all
ViaTV products, the VC50 model is appropriate for security and monitoring
applications. The accessory port of the VC50 unit also permits attachment
of various peripheral devices, such as a wireless keyboard that transmits
text on the display screen along with video. The VC50 product may be
connected to high performance digital video and document cameras as well
as full-duplex speakerphones to create a room based, corporate video
communication system.
- VC55 Modular Videophone. Similar to the VC50 Modular Videophone, the VC55
model also has internet and email capabilities enabled by software
developed by PlanetWeb, Inc. internet browsing and email may be
accomplished by the use of the telephone keypad and a pop-up screen
keyboard or
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with the use of the optional wireless keyboard. The VC50 and VC55 Modular
Videophones were both introduced in September 1997.
- VC105 Set-top Videophone. The VC105 Set-top Videophone is a successor to
the Company's initial VideoCommunicator product, the VC100, which was
first sold in February 1997. While the VC105 model does require the use
of a television as a display, it contains a built-in digital video
camera. Thus, it is a simple to install and use videophone, targeted
primarily for home and small-business video communication use.
- VC150 Desktop Videophone. The VC150 Desktop Videophone, which the Company
first shipped in March 1998, contains a built-in digital camera and a
built-in four-inch LCD display. As a result, it merely requires
connection to a touch-tone telephone. Thus, it is suited for desktop or
countertop use in a home or business environment.
The Company offers a number of accessories for use with its ViaTV
videophones, including wireless keyboards and cameras for use with the VC50 and
VC55 models and an international travel kit for use with the ViaTV products.
Currently, the Company is developing additional accessories for its ViaTV
products, including a full-duplex speakerphone.*
The Company plans to extend its VideoCommunicator product line in the
future by developing products in new form factors and products that are designed
to comply with emerging video telephony standards.* The Company further intends
to differentiate its products by adding features and providing further picture
and audio quality enhancements.* See "Research and Development."
The Company is dependent on continual and successful development and
introduction of new products. See "Factors That May Affect Future
Results -- Rapid Technological Change; Dependence on New Product Introduction"
and "Factors That May Affect Future Results -- Compliance with Regulations and
Industry Standards."
Video Communication Semiconductors
The Company's video communication semiconductors are based on the Company's
proprietary architecture. This architecture combines, on a single chip, a custom
RISC microprocessor, a high performance DSP core, specialized video processing
circuitry, static random access memory and proprietary software, which together
perform the core processing functions required by video communication and other
digital video applications.
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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The table below describes the Company's video communication semiconductors
and their applications:
- --------------------------------------------------------------------------------------------
PRODUCT DESCRIPTION APPLICATIONS
------- ----------- ------------
- --------------------------------------------------------------------------------------------
Video H.320 compression semiconductor - PC ISDN video communication add-in
Communications for ISDN video communication boards
Processor (VCP) systems; or H.323 Semiconductor - ISDN group video communication
for LAN video conferencing systems systems
or internet phone calls. - LAN video communication systems
- Internet phone calls
- --------------------------------------------------------------------------------------------
Low bit-rate H.324 compression semiconductor - Consumer video telephones for POTS
Videophone for POTS video communication - PC videophone add-in boards for
Processor (LVP) systems Compression semiconductor POTS
for video capture and encoding - Cameras with embedded compression
systems - Video capture PC add-in boards
- --------------------------------------------------------------------------------------------
Video to PCI Interface chip which connects the - PC (POTS, ISDN or LAN-based) video
Interface Chip VCP/LVP devices to the PCI Bus communication boards
(VPIC)
- --------------------------------------------------------------------------------------------
VCPex Recently announced successor to - See VCP and LVP applications above
the VCP and LVP
- --------------------------------------------------------------------------------------------
- VCP -- Video Communications Processor. The Company's VCP is an integrated
video communication semiconductor, which allows OEMs to develop video
communication systems based on the H.320 standard for ISDN video
communication or on the H.323 standard for LAN video communication or
internet phone calls. In recent quarters, the VCP accounted for the
majority of the Company's semiconductor product sales. The Company's
proprietary RISC and DSP technology allows a single VCP semiconductor to
output up to 30 frames per second of H.320 based video over an ISDN line.
The VCP includes video processing circuitry that compresses and
decompresses video images. Systems designed using multiple VCPs are
capable of providing full-duplex video quality approaching that of a
television. The VCP can reside on PC add-in cards or non-PC based
corporate conference room systems.
- LVP -- Low bit-rate Videophone Processor. The LVP semiconductor is
designed to support H.324 based videophones using standard POTS phone
lines. Systems based on the LVP benefit from the same RISC and DSP
technology found in the Company's VCP product, and are designed to
deliver video at up to 15 frames per second over a standard POTS
telephone line. The LVP can be designed into systems in a variety of form
factors, including non-PC based systems that utilize a telephone and
either a television or LCD display. The LVP can also be designed into PC
videophone add-in boards and used for multimedia compression applications
which require high processing power to compress high bandwidth digital
video, such as cameras with embedded compression, PC add-in boards for
video capture and editing and CD-ROM title development. The LVP is the
core video communication semiconductor inside the Company's ViaTV
products.
- VPIC -- Video to PCI Interface Chip. The VPIC is a companion
semiconductor to the Company's video communication semiconductors. The
VPIC provides a direct interface between the Company's compression
semiconductors and the high speed PCI expansion bus found in PCs. By
providing a direct path into the PC's graphic display memory, the VPIC
allows PC board designers to improve the performance and quality of their
designs based on the Company's video communication semiconductors.
- VCPex. The Company recently announced the introduction of its VCPex
semiconductor, which is the successor to its VCP and LVP semiconductors.
The VCPex provides greater functionality and operates at greater speeds
than the VCP and LVP.
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The Company intends to design future generations of its video communication
semiconductors to allow the development of video communication systems with
price/performance improvements.* See "Research and Development."
Application Software
The Company sells its semiconductors with its proprietary application
specific software to address the unique system requirements of various
international video telephony standards. This software, which is a combination
of microcode assembly and C firmware, enables the Company's proprietary
semiconductor architecture to implement multiple compression standards such as
H.320, H.323, H.324 and MPEG. In many cases, by enhancing its application
software, the Company can improve the quality of transmitted video images,
address emerging standards and add user features to its existing video
communication semiconductors. Certain of the Company's video communication
software may be ported to other platforms such as PCs or embedded controllers.
The Company supplies an Application Programmers Interface (API) with its
software to allow limited customization through an external microprocessor or
host controller. The Company also sells licenses for the source code for its
software to customers who wish to modify the software by adding their own
features and controls. Development kits are also licensed to customers allowing
them to write, compile and develop software for the Company's proprietary
semiconductor architecture.
Reference Boards and Designs
The Company provides a range of printed circuit boards and designs as
reference boards or reference designs to its customers that serve as examples
for targeted applications. Each reference board and reference design is provided
with schematics, complete documentation, video processor software and
board-level software diagnostics. This allows the customer to leverage the
Company's systems design expertise. These reference boards and reference designs
enable customers to more quickly introduce new products and improve the
Company's technical support capabilities. Examples of the Company's reference
board designs include the DVC9-I, which is designed for H.320 systems based on
the VCP, and the DVC9-P, which is designed for H.324 systems based on the LVP.
The Company also recently announced its DVC10 reference board design based on
its VCPex semiconductor for use with H.320, H.323 and H.324 systems. Each of the
Company's reference boards and reference designs specifies the use of one of the
Company's video communication semiconductors on the board or within the design.
TECHNOLOGY
The Company has developed the following technologies:
Semiconductor Architecture
The Company's video communication semiconductors share a common
architecture that enables implementation of video communication applications in
a highly efficient manner. In such an application, a video communication
terminal must compress and transmit audio and video data while simultaneously
receiving and decompressing video data from a remote source. The Company's
semiconductor architecture integrates two core processors that run in parallel:
a 32-bit RISC microprocessor and a 64-bit Single Instruction Multiple Data
(SIMD) DSP.
The Company's VCP and LVP semiconductors currently in production are
manufactured using 0.5 micron, 3-layer metal complementary metal oxide
semiconductor (CMOS) process technology, while the VCPex is based on 0.35
micron, 4-layer metal CMOS process technology. The VCP and LVP operate at 5
volts, while the VCPex operates at 3.3 volts.
