===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from to
-------------- --------------
Commission file number: 0-29939
----------------------
OMNIVISION TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0401990
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1341 Orleans Drive, Sunnyvale, California 94089-1136
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 542-3000
----------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
At December 8, 2003, 27,138,362 shares of common stock of the Registrant
were outstanding.
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OMNIVISION TECHNOLOGIES, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets (unaudited) -
October 31, 2003 and April 30, 2003............................ 3
Condensed Consolidated Income Statements (unaudited) -
Three and Six Months Ended October 31, 2003 and 2002........... 4
Condensed Consolidated Statements of Cash Flows (unaudited) -
Six Months Ended October 31, 2003 and 2002..................... 5
Notes to Condensed Consolidated Financial Statements (unaudited). 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 40
Item 4. Controls and Procedures.......................................... 40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 41
Item 4. Submission of Matters to a Vote of Security Holders.............. 42
Item 5. Other Information................................................ 42
Item 6. Exhibits and Reports on Form 8-K................................. 43
Signatures................................................................ 44
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data and per share data)
(unaudited)
October 31, April 30,
2003 2003
---------- --------
ASSETS
Current assets:
Cash and cash equivalents............................. $ 173,796 $ 50,438
Restricted cash....................................... 1,068 --
Short-term investments................................ 11,548 10,224
Accounts receivable, net.............................. 39,649 19,133
Inventories........................................... 29,302 13,642
Refundable and deferred income taxes.................. 6,438 7,642
Prepaid expenses and other assets..................... 1,696 1,195
--------- ---------
Total current assets................................ 263,497 102,274
Property, plant and equipment, net...................... 18,370 12,456
Long-term investments................................... 4,828 2,845
Other non-current assets................................ 407 378
--------- ---------
Total assets........................................ $ 287,102 $ 117,953
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 38,031 $ 10,528
Accrued expenses and other liabilities................ 12,954 8,037
Deferred income....................................... 4,341 2,845
--------- ---------
Total current liabilities........................... 55,326 21,410
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock, $0.001 par value; 100,000,000 shares
authorized; 27,078,952 and 23,402,908 shares issued
and outstanding..................................... 27 23
Additional paid-in capital............................ 222,133 104,848
Deferred compensation related to stock options........ (71) (159)
Retained earnings (accumulated deficit)............... 9,687 (8,169)
--------- ---------
Total stockholders' equity.......................... 231,776 96,543
--------- ---------
Total liabilities and stockholders' equity.......... $ 287,102 $ 117,953
========= =========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues.............................. $ 68,540 $ 21,743 $115,032 $ 38,533
Cost of revenues(1)................... 42,476 13,063 71,604 23,337
-------- -------- -------- --------
Gross profit.......................... 26,064 8,680 43,428 15,196
-------- -------- -------- --------
Operating expenses:
Research and development............ 3,173 2,489 6,753 5,119
Selling, general and administrative. 5,705 2,710 10,195 4,790
Stock-based compensation charge(2).. 95 150 196 264
-------- -------- -------- --------
Total operating expenses.......... 8,973 5,349 17,144 10,173
-------- -------- -------- --------
Income from operations................ 17,091 3,331 26,284 5,023
Interest income, net.................. 548 216 770 432
-------- -------- -------- --------
Income before income taxes............ 17,639 3,547 27,054 5,455
Provision for income taxes............ 5,997 532 9,198 818
-------- -------- -------- --------
Net income............................ $ 11,642 $ 3,015 $ 17,856 $ 4,637
======== ======== ======== ========
Net income per share:
Basic............................... $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
Diluted............................. $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
Shares used in computing net income
per share:
Basic............................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
Diluted............................. 30,148 24,441 28,827 24,955
======== ======== ======== ========
(1) Stock-based compensation charges
included in Cost of revenues.... $ 1 $ 4 $ 3 $ 7
======== ======== ======== ========
(2) Stock-based compensation charges
by functional area:
Research and development........ $ 14 $ 36 $ 42 $ 82
Selling, general and
administrative................ 81 114 154 182
-------- -------- -------- --------
$ 95 $ 150 $ 196 $ 264
======== ======== ======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
4
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
October 31,
------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income.............................................. $ 17,856 $ 4,637
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization......................... 716 432
Amortization of deferred stock-based compensation..... 198 271
Changes in assets and liabilities:
Accounts receivable, net............................ (20,516) (4,324)
Inventories......................................... (15,660) (8,661)
Refundable and deferred income taxes................ 1,204 82
Prepaid expenses and other assets................... (530) (1,492)
Accounts payable.................................... 27,503 5,896
Accrued expenses and other liabilities.............. 4,917 596
Deferred income..................................... 1,496 275
-------- --------
Net cash provided by (used in) operating
activities...................................... 17,184 (2,288)
-------- --------
Cash flows from investing activities:
Purchase of short-term marketable investments........... (1,324) (2,000)
Restricted cash......................................... (1,068) --
Proceeds from sale of short-term investments............ -- 2,002
Purchase of long-term non-marketable investment......... (1,983) --
Purchases of property, plant and equipment.............. (6,630) (2,797)
-------- --------
Net cash used in investing activities............. (11,005) (2,795)
-------- --------
Cash flows from financing activities:
Deposit refunded........................................ -- (600)
Proceeds from issuance of common stock, net............. 117,179 1,279
Payment for repurchase of common stock, net............. -- (1)
-------- --------
Net cash provided by financing activities......... 117,179 678
-------- --------
Net increase (decrease) in cash and cash equivalents...... 123,358 (4,405)
Cash and cash equivalents at beginning of period.......... 50,438 55,803
-------- --------
Cash and cash equivalents at end of period................ $173,796 $ 51,398
======== ========
Supplemental cash flow information:
Taxes paid.............................................. $ 7,210 $ 2,088
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
5
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Note 1 -- Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements as
of October 31, 2003 and April 30, 2003 and for the three and six months ended
October 31, 2003 and 2002 have been prepared by OmniVision Technologies, Inc.