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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The Company's RISC processor core uses a proprietary instruction set
specifically designed for video communication applications. The RISC core in the
VCP and LVP operates at frequencies up to 36 MHz, while the VCPex RISC core
operates at 40 MHz. The RISC core controls the overall chip operation and
manages the input/output interface through a variety of specialized ports which
connect the chip directly to external host, audio and network subsystems. This
core is programmable in the C programming language and allows customers to add
their own features and functionality to the device software provided by the
Company. The RISC core accesses 32-bit instructions and data through a bus that
interfaces to external static random access memory (SRAM).
The Company's DSP core is a SIMD processor that implements computationally
intensive video, audio and graphics processing routines as well as certain
digital communications protocols. The DSP core in the VCP and LVP operates at
frequencies up to 72 MHz, while the VCPex DSP core operates at 80 MHz. The DSP
core is programmable with a proprietary instruction set consisting of
variable-length 32-bit and 64-bit microcode instructions that provide the
flexibility to improve algorithm performance, enhance video and audio quality
and maintain compliance with changing digital video standards. The DSP core
accesses their instructions through an internal bus that interfaces to 8
kilobytes of on-chip SRAM and 8 kilobytes of on-chip read-only memory (ROM) that
is preprogrammed with video and audio processing subroutines.
The RISC and DSP cores combine to provide an efficient and flexible
architecture that can be reconfigured through a change of application software.
This flexibility allows the architecture to implement the fundamental processing
steps that form the basis of H.320, H.323 and H.324 (together, H.32x) standards-
based video communication systems.
The Company's semiconductors contain hardware-accelerated video pre- and
post-processing capabilities that enhance video quality and provide an interface
to various video capture and display devices. These capabilities include
filtering, scaling, noise reduction and interlacing.
The Company's semiconductors contain interfaces to the external devices
that comprise a typical video communication system. These interfaces include a
digital video port, digital audio port, a programmable serial port (for
communication via a synchronous digital interface) and a host port (for
communication with a PC or microcontroller). In addition, the semiconductors
contain memory bus interfaces to external SRAM for access to stored RISC
instruction and data and to external dynamic random access memory (DRAM) for
access to stored video and graphics data.
Application Software
The Company has developed a broad range of application software that runs
on the Company's semiconductor products. The Company's application software
allows the use of its semiconductors in systems that conform with various
international video telephony standards. By refining its software, the Company
can enhance picture quality, address new standards and add significant user
features. In addition, certain of the Company's customers have licensed source
code to which they add proprietary features, custom interfaces and, in some
cases, algorithm improvements. See "Licensing and Development Arrangements."
The Company's software can be categorized as follows:
- Control protocols that run on the RISC and manage user control, call
negotiation, call progress and mixing and separation of audio, video and
other data.
- Audio and video codec routines that run on the DSP.
- Digital communication protocols that interface to external communications
networks such as POTS and ISDN.
- Development tools such as compilers, assemblers and debuggers that allow
the Company and customers to write new applications and modify existing
applications.
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Algorithm Expertise
The Company has devoted significant resources to develop video and audio
codec algorithms to meet international video telephony standards. While the
H.32x standards clearly specify the syntax requirements of a standards-compliant
decoder, and thus what constitutes a valid H.32x bitstream, they do not specify
the methods by which an H.32x encoder generates such a bitstream. The
flexibility of the Company's video communication semiconductor architecture
allows the Company to apply its core algorithm expertise to develop products for
a variety of video communication applications.
The Company's algorithm expertise enables the following:
- Video Coding Efficiency and Video Quality. The Company's proprietary
motion search, mode decision and rate buffer control algorithms enhance
video quality for H.32x video communication applications.
- Integrated Control of Real-Time Systems. Video communication systems are
inherently complex due to the convergence of video, audio and control
information. The Company's proprietary semiconductor architecture and
interrupt-driven control software manage these varying data streams in
concert thereby reducing the complexity of the external system design. In
addition, the Company's single-chip control of audio and video data in
certain applications provides for audio/video synchronization and low
end-to-end latency.
- Robustness to Varying Network Conditions. Video communication systems
must interface to networks with transmission characteristics that vary
over time. These characteristics can cause network bandwidth to change
and can result in the loss or corruption of transmitted information. The
Company has developed control algorithms that adapt to changes in network
bandwidth and that recover from the loss or corruption of data in a way
that reduces negative perceptual effects on the user.
System Design
The Company has developed expertise in integrating its semiconductors and
software with peripheral components to produce complete video communication
systems. The Company's system technology consists of modular subsystems that can
be rearranged to interface to various networks (such as POTS, ISDN and LAN) and
to interface to various video capture and display devices.
CUSTOMERS AND MARKETING
The Company markets its semiconductors and associated software through its
own direct sales force as well as through distributors. The Company sells its
VCP semiconductors and related software and reference designs primarily to OEMs
of ISDN office video communication systems that use the H.320 standard,
including PictureTel, Siemens, Sony, VideoServer, VCON and Vtel. The Company
sells its LVP semiconductors and related software and reference board designs to
OEMs of POTS video communication systems for the consumer market using the H.324
standard, such as Kyushu Matsushita Electric Co., Ltd. (KME), Leadtek, Sony and
Truedox.
The Company markets its VideoCommunicators through retail channels such as
Best Buy, CompUSA, Fry's Electronics, J & R Computer World, OfficeMax and
Staples; catalogs such as Hammacher Schlemmer and MicroWarehouse; and
distributors such as D&H, IngramMicro and Wynit. The Company also sells its
VideoCommunicators through a direct marketing effort utilizing a combination of
advertising and toll-free telemarketing in the United States and the United
Kingdom. In conjunction with the Company's distributors and resellers, the ViaTV
products are sold in a number of countries throughout North America, Europe and
Asia. The Company's VideoCommunicators sales efforts are supported by
co-marketing relationships with third parties such as EFA Corporation, GTE and
AT&T.
The Company's direct sales force supports domestic and international sales
and operates from the Company's headquarters in Santa Clara, California and a
European office in London. As of March 31, 1998, the Company employed 35 persons
in sales and marketing. These persons provide account support for direct,
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OEM, distributor and retail channel customers of the Company's products. In
addition, these persons staff the Company's telemarketing and end user customer
support efforts for its VideoCommunicator products. The Company's sales and
marketing personnel typically provide support to its OEM, distributor and retail
channel customers through sales literature, periodic training, customer
symposia, pre-sales support and joint sales calls. The Company utilizes several
marketing programs to support the sale and distribution of its products,
including participation in industry trade shows and conferences. The Company
also publishes technical articles, distributes sales and product literature and
has an active public relations plan to encourage coverage of the Company's
products and technology by the media. In relation to its ViaTV products, the
Company also utilizes advertising in print media and on television and radio, in
some cases in conjunction with its OEM, distributor and retail channel
customers.
Historically, a significant portion of the Company's sales has been to
relatively few customers, although the composition of these customers has
varied. Revenues from the Company's ten largest customers in the years ended
March 31, 1998, 1997 and 1996 accounted for approximately 61%, 61% and 65%,
respectively, of its total revenues. During these periods the Company had three
customers that accounted for 10% or more of total revenues: 3Com accounted for
20% during the year ended March 31, 1998; ASCII, the Company's former
distributor in Japan, accounted for 13% during the year ended March 31, 1997;
and ESS Technology accounted for 24% during the year ended March 31, 1996. In
addition, the Company has recently been, and will continue in the foreseeable
future to be, dependent on the video communication industry. The loss of, or any
reduction in orders from, a significant customer, or any general decline in the
market for video communication products, could have a material adverse effect on
the Company's business and operating results. See "Factors That May Affect
Future Results -- Product Concentration; Potential Loss of Semiconductor Sales;
Dependence on Video Communication Industry" and "Factors That May Affect Future
Results -- Dependence on Key Customers."
Sales to customers outside of the United States represented 47%, 54% and
49% of total revenues in the fiscal years ended March 31, 1998, 1997 and 1996,
respectively. Specifically, sales to customers in the Asia Pacific region
represented 25%, 33% and 32% of the Company's total revenues for the years ended
March 31, 1998, 1997 and 1996, respectively, while sales to customers in Europe
represented 22%, 21% and 17% of the Company's total revenues for the same
periods, respectively. Such reliance on foreign customers involves a number of
risks. See "Factors That May Affect Future Results -- International Operations."
As a result of consumer preferences, marketplace conditions and the limits
of video communications over the POTS infrastructure, a significant market for
the ViaTV videophones and the Company's OEM customers products for POTS may not
develop. See "Factors That May Affect Future Results -- Uncertainty of Market
Acceptance; Limits of Existing Technology."
MANUFACTURING
The Company outsources the manufacture of its VideoCommunicators and
semiconductors to subcontract manufacturers and independent foundries. The
Company's VideoCommunicator subcontract manufacturers include EFA Corporation in
Taiwan, Flash Electronics in Fremont, California and Vtech Communications in
Hong Kong, while its semiconductor manufacturers include Taiwan Semiconductor
Manufacturing Corporation and UMC in Taiwan. The company also relies on Amkor
Electronics in South Korea for packaging and testing of its semiconductors. The
Company does not have long term purchase agreements with its subcontract
manufacturers or its component suppliers. There can be no assurance that the
Company's contract manufacturers will be able or willing to reliably manufacture
the Company's products, or that the Company's component suppliers will be able
or willing to reliably supply components for the Company's products, in volumes,
on a cost effective basis or in a timely manner. The Company may experience
difficulties due to its reliance on independent subcontract manufacturers,
semiconductor foundries and component suppliers that could have a material
adverse effect on the Company's business and operating results.
In addition, from time to time the Company may issue non-cancelable
purchase orders to its third-party manufacturers for raw materials used in its
VideoCommunicator products to ensure availability for long lead-
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time items or to take advantage of favorable pricing terms. If the Company
should experience decreased demand for its VideoCommunicator products, the
Company would still be required to take delivery of and make payment for such
raw materials. In the event of a significant decrease in VideoCommunicator
product demand, such purchase commitments could have a material adverse effect
on the Company's business and operating results. The Company's reliance on
foreign subcontract manufacturers involves a number of risks. See "Factors That
May Affect Future Results -- International Operations."
RESEARCH AND DEVELOPMENT
As of March 31, 1998, the Company had 55 employees engaged in research and
development. Research and development expenses in the years ended March 31,
1998, 1997 and 1996 were $12.3 million, $10.5 million and $7.7 million,
respectively. The Company's development of new products and the enhancement of
existing products is essential to its success.* Accordingly, the Company
anticipates that research and developments expenses will continue to increase in
the foreseeable future.* However, such expenses may fluctuate from quarter to
quarter depending on a wide range of factors, including the status of and
prospects for various development projects.*
The Company's current and future research and development efforts relating
primarily to video communication semiconductors have and will continue to focus
on the Company's next generations of these products.* Areas of emphasis will
include an enhanced version of its video communication semiconductor
architecture intended to provide higher performance, enhanced functionality and
further integration of certain essential system functions.* This integration is
designed to permit improved system price/performance.* Future software
developments may focus on emerging video telephony standards, picture quality
enhancements and additional features supporting both the Company's systems
products and its OEM customer products.*
Research and development efforts relating to the Company's
VideoCommunicators are directed towards the addition of features and picture and
audio quality enhancements.* To expand its family of VideoCommunicators, the
Company is developing new form factors and products that are designed to comply
with emerging video telephony standards.*
If the Company is unable to develop and introduce new or enhanced products
in a timely manner, or if such new or enhanced products do not achieve
sufficient market acceptance, it would have a material adverse effect on the
Company's business and operating results. See "Factors That May Affect Future
Results -- Uncertainty of Market Acceptance; Limits of Existing Technology" and
"Factors That May Affect Future Results -- Rapid Technological Change;
Dependence on New Product Introduction."
LICENSING AND DEVELOPMENT ARRANGEMENTS
The Company has entered into licensing and development arrangements with
other companies to promote the design, development, manufacture and sale of the
Company's products. The Company intends to continue to license its
semiconductor, software and systems technology to other companies, many of which
are current or potential competitors of the Company. Such arrangements may
enable these companies to use the Company's technology to produce products that
compete with the Company's VideoCommunicators. See "Competition." The Company's
most significant licenses are with 3Com and KME.
On May 5, 1997, the Company entered into a license agreement with 3Com.
Pursuant to the agreement, the Company has granted to 3Com, for an initial
license fee plus certain royalties, a license to make, use and sell systems and
products containing the Company's proprietary technology relating to its
VideoCommunicators and its PC-related video communication products. As a result,
3Com has a license to substantially all of the Company's technology underlying
its VideoCommunicators. 3Com is prohibited under the agreement
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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from selling the Company's semiconductors on the open market. Both parties have
also agreed to license to each other any enhancements to the technology which
are developed by either party, unless 3Com elects to discontinue sharing at any
time or the Company elects to discontinue sharing (which it may do at any time
following June 30, 2000). Any enhancements or other technology developed by 3Com
cannot be sublicensed by the Company or incorporated into semiconductors which
the Company sells on the open market in component form, but can be incorporated
into semiconductors that the Company uses in the VideoComunicators. Pursuant to
the Company's agreement with 3Com, the Company was prohibited, until May 5,
1998, from licensing the technology to others, except in limited circumstances.
The KME agreement provides to KME, for a license fee previously paid in
full to the Company, all of the source code and object code of the H.324
software for 8x8's LVP semiconductor product and related development software,
as well as certain board schematics (the "H.324 Technology"), and grants KME a
perpetual, nonexclusive, nonassignable worldwide license to make, use or sell
products with the H.324 Technology. Under this arrangement, KME also has a
nonassignable option, upon payment of additional consideration, to obtain the
Company's LVP and VCP semiconductor technology for use only on systems assembled
by KME or its affiliates, which would include any entity controlled directly or
indirectly by Matsushita. As a result, KME has a license to substantially all of
the Company's technology underlying its VideoCommunicators. In addition, KME
must pay to the Company a royalty for any LVP or VCP semiconductor it
manufactures or any product wherein KME uses any part of the LVP or VCP
semiconductor technology. Both parties agree to license to the other party, at
no charge, any enhancements to the H.324 Technology or the LVP or VCP
semiconductor made by either party, until such time as KME decides to
discontinue sharing of enhancements.
The Company has licensed portions of its semiconductor, software and
systems technology to others. The Company has licensed the right to manufacture
certain of its video communication semiconductors, subject to payment of
royalties, to several video communication systems manufacturers. In addition,
the Company has licensed portions of its video communication semiconductor
technology to ESS Technology. Of these licensees, ESS Technology may sell
semiconductors based on the licensed technology to third parties, while the
other licensees are limited to sale of such semiconductors as part of video
communication systems or sub-systems. The obligation of ESS Technology to pay
royalties to the Company with regard to the sale of semiconductors based on the
licensed technology, will expire in October 2000, or earlier, if the Company
exercises its right to a royalty-free license to certain technology of ESS
Technology. In order to encourage the use of its semiconductors, the Company has
licensed portions of its systems technology and software object code for its
semiconductors to virtually all of its semiconductor customers. Moreover, many
of the Company's OEM customers have licensed portions of the source code to its
software for its semiconductors. In addition to KME and 3Com, a number of video
communication system manufacturers have licensed substantial portions of the
Company's source code.
In the years ended March 31, 1998, 1997 and 1996, technology licensing
revenues (all of which were nonrecurring) were $14.5 million, $3.9 million and
$9.0 million, respectively. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." There can be no assurance that
the Company will receive such licensing revenues in the future. See "Factors
That May Affect Future Results -- No Assurance of Future License and Other
Revenues."
In addition to licensing its technology to others, the Company from time to
time will take a license to others' technology. For example, the web browser
software running on the VC55 was developed by, and is licensed from, PlanetWeb,
Inc. The Company has in the past licensed and in the future expects to
continuing licensing its technology to others, many of whom are located or may
be located abroad. There are no assurances that such licensees will protect the
Company's technology from misappropriation. Also, the Company's reliance on
licensing technology from third parties subjects the Company to certain risks.
See "Factors That May Effect Future Results -- Dependence on Proprietary
Technology; Reliance on Third Party Licenses."
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COMPETITION
The Company competes with both independent manufacturers of video
communication semiconductors and with the introduction of its VideoCommunicator
products now competes with manufacturers of video communication products
targeted at the consumer market. The markets for the Company's products are
characterized by intense competition, declining average selling prices and rapid
technological change.