and subsidiaries (the "Company" or "OmniVision") in accordance with the rules
and regulations of the Securities and Exchange Commission. The amounts as of
April 30, 2003 have been derived from the Company's annual audited financial
statements. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted in accordance with such rules and
regulations. In the opinion of management, the accompanying unaudited financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the Company
and its results of operations and cash flows as of and for the periods
presented. These financial statements should be read in conjunction with the
annual audited financial statements and notes thereto as of and for the year
ended April 30, 2003, included in the Company's Annual Report on Form 10-K.
The results of operations for the three and six months ended October 31,
2003 are not necessarily indicative of the results that may be expected for the
year ending April 30, 2004 or any other future interim period, and the Company
makes no representations related thereto.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Note 2 -- Summary of Significant Accounting Policies
------------------------------------------
Revenue Recognition
-------------------
The Company recognizes revenue from the sale of products to original
equipment manufacturers and value added resellers upon the shipment of its
products to the customer provided that the Company has received a signed
purchase order, the price is fixed or determinable, title and risk of loss has
transferred to the customer, collection of resulting receivables is considered
reasonably assured, product returns are reasonably estimable, there are no
customer acceptance requirements and there are no remaining significant
obligations. The Company provides for future returns based on historical
experiences at the time revenue is recognized. For certain shipments to
distributors under agreements allowing for return or credits, revenue is
deferred until the distributor resells the product to the end-user customer.
Deferred income on shipment to distributors represents the amount billed less
the cost of inventory shipped to but not yet sold by distributors.
Short-Term Investments
----------------------
The Company's short-term investments, which are classified as available-
for-sale, are invested in marketable high-grade corporate securities and
government bonds maturing twelve months or less from the date of purchase.
These investments are reported at fair value which approximates cost.
Unrealized gains or losses are recorded in stockholders' equity and included in
other comprehensive income (losses). Unrealized gains or losses were not
significant during any period presented in these financial statements.
Stock-Based Compensation
------------------------
The Company accounts for stock-based employee compensation arrangements
using the intrinsic value method in accordance with the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
------------------------------
Employees" ("APB 25"), and the Financial Accounting Standards Board ("FASB")
- ---------
FASB Interpretation 44, "Accounting for Certain Transactions Involving Stock
---------------------------------------------------
Compensation" ("FIN 44"), and complies with the disclosure provisions of
- ------------
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
---------------------
Based Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for
- ------------------ --------------
Stock-Based Compensation--Transition and Disclosure--An Amendment of FASB
- -------------------------------------------------------------------------
Statement No. 123" ("SFAS 148"). Under APB 25, compensation cost is recognized
- -----------------
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
based on the difference, if any, on the date of grant between the fair value of
the Company's stock and the amount an employee must pay to acquire the stock.
Deferred stock-based compensation is then amortized over the vesting period of
the option on an accelerated basis using the multiple option approach as
defined in paragraph 24 of FIN 28. SFAS 123 describes a "fair value" based
method of accounting for an employee stock option or similar equity instrument.
The following table illustrates the effect on net income and net income per
share as if the Company had applied the fair value recognition provisions of
SFAS 123 and SFAS 148 to stock-based employee grants compensation and is
referenced to in this Note as "as adjusted" (in thousands, except per share
amounts):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported................ $ 11,642 $ 3,015 $ 17,856 $ 4,637
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 20 59 58 138
Deduct: Total stock-based employee
compensation determined under
fair value based method for all
awards, net of related tax
effects........................ 4,591 1,983 7,696 3,377
-------- -------- -------- --------
As adjusted net income................. $ 7,072 $ 1,091 $ 10,218 $ 1,398
======== ======== ======== ========
Net income per share -- Basic:
As reported.......................... $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
As adjusted.......................... $ 0.26 $ 0.05 $ 0.40 $ 0.06
======== ======== ======== ========
Net income per share -- Diluted:
As reported.......................... $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
As adjusted.......................... $ 0.25 $ 0.05 $ 0.40 $ 0.06
======== ======== ======== ========
Shares used in computing net income per
share -- Basic:
As reported.......................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
As adjusted.......................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
Shares used in computing net income per
share -- Diluted:
As reported.......................... 30,148 24,441 28,827 24,955
======== ======== ======== ========
As adjusted.......................... 28,719 22,552 25,587 22,487
======== ======== ======== ========
The Company accounts for stock issued to non-employees in accordance with
the provisions of SFAS 123 and Emerging Issues Task Force Consensus No. 96-18,
"Accounting for Equity Instruments that are Offered to Other than Employees for
------------------------------------------------------------------------------
Acquiring or in Conjunction with Selling Goods or Services" ("EITF 96-18").