The competitive factors in the market for the Company's VideoCommunicators
include audio and video quality, phone line connectivity at high transmission
rates, ability to connect and maintain stable connections, ease of use, price,
access to enabling technologies, product design, time-to-market, adherence to
industry standards, interoperability, strength of distribution channels,
customer support, reliability and brand name. The Company expects intense
competition for its VideoCommunicators from:
- Large consumer electronics manufacturers. The Company will face intense
competition from many well known, established suppliers of consumer
electronics products, which may include Lucent Technologies, Matsushita,
Philips, Samsung and Sony. The Company does face competition from 3Com.
Many of these potential competitors sell television and telephone
products into which they may integrate video communication systems,
thereby eliminating a consumer's need to purchase a separate video
communication system, such as the Company's ViaTV product.
- Personal computer system and software manufacturers. Potential customers
for the Company's VideoCommunicators may elect instead to buy PCs
equipped with video communication capabilities, which are currently
available. As a result, the Company faces or may face competition from
Intel; PC system manufacturers such as Apple, Compaq, Dell, IBM and Sony;
PC software suppliers such as Microsoft and Netscape; and PC add-on
component suppliers.
- Existing manufacturers of corporate video communication
equipment. Manufacturers of more expensive corporate video communication
systems have continually reduced the cost of their products and may enter
the market for lower cost consumer video communication products.
Potential competitors include PictureTel, Polycom, Sony, Tandberg, VCON
and Vtel.
- Emerging suppliers of internet appliances. Potential customers for the
Company's VideoCommunicators may elect instead to buy standalone internet
access terminals which may provide some or all of the functionality of
the Company's products. Consumer products for television-based internet
access have been announced or introduced by companies such as Microsoft,
Philips and Sony.
C-Phone, Leadtek, 3Com and Truedox are among the companies selling low cost
videophones. Many other companies have announced the development of low cost
videophones. The Company expects that additional companies will introduce
products that compete with the VideoCommunicators in the future. Certain
manufacturers or potential manufacturers of low cost videophones have licensed
or purchased, or may license or purchase, the Company's technology and
semiconductors in order to do so. KME and 3Com in particular have licensed
substantially all of the technology underlying the VideoCommunicators, and may
use such technology to introduce products that compete with the
VideoCommunicators. Each of Leadtek and Truedox license the Company's technology
and purchase the Company's video communication semiconductors. The Company
aggressively licenses its semiconductor, software and systems technology and
sells its semiconductor and system products to third parties. Thus, it is likely
that additional of the Company's OEM customers will become competitors with
respect to the Company's VideoCommunicator business. Other competitors may
purchase video communication semiconductor and related technology from other
suppliers.
The principal competitive factors in the market for video communication
semiconductors include product definition, product design, system integration,
chip size, functionality, time-to-market, adherence to industry standards, price
and reliability. The Company has a number of competitors in this market
including Analog Devices, Chromatic Research, Lucent Technologies, Motorola,
Philips, Texas Instruments and Winbond Electronics. Potential competitors
include ESS Technology, which has licensed certain of the Company's video
communication semiconductor technology, and Rockwell Semiconductor Systems.
Certain of the Company's competitors for video communication semiconductors
maintain their own semiconductor foundries and may therefore benefit from
certain capacity, cost and technical advantages. In addition, the presence of
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the Company in the video communication systems business may result in certain
customers or potential customers perceiving the Company as a competitor or
potential competitor, which may be used by other semiconductor manufacturers to
their advantage.
The Company's reliance on developing vertically integrated technology,
comprising systems, circuit boards, software and semiconductors, places a
significant strain on the Company and its research and development resources.
Competitors that focus on one aspect of technology, such as systems or
semiconductors, may have a considerable advantage over the Company. In addition,
many of the Company's current and potential competitors have longer operating
histories, are substantially larger, and have greater financial, manufacturing,
marketing, technical and other resources. Many also have greater name
recognition and a larger installed base of products than the Company.
Competition in the Company's markets may result in significant price reductions.
As a result of their greater resources, many current and potential competitors
may be better able than the Company to initiate and withstand significant price
competition or downturns in the economy. There can be no assurance that the
Company will be able to continue to compete effectively, and any failure to do
so would have a material adverse effect on the Company's business and operating
results.
EMPLOYEES
As of March 31, 1998, the Company employed a total of 136 people, including
25 in manufacturing operations, 55 in research and development, 35 in sales and
marketing and 21 in general and administrative capacities. The Company also
employs a number of temporary employees and consultants on a contract basis.
The Company's future success will depend, in part, upon its ability to
attract and retain qualified personnel. Competition for qualified personnel in
the electronics and communications industries is intense, particularly in the
San Francisco Bay area where the Company is located. There can be no assurance
that the Company will be successful in retaining its key employees or that it
will be able to attract skilled personnel as the Company grows. See "Factors
That May Affect Future Results -- Management of Growth and Change; Dependence on
Key Personnel."
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following factors as well as the factors discussed above under the
headings "Competition" and "Manufacturing" should be considered in conjunction
with the information in this Report on Form 10-K.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
The Company recorded operating losses in three of the four quarters in
fiscal 1998 and recorded operating losses of $13.6 million and $4.1 million in
the years ended March 31, 1997 and 1996, respectively. The Company would not
have been profitable in fiscal 1998 had it not received nonrecurring license and
other revenues. Revenues fluctuated from $28.8 million in fiscal 1996 to $19.1
million in fiscal 1997 to $49.8 million in fiscal 1998. In view of the Company's
historical operating losses, there can be no assurance that the Company will be
able to sustain profitability on either an annual or quarterly basis.
NO ASSURANCE OF FUTURE LICENSE AND OTHER REVENUES
The Company has in the past received substantial revenues from licensing of
technology. License and other revenues, all of which were nonrecurring, were
$14.5 million, $3.9 million and $9.0 million in the fiscal years ended March 31,
1998, 1997 and 1996, respectively. There can be no assurance that the Company
will receive revenues from licensing of its technology in the future, which
could have a material adverse effect on the Company's business and operating
results.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's historical operating results have fluctuated significantly
and will likely continue to fluctuate in the future. On an annual and a
quarterly basis there are a number of factors that may affect the operating
results of the Company, many of which are outside the Company's control. These
include, but are
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not limited to: changes in market demand, the timing of customer orders,
competitive market conditions, lengthy sales cycles, regulatory approval cycles,
new product introductions by the Company or its competitors, market acceptance
of new or existing products, the cost and availability of components, the mix of
the Company's customer base and sales channels, the mix of products sold, the
management of inventory and the accuracy of the reporting of sell-through by
resellers of the Company's products, the level of international sales, continued
compliance with industry standards and general economic conditions.
The Company's gross margin is affected by a number of factors including
product mix, the recognition of license and other revenues for which there may
be no or little corresponding cost of revenues, product pricing, the allocation
between international and domestic sales, the percentage of direct sales and
sales to resellers, and manufacturing and component costs. The markets for the
Company's products are characterized by falling average selling prices. The
Company expects that, as a result of competitive pressures and other factors,
gross profit as a percentage of revenue for the Company's semiconductor products
will likely decrease for the foreseeable future. In addition, the gross margins
for the Company's VideoComunicators are, and will continue to be, substantially
lower than the gross margins for its semiconductors. Thus, the growth of the
Company's VideoCommunicator business has reduced overall product gross profit as
a percentage of revenue. Continued growth of the Company's VideoCommunicator
business relative to its semiconductor business will result in a further
reduction in product gross profit as a percentage of revenue.
If the Company cannot adequately compensate for falling average selling
prices with lower costs of sales, its gross margins will be reduced and there
may be a material adverse effect on the Company's business and operating
results. In the event that the Company encounters significant price competition
in the markets for its products, the Company could be at a significant
disadvantage compared to its competitors, many of which have substantially
greater resources, and therefore may be better able to withstand an extended
period of downward pricing pressure.
Variations in timing of sales may cause significant fluctuations in future
operating results. In addition, because a significant portion of the Company's
business, including sales of its VideoCommunicator products, may be derived from
orders placed by a limited number of large customers, including OEM customers,
the timing of such orders can also cause significant fluctuations in the
Company's operating results. For example, 3Com, which purchased approximately
34% of videophone systems sold by the Company in the year ended March 31, 1998,
has not ordered additional products from the Company since delivery of its
purchases in the quarter ended December 31, 1998. Anticipated orders from
customers may fail to materialize. Delivery schedules may be deferred or
canceled for a number of reasons, including changes in specific customer
requirements or international economic conditions. The adverse impact of a
shortfall in the Company's revenues may be magnified by the Company's inability
to adjust spending to compensate for such shortfall. Announcements by the
Company or its competitors of new products and technologies could cause
customers to defer purchases of the Company's existing products, which would
also have a material adverse effect on the Company's business and operating
results.
The Company's products have lead times of up to four months, and are built
to forecasts that are necessarily imperfect, particularly given the early stage
of the videophone market. Because of the Company's practice of building its
products to necessarily imprecise forecasts, it is likely that, from time to
time, the Company will have either excess or insufficient product inventory.
This risk is heightened because of the need for and presence of significant
VideoCommunicator inventory in retail distribution. Further, because retailers
and other distributors may have significant quantities of VideoCommunicator
inventory on hand and generally have contractual rights to price protection if
the Company decreases the selling price, in the event of a significant price
decrease, the Company's cost of such inventory may exceed the Company's actual
selling price. Excess inventory levels will subject the Company to the risk of
inventory obsolescence and the risk that the Company's selling prices may drop
below the Company's inventory costs, while insufficient levels of inventory may
negatively affect relations with customers. Any of these factors could have a
material adverse effect on the Company's operating results and business.
The Company's introduction of VideoCommunicators has resulted in
substantially different patterns in operating results. For example, during
fiscal 1998, the Company's operating results were subject to increased
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seasonality with sales higher during the Company's third fiscal quarter,
corresponding to the Christmas shopping season. In addition, the Company is
spending substantial additional amounts on advertising, support of the retail
channel, toll-free marketing and customer support. There can be no assurance
that revenues adequate to justify such spending will result. The Company's shift
to sale of VideoCommunicators has resulted in higher levels of product inventory
and product returns, the necessity of granting price protection to resellers,
more lengthy receivable collection cycles and higher warranty costs, which may
have a material adverse effect on the Company's business and operating results.
As a result of these and other factors, it is likely that in some future
period the Company's operating results will be below the expectations of
securities analysts or investors, which would likely result in a significant
reduction in the market price for the Company's common stock.
DEPENDENCE ON KEY CUSTOMERS
Historically, a significant portion of the Company's sales has been to
relatively few customers, although the composition of these customers has
varied. Revenues from the Company's ten largest customers in the years ended
March 31, 1998, 1997 and 1996 accounted for approximately 61%, 61% and 65%,
respectively, of total revenues. During these periods the Company had three
customers that accounted for ten percent or more of total revenues. 3Com
accounted for 20% of total revenues during the year ended March 31, 1998; ASCII,
the Company's former distributor in Japan, accounted for 13% of total revenues
during the year ended March 31, 1997; and ESS Technology accounted for 24% of
total revenues during the year ended March 31, 1996. Substantially all the
Company's product sales have been made, and are expected to be made, on a
purchase order basis. None of the Company's customers has entered into a
long-term agreement requiring it to purchase the Company's products. Further,
all of the Company's license and other revenues are nonrecurring.
UNCERTAINTY OF MARKET ACCEPTANCE; LIMITS OF EXISTING TECHNOLOGY
Previous efforts to sell consumer videophones have been unsuccessful and
there can be no assurance that the market for such products will develop. The
current installed base of H.324 compliant videophones, which are compatible with
the Company's ViaTV videophones, is quite limited, providing few parties for a
purchaser of a single videophone to call. In addition, many consumers may not
wish to be seen during a telephone call. The Company has no reliable data to
suggest that there will be significant customer demand for such products,
including the Company's VideoCommunicators and products offered by certain of
the Company's OEM customers.
The Company's current ViaTV product line as well as products made by the
Company's OEM customers for use on POTS, is not capable of delivering video data
at rates of 24 frames per second. Below this data rate, the human eye can detect
degradation of video quality. Further, POTS infrastructure varies widely in
configuration and integrity, which can result in decreased rates of transmission
and difficulties in establishing and maintaining connections. Actual or
perceived technical difficulties or insufficient video quality related to video
communication on POTS could impede market acceptance and have a material adverse
effect on the Company's business and results of operations.
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCT INTRODUCTION
The video communication semiconductor and video communication markets are
characterized by rapid changes in customer requirements, frequent introductions
of new and enhanced products, and continuing and rapid technological
advancement. To compete successfully, the Company must continue to design,
develop, manufacture and sell new and enhanced products that provide
increasingly higher levels of performance and reliability and lower cost, take
advantage of technological advancements and changes, and respond to new customer
requirements. The Company's success in designing, developing, manufacturing and
selling such products will depend on a variety of factors, including the
identification of market demand for new products, product selection, timely
implementation of product design and development, product performance, cost-
effectiveness of products under development, effective manufacturing processes
and the success of promotional efforts.
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The Company plans to introduce additional VideoCommunicators and video
communication semiconductors. The development of new products or enhancements to
existing products involves technical and other risks, which the Company may not
fully understand. In addition, new product introductions or enhancements to
products may decrease demand for existing products resulting in higher than
expected product returns and/or excess inventory of existing products. The
Company has in the past experienced delays in the development of new products
and the enhancement of existing products, and such delays will likely occur in
the future.
If the Company is unable, due to resource constraints or technological or
other reasons, to develop and introduce new or enhanced products in a timely
manner, if such new or enhanced products do not achieve sufficient market
acceptance or if such new product introductions decrease demand for existing
products, it would have a material adverse effect on the Company's business and
operating results.
DEPENDENCE ON PROPRIETARY TECHNOLOGY; RELIANCE ON THIRD PARTY LICENSES
The Company relies in part on trademark, copyright and trade secret law to
protect its intellectual property in the United States and abroad. The Company
seeks to protect its software, documentation and other written materials under
trade secret and copyright law, which afford only limited protection. The
Company also relies in part on patent law to protect its intellectual property
in the United States and abroad. The Company currently holds four United States
patents, including patents relating to video compression and memory architecture
technology, and has a number of United States and foreign patent applications
pending. There can be no assurance that any such patent applications will result
in an issued patent. There can be no assurance that the Company's means of
protecting its proprietary rights in the United States or abroad (where
effective intellectual property protection may be unavailable or limited) will
be adequate or that competitors will not independently develop technologies that
are similar or superior to the Company's technology, duplicate the Company's
technology or design around any patent of the Company. The Company has in the
past licensed and in the future expects to continuing licensing its technology
to others, many of whom are located or may be located abroad. There are no
assurances that such licensees will protect the Company's technology from
misappropriation. Moreover, litigation may be necessary in the future to enforce
the Company's intellectual property rights, to determine the validity and scope
of the proprietary rights of others, or to defend against claims of infringement
or invalidity. Such litigation could result in substantial costs and diversion
of management time and resources and could have a material adverse effect on the
Company's business and operating results.
There has been substantial litigation in the semiconductor, electronics and
related industries regarding intellectual property rights, and there can be no
assurance that third parties will not claim infringement by the Company of their
intellectual property rights. The Company's broad range of technology, including
systems, digital and analog circuits, software and semiconductors, increases the
likelihood that third parties may claim infringement by the Company of their
intellectual property rights. If the Company were found to be infringing on the
intellectual property rights of any third party, the Company could be subject to
liabilities for such infringement, which could be material, and the Company
could be required to refrain from using, manufacturing or selling certain
products or using certain processes, either of which could have a material
adverse effect on the Company's business and operating results.
The Company relies upon certain technology, including hardware and
software, licensed from third parties. The loss of, or inability to maintain,
existing licenses could have a material adverse effect on the Company's business
and operating results.
COMPLIANCE WITH REGULATIONS AND INDUSTRY STANDARDS
The Company must comply with certain rules and regulations of the Federal
Communications Commission regarding electromagnetic radiation and standards
established by Underwriters Laboratories as well as similar regulations and
standards applicable in other countries. The failure of the Company's products
to comply, or delays in compliance, with the various existing and evolving
government regulations and industry
17
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standards could delay or interrupt volume production of VideoCommunicators,
which would have a material adverse effect on the Company's business and
operating results.
INTERNATIONAL OPERATIONS
Sales to customers outside of the United States represented 47%, 54% and
49% of total revenues in the fiscal years ended March 31, 1998, 1997 and 1996,
respectively. Specifically, sales to customers in the Asia Pacific region
represented 25%, 33% and 32% of the Company's total revenues for the years ended
March 31, 1998, 1997 and 1996, respectively, while sales to customers in Europe
represented 22%, 21% and 17% of the Company's total revenues for the same
periods, respectively.
International sales of the Company's semiconductors will continue to
represent a substantial portion of the Company's product revenues for the
foreseeable future. In addition, substantially all of the Company's current
products are, and substantially all of the Company's future products will be,
manufactured, assembled and tested by independent third parties in foreign
countries. International sales and manufacturing are subject to a number of
risks, including general economic conditions in regions such as Asia, changes in
foreign government regulations and telecommunications standards, export license
requirements, tariffs and taxes, other trade barriers, fluctuations in currency
exchange rates, difficulty in collecting accounts receivable and difficulty in
staffing and managing foreign operations. The Company is also subject to
geopolitical risks, such as political, social and economic instability,
potential hostilities and changes in diplomatic and trade relationships, in
connection with its international operations. A significant decline in demand
from foreign markets, such as may result from the current economic conditions in
the Asia Pacific region, could have a material adverse effect on the Company's
business and operating results.
MANAGEMENT OF GROWTH AND CHANGE; DEPENDENCE ON KEY PERSONNEL
The development and marketing of the Company's VideoCommunicators will
continue to place a significant strain on the Company's limited personnel,
management and other resources, particularly in light of the Company's limited
experience in developing, manufacturing, marketing and selling consumer
products. The Company's ability to manage any future growth effectively will
require it to successfully attract, train, motivate, retain and manage
employees, particularly key engineering and managerial personnel, to effectively
integrate new employees into its operations and to continue to improve its
operational, financial and management systems. The Company's failure to manage
its growth and changes in its business effectively and to attract and retain key
personnel could have a material adverse effect on the Company's business and
operating results.
Further, the Company is highly dependent on the continued service of and
its ability to attract and retain qualified technical, marketing, sales and
managerial personnel. The competition for such personnel is intense,
particularly in the San Francisco Bay area where the Company is located. The
loss of any such person or the failure to recruit additional key technical and
sales personnel in a timely manner would have a material adverse effect on the
Company's business and operating results. There can be no assurance that the
Company will be able to continue to attract and retain the qualified personnel
necessary for the development of its business. The Company currently does not
have employment contracts with any of its employees and does not maintain key
person life insurance policies on any of its employees.
PRODUCT CONCENTRATION; DEPENDENCE ON VIDEO COMMUNICATION INDUSTRY
Sales of video communication products accounted for approximately 100%, 86%
and 66% of total product revenues in the fiscal years ended March 31, 1998, 1997
and 1996, respectively. Any general decline in the market for video
communication products could have a material adverse effect on the Company's
business and operating results.
POTENTIAL VOLATILITY OF STOCK PRICE
The market price of the shares of the Company's common stock has been and
is likely to be highly volatile. It may be significantly affected by factors
such as: actual or anticipated fluctuations in the Company's
18
21
operating results; announcements of technical innovations; loss of key
personnel; new products or new contracts by the Company, its competitors or
their customers; governmental regulatory action; developments with respect to
patents or proprietary rights, general market conditions, changes in financial
estimates by securities analysts and other factors which could be unrelated to,
or outside the control of, the Company. The stock market has from time to time
experienced significant price and volume fluctuations that have particularly
affected the market prices for the common stocks of technology companies and
that have often been unrelated to the operating performance of particular
companies. These broad market fluctuations may adversely affect the market price
of the Company's common stock. In the past, following periods of volatility in
the market price of a Company's securities, securities class action litigation
has often been initiated against the issuing company. There can be no assurance
that such litigation will not occur in the future with respect to the Company.
Such litigation could result in substantial costs and a diversion of
management's attention and resources, which would have a material adverse effect
on the Company's business and operating results. Any settlement or adverse
determination in such litigation would also subject the Company to significant
liability, which would have a material adverse effect on the Company's business
and financial condition.
NEED FOR ADDITIONAL CAPITAL
The Company believes that it may require additional financial resources
over the next several years for working capital, research and development,
expansion of sales and marketing resources, and capital expenditures. Net cash
used in operating activities for the year ended March 31, 1998 was approximately
$6.5 million, resulting primarily from cash requirements of the Company's
VideoCommunicator business. The Company has incurred and will continue to incur,
significant costs related on the development of ViaTV products, advertising for
its ViaTV products, support of the retail sales channel and growth in ViaTV
inventory. The Company believes that it will be able to fund planned
expenditures and satisfy its cash requirements for at least the next twelve
months from cash flow from operations, if any, and existing cash balances. As of
March 31, 1998, the Company had approximately $26.7 million in cash and cash
equivalents. However, the Company is operating in a rapidly changing industry.
There can be no assurance that the Company will not seek to exploit business
opportunities that will require it to raise additional capital from equity or
debt sources to finance its growth and capital requirements. In particular, the
development and marketing of new products could require a significant commitment
of resources, which could in turn require the Company to obtain additional
financing earlier than otherwise expected. There can be no assurance that the
Company will be able to obtain additional financing as needed on acceptable
terms or at all. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" under
Item 7 below.
ITEM 2. PROPERTIES
The Company's principal operations are located in an approximately 45,623
square foot facility in Santa Clara, California. This lease expires in April
1999. The Company also leases 2,663 square feet in London, England. This lease
expires in January 1999 and the Company has no option to extend the lease. The
Company's existing facilities are adequate to meet its current needs.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a
party or to which any of its properties is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Company effected its initial public offering on July 2, 1997. Since
that date, 8x8's common stock has been traded on the Nasdaq National Market
under the symbol "EGHT." No dividends have ever been paid or declared on 8x8's
common stock. The Company currently does not anticipate paying any cash
dividends on its capital stock in the foreseeable future. As of March 31, 1998,
there were 238 holders of record of the Company's common stock. Many of the
Company's shares of common stock are held by brokers and other institutions on
behalf of stockholders, therefore, the Company is unable to determine the total
number of stockholders represented by these record holders. Responses from
brokers and other institutions regarding shares held on behalf of other
stockholders indicate that there were at least 5,525 such other stockholders as
of March 31, 1998.
PRICE RANGE OF COMMON STOCK
PERIOD HIGH LOW
------ ----- -----
July 2, 1997 to September 30, 1997.......................... $11 13/1 $6 5/8
October 1, 1997 to December 31, 1997........................ $16 $10 7/1
January 1, 1998 to March 31, 1998........................... $10 7/ $5 1/2
On February 17, 1998, the Company, issued to Stanford University a warrant
to purchase 10,000 shares of the Company's common stock at a per share exercise
price of $5.50, then equal to its fair market value. This warrant expires on or
before February 17, 1999. This warrant and the underlying shares are not
registered under the Securities Act of 1933, as amended, and were issued
pursuant to the exemption provided by Section 4(2) of such Act.
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED MARCH 31,
---------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total revenues............................ $49,776 $19,146 $28,774 $19,929 $34,401
Net income (loss)......................... 3,727 (13,613) (3,217) (5,881) (348)
Net income (loss) per share:
Basic..................................... $ 0.31 $ (2.56) $ (0.70) $ (1.34) $ (0.08)
Diluted................................... $ 0.25 $ (2.56) $ (0.70) $ (1.34) $ (0.08)
Total assets.................... $46,429 $12,727 $23,067 $20,644 $21,908
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company was incorporated in February 1987 in California and
reincorporated in Delaware in December 1996. Since June 1995, the Company has
been executing a business strategy designed to focus the Company's efforts
towards video communication. As part of this strategy, the Company discontinued
sales of its MPEG semiconductor product line and reduced its workforce in the
quarter ended June 30, 1996.
In the fiscal years ended March 31, 1998, 1997 and 1996, sales of the
Company's video communication products accounted for 100%, 86% and 66%,
respectively, of product revenues.
To address new opportunities, the Company has leveraged its strengths in
semiconductor design and related software to develop and market low cost video
communication systems (hereinafter referred to as its "VideoCommunicators"). The
Company began shipping the first product in its planned family of
VideoCommunicator products, ViaTV videophone model VC100, in February 1997.
Subsequently, the Company introduced the VC105, an upgraded VC100, and added
three new models, the VC50, VC55 and VC150, to the
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ViaTV product line. The Company also has introduced versions of its ViaTV
videophones designed for European and Asian markets.
The Company is marketing its VideoCommunicators through retail channels,
catalogs and original equipment manufacturers (OEMs) as well as through direct
marketing efforts utilizing a combination of advertising, toll-free
telemarketing and direct mail supported by co-marketing arrangements with third
parties. The Company sells its video communication semiconductors and related
software to OEMs and distributors.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Consolidated Statements of Operations and the notes thereto:
Revenues
YEAR ENDED MARCH 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
(IN MILLIONS)
Product revenues..................... $35.3 71% $15.2 80% $19.8 69%
License and other revenues........... 14.5 29% 3.9 20% 9.0 31%
----- --- ----- --- ----- ---
$49.8 100% $19.1 100% $28.8 100%
===== === ===== === ===== ===
Total revenues were $49.8 million, $19.1 million and $28.8 million for the
fiscal years ended March 31, 1998, 1997 and 1996, respectively. Total revenues
for fiscal 1998 were divided among video communication semiconductors (44%),
videophone systems (27%) and nonrecurring license and other revenues (29%). In
fiscal 1997, total revenues were divided between semiconductors (80%) and
nonrecurring license and other revenues (20%). In fiscal 1996, total revenues
were divided between semiconductors (69%) and nonrecurring license and other
revenues (31%).
Product revenues were $35.3 million in fiscal 1998, an increase of $20.1
million above the $15.2 million reported in fiscal 1997, and $15.5 million above
the $19.8 million reported in fiscal 1996. The increase in product revenues is
primarily due to sales generated from the Company's ViaTV products, combined
with an increase in sales of the Company's video communication semiconductors,
offset by a decrease in both MPEG semiconductor and math co-processor sales due
to the discontinuation of such product lines in fiscal 1997.
License and other revenues consist of technology licenses, including
royalties required under such licenses, and nonrecurring engineering fees for
services performed by the Company for its customers. License and other revenues
were $14.5 million in fiscal 1998, an increase of $10.6 million above the $3.9
million reported in fiscal 1997, and $5.5 million above the $9.0 million
reported in fiscal 1996. In fiscal 1998, license and other revenues included
approximately $5.3 million paid by 3Com for a license to substantially all of
the Company's technology underlying its video communicators. There can be no
assurance that the Company will receive any revenues from licensing or other
such arrangements in the future.* See "Factors That May Affect Future
Results -- No Assurance of Future License and Other Revenues" and "Factors That
May Affect Future Results -- Dependence on Key Customers."
Product sales and license and other revenues derived from 3Com represented
approximately 20% of total revenues for the fiscal year ended March 31, 1998.
Product sales to ASCII, the Company's former distributor in Japan (the Company
terminated its distribution relationship with ASCII effective June 30, 1997),
represented approximately 13% of total revenues for the fiscal year ended March
31, 1997. License and other revenues derived from ESS Technology represented
approximately 24% of total revenues for the fiscal year ended March 31, 1996.
Dependence on significant customers entails certain risks.* See "Factors That
May
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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Affect Future Results -- Potential Fluctuations in Operating Results" and
"Factors That May Affect Future Results -- Potential Fluctuations in Operating
Results -- Dependence on Key Customers."
The Company's sales to Europe represented 22%, 21% and 17% of total
revenues for the fiscal years ended March 31, 1998, 1997, 1996, respectively.
The Company's sales to the Asia Pacific region represented 25%, 33% and 32% of
total revenues for the fiscal years ended March 31, 1998, 1997, and 1996,
respectively. See "Factors That May Affect Future Results -- International
Operations."
Cost of Revenues
YEAR ENDED MARCH 31,
-----------------------
1998 1997 1996
----- ----- -----
(IN MILLIONS)
Cost of product revenues............................ $17.8 $12.0 $16.7
As a percentage of product revenues................. 50% 79% 84%
Cost of license and other revenues.................. $ 1.1 $ -- $ --
As a percentage of license and other revenues....... 7% 0% 0%
The cost of product revenues consists of costs associated with
VideoCommunicator components, semiconductor wafer fabrication, VideoCommunicator
and semiconductor assembly and testing performed by third-party vendors and
direct and indirect costs associated with purchasing, scheduling and quality
assurance. Costs of product revenues were $17.8 million, $12.0 million and $16.7
million for the fiscal years ended March 31, 1998, 1997, and 1996, respectively.
The cost of product revenues in fiscal 1998 included costs associated with
increased shipments of its VideoCommunicator products, which the Company began
shipping in February 1997, as well as increased shipments of the Company's video
communication semiconductor products. The cost structure of the Company's ViaTV
product line is substantially different from the Company's video communication
semiconductor products and the cost of product revenues for the ViaTV product
line is substantially greater as a percentage of related revenues. In fiscal
1997, cost of product revenues included a $4.0 million charge associated with
the write-off of inventories related to the Company's discontinuation of the
MPEG product line in September 1996. As a result of this write-off, costs for
the period increased and were equal to 79% of product revenue. In fiscal 1996,
cost of product revenues were adversely impacted by the costs of the MPEG
product line which exceeded the revenue generated by this product line.
Cost of license and other revenues was $1.1 million for the fiscal year
ended March 31, 1998 and consisted of personnel and other costs incurred to
perform certain development work under terms of a nonrecurring engineering
contract between the Company and one of its customers. There were no costs
associated with license and other revenues in the fiscal years ended March 31,
1997 and 1996, respectively.
Gross Profit
YEAR ENDED MARCH 31,
----------------------
1998 1997 1996
----- ---- -----
(IN MILLIONS)
Gross profit......................................... $30.9 $7.1 $12.1
As a percentage of total revenues.................... 62% 37% 42%
Total gross profit was $30.9 million, $7.1 million and $12.1 million in
fiscal 1998, 1997 and 1996, respectively. Gross profit from product revenues was
$17.5 million, $3.2 million and $3.1 million for the fiscal years ended March
31, 1998, 1997, and 1996, respectively. Gross profit from license and other
revenues, all of which were nonrecurring, less related costs, was $13.4 million,
$3.9 million and $9.0 million in fiscal 1998, 1997 and 1996, respectively. There
can be no assurance that the Company will receive any revenues from such license
and other revenues sources in the future.* See "Factors That May Affect Future
Results -- No Assurance of Future License and Other Revenues."
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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25
The increase in gross profit and margin from product revenues in fiscal
1998 was due primarily to the increase in video communication semiconductor
revenues. In fiscal 1997, the significant decline in gross profit and margin
relates primarily to charges associated with the write-off of inventories
related to the Company's exit from the MPEG market. In fiscal 1997, the Company
sold its remaining MPEG inventory. The gross profit from product revenues for
fiscal 1996 was adversely impacted by negative margin from sales of MPEG
products.
The markets for the Company's products are characterized by falling average
selling prices, which could have a material adverse effect on the Company's
future business and operating results if the Company cannot achieve lower cost
of sales.* The Company expects that, as a result of competitive pressures and
other factors, gross profit as a percentage of revenue for the Company's
semiconductor products will likely decrease for the foreseeable future.* Gross
profit as a percent of revenue is substantially lower for the sales of ViaTV
products than for sales of the Company's semiconductors. If ViaTV product
revenue continues to grow as a percentage of total product revenue, the Company
expects that gross profit as a percentage of total product revenue will
decrease.* See "Factors That May Affect Future Results -- Fluctuations in
Operating Results."
Operating Expenses -- Research and Development
YEAR ENDED MARCH 31,
----------------------
1998 1997 1996
----- ----- ----
(IN MILLIONS)
Research and development............................. $12.3 $10.5 $7.7
As a percentage of total revenues.................... 25% 55% 27%
Research and development expenses consist primarily of personnel, system
prototype design and fabrication, mask, prototype wafer and equipment costs
necessary for the Company to conduct its development efforts. Research and
development costs, including software development costs, are expensed as
incurred. Research and development expenses were $12.3 million, $10.5 million
and $7.7 million for fiscal 1998, 1997 and 1996, respectively. During fiscal
1998 and 1997, research and development expenses were concentrated on video
communication semiconductors and VideoCommunicators. Higher research and
development expenses during fiscal 1998 were due to increased headcount,
increased engineering and prototype expenses associated with the Company's
VideoCommunicator products, and mask and prototype costs associated with the
ongoing development of the Company's next generation video communication
semiconductor product. A significant portion of research and development
expenses during fiscal 1996 was attributable to the development of products that
were subsequently discontinued, including an Intel compatible x86 microprocessor
and graphics and MPEG semiconductors.
During fiscal 1998, the overall increase in research and development
expenses was partially offset by the use of research and development personnel
to perform nonrecurring engineering services under a revenue generating
contract. The costs associated with this contract are included in the cost of
license and other revenues. Although total research and development expenses
increased from fiscal 1997 to fiscal 1998 as a result of the factors listed
above, the non-cash compensation expense recognized on certain stock option
grants and charged to research and development decreased to $416,000 in fiscal
1998 from $1.1 million in fiscal 1997.
The Company expects to continue to allocate substantial resources to
research and development.* However, future research and development costs may
vary both in absolute dollars and as a percentage of total revenues.* See
"Factors That May Affect Future Results -- Rapid Technological Change;
Dependence on New Product Introduction."
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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26
Operating Expenses -- Selling, General and Administrative
YEAR ENDED MARCH 31,
----------------------
1998 1997 1996
----- ----- ----
(IN MILLIONS)
Selling, general and administrative.................. $17.4 $10.1 $7.9
As a percentage of total revenues.................... 35% 53% 27%
Selling, general and administrative expenses consist primarily of personnel
and related overhead costs for sales, marketing, finance, human resources and
general management. Such costs also include advertising, sales commissions,
trade show and other marketing and promotional expenses. Selling, general and
administrative expenses were $17.4 million, $10.1 million and $7.9 million in
fiscal 1998, 1997 and 1996, respectively. Expenses increased due to additional
headcount, higher compensation costs and costs associated with the marketing,
advertising and promotion of the Company's VideoCommunicator product line. The
Company expects that its sales and marketing expenses may increase as the
Company launches new VideoCommunicator products and promotes its current
VideoCommunicator products.* Therefore, future selling, general and
administrative costs may vary both in absolute dollars and as a percentage of
total revenues.* See "Factors That May Affect Future Results -- Potential
Fluctuations in Operating Results."
While total expenses increased from fiscal 1997 to fiscal 1998 as a result
of the factors listed above, the non-cash compensation expense recognized on
certain stock option grants and charged to selling, general and administrative
decreased to $741,000 in fiscal 1998 from $3.1 million in fiscal 1997.
Restructuring Costs
YEAR ENDED MARCH 31,
--------------------
1998 1997 1996
---- ---- ----
(IN MILLIONS)
Restructuring costs.................................... $-- $0.1 $0.6
As a percentage of total revenues...................... 0% 1% 2%
During fiscal 1997, the Company recorded a $59,000 charge for restructuring
its operations by reducing its workforce. As of March 31, 1997, the Company's
restructuring actions were fully completed and there were no remaining
restructuring cost accruals.
During fiscal 1996, the Company recorded a $603,000 restructuring charge
related to discontinuing certain research and development activities not related
to video communication products. These restructuring costs related primarily to
the write-off of equipment associated with the discontinued research and
development efforts.
Other Income, Net
In fiscal 1998, 1997 and 1996, other income, net, was $1.5 million,
$120,000 and $952,000, respectively. In fiscal 1998, other income, net,
consisted primarily of interest income from the Company's short-term cash
investments. Interest income in fiscal 1998 included interest earned on the
proceeds from the Company's initial public offering in July 1997. During fiscal
1996, the Company acquired equity positions in four privately held companies. In
fiscal 1996, the Company realized $727,000 of income by selling the stock of one
of these entities. The Company's investment in each of these entities represents
less than 15% of the outstanding voting stock of these entities and accordingly,
the Company has accounted for these investments on a cost basis. As of March 31,
1998, these investments were fully reserved.
- ---------------
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. See "Manufacturing"
commencing on page 10, "Competition" on page 13 and "Factors That May Affect
Future Results" commencing on page 14 for a discussion of certain factors
that could affect future performance.
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27
(Benefit) Provision for Income Taxes
In August 1995, the Internal Revenue Service (IRS) asserted a deficiency
against the Company for the taxable year 1992. The IRS alleged that as of March
31, 1992, the Company had accumulated earnings beyond the reasonable needs of
its business. The Company contested this assessment. On May 15, 1997, the
Company received a notice from the IRS indicating that the IRS fully reversed
its assertion of deficiency. As a result, the Company reversed approximately
$1.0 million of its income tax liability during fiscal 1998. In fiscal 1997 and
1996, the provisions for income taxes were not material and represented certain
foreign withholding taxes and taxes related to the Company's foreign subsidiary.
At March 31, 1998, the Company had approximately $5.4 million of federal
net operating loss carryforwards and approximately $1.9 million of research and
development tax credit carryforwards available to offset future tax liabilities;
such carryforwards expire beginning in the years 2012 and 2009, respectively.
Under the ownership change limitations of the Internal Revenue Code of 1986, as
amended, the amount and benefit from the net operating losses and credit
carryforwards may be impaired or limited in certain circumstances.
At March 31, 1998, the Company had gross deferred tax assets of
approximately $7.8 million. The weight of available evidence indicates that it
is more likely than not that the Company will not be able to realize its
deferred tax assets and thus a full valuation reserve has been recorded at March
31, 1998.
Year 2000
Computer systems may experience problems handling dates beyond the year
1999 because many computer programs use only two digits to identify a year in a
date field. The Company is assessing both the readiness of its products and its
internal computer systems for handling the year 2000. The Company expects to
implement successfully the systems and programming changes necessary to address
year 2000 issues, and does not believe that the cost of such actions will have a
material effect on the Company's business and operating results. The Company is
also assessing the possible effects on the Company's operations of the year 2000
readiness of key suppliers, subcontractors and customers. The Company's reliance
on suppliers, subcontractors and customers, and, therefore, on the proper
functioning of their information systems and software, means that failure to
address year 2000 issues by its suppliers, subcontractors and customers could
have a material impact on the Company's business and operating results.
Liquidity and Capital Resources
As of March 31, 1998, the Company had cash and liquid investments totaling
$26.7 million, representing an increase of $18.0 million from March 31, 1997. In
July 1997, the Company completed an initial public offering of its common stock,
selling 4,140,000 shares at $6.50 per share. Net proceeds to the Company were
approximately $24.7 million after deducting related issuance costs. Prior to the
Company's initial public offering, the Company had satisfied its liquidity needs
principally from proceeds generated from two issuances of its equity securities
after fiscal 1994 and from cash generated from operations in fiscal 1994 and
prior years. The Company currently has no bank borrowing arrangements.
Net cash used in operations was $6.5 million, $4.3 million and $625,000 in
fiscal 1998, 1997 and 1996, respectively. Cash used in operations in fiscal 1998
reflected a $3.5 million increase in accounts receivable, a $11.6 million
increase in inventory, and a $522,000 increase in prepaid expenses and other
assets, offset by net income of $3.7 million, increases of $2.1 million in
deferred revenue, $1.2 million in accounts payable, $519,000 in accrued
compensation, and noncash items, including a deferred compensation charge of
$1.3 million. In addition to increased revenues, the increase in accounts
receivable in fiscal 1998 was partially due to increased ViaTV sales to
customers in the retail channel, which typically negotiate payment terms greater
than 30 days. The increase in inventory in fiscal 1998 was due to increases in
both ViaTV inventory held by the Company and inventory balances held by
retailers. Because the Company does not recognize revenue on the shipment of its
VideoCommunicator products to retailers or distributors until sell-through to
the distributor or retailer customer, product inventories at retailers and
distributors are reflected in the Company's inventories and are expected to
increase if the Company succeeds in further broadening its
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distribution channels.* In addition, deferred revenue is expected to increase if
the Company succeeds in broadening its distribution channels and introducing
additional products into its distribution channels.*
Cash used in operations in fiscal 1997 reflects a net loss of $13.6
million, and a decrease in accounts payable of $4.2 million. Cash used in
operations w