- ----------------------------------------------------------
Under SFAS 123 and EITF 96-18, stock option awards issued to non-employees are
accounted for at their fair value, determined using the Black-Scholes option
pricing model.
Recent Accounting Pronouncements
- --------------------------------
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN 46"). FIN 46
requires certain variable interest entities to be consolidated by the primary
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The original effective date
of FIN 46 was delayed to the first reporting period after December 15, 2003 for
any variable interest entities or potential variable interest entities created
before February 1, 2003. The Company does not expect the adoption of FIN 46 to
have a material impact on its consolidated financial position, results of
operations and cash flows.
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Note 3 -- Balance Sheet Accounts (In Thousands)
------------------------------------
October 31, April 30,
2003 2003
---------- --------
Cash and cash equivalents:
Cash.................................................. $ 4,142 $ 941
Money market funds.................................... 91,748 25,363
Commercial paper...................................... 77,906 24,134
--------- ---------
$ 173,796 $ 50,438
========= =========
Accounts receivable:
Accounts receivable................................... $ 46,122 $ 21,188
Less: Allowance for doubtful accounts................. (2,315) (915)
Sales return reserve............................ (4,158) (1,140)
--------- ---------
$ 39,649 $ 19,133
========= =========
Inventories:
Work in progress...................................... $ 17,985 $ 8,942
Finished goods........................................ 11,317 4,700
--------- ---------
$ 29,302 $ 13,642
========= =========
Prepaid expenses and other assets:
Prepaid expenses...................................... $ 1,444 $ 1,187
Other receivables..................................... 252 8
--------- ---------
$ 1,696 $ 1,195
========= =========
Property, plant and equipment, net:
Building.............................................. $ 8,244 $ --
Building improvements................................. 3,310 --
Machinery and equipment............................... 6,728 3,607
Furniture and fixtures................................ 216 283
Software.............................................. 1,103 976
Construction in progress.............................. 2,881 10,986
--------- ---------
22,482 15,852
Less: Accumulated depreciation and amortization....... (4,112) (3,396)
--------- ---------
$ 18,370 $ 12,456
========= =========
Note 4 -- Net Income Per Share
--------------------
Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed using the weighted average number of common
and potentially dilutive common shares outstanding during the period using the
treasury stock method. Potentially dilutive common shares include the effect of
stock options. For the three and six months ended October 31, 2002, 2,372,300
and 1,552,050 shares of common stock subject to outstanding options were not
included in the calculation of diluted net income per share as they were
considered antidilutive (i.e., the per share exercise price for such options
exceeded the trading price of the Company's common stock as reported on The
Nasdaq Stock Market). For the six months ended October 31, 2003, 300,875 shares
of common stock subject to outstanding options were not included in the
calculation of diluted net income per share as they were considered
antidilutive. There were no antidilutive shares for the three months ended
October 31, 2003.
9
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The following table sets forth the computation of basic and diluted income
per share attributable to common stockholders for the periods indicated (in
thousands, except per share data):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net income........................... $ 11,642 $ 3,015 $ 17,856 $ 4,637
======== ======== ======== ========
Denominator:
Weighted average shares.............. 26,997 22,552 25,442 22,487
Weighted average unvested common
shares subject to repurchase....... (24) (114) (36) (139)
-------- -------- -------- --------
Denominator for basic net income
per share.......................... 26,973 22,438 25,406 22,348
Effect of dilutive securities:
Common stock options................. 3,151 1,889 3,385 2,468
Unvested common stock subject to
repurchase......................... 24 114 36 139
-------- -------- -------- --------
Denominator for dilutive net income
per share......................... 30,148 24,441 28,827 24,955
======== ======== ======== ========
Basic net income per share............. $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
Diluted net income per share........... $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
In July 2003, the Company sold 3,093,226 shares of common stock in a
follow-on public offering at a price of $38.75 per share, resulting in net
proceeds of approximately $113.2 million. The incremental shares are reflected
in the weighted average shares outstanding during the three- and six-month
periods ended October 31, 2003.
Note 5 -- Segment, Product Line and Geographic Information
------------------------------------------------
The Company identifies its operating segments based on business
activities, management responsibility and geographic location. For all periods
presented, the Company operated in a single business segment.
Revenues from the Company's two product lines, digital and analog image
sensors, were as follows (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Digital image sensors.................. $ 61,174 $ 16,121 $ 99,721 $ 24,615
Analog image sensors................... 7,366 5,622 15,311 13,918
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
10
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The Company sells its products primarily to customers in the Asia Pacific
region and in the United States of America. Revenues by geographic locations
are not necessarily representative of the geographic distribution of sales into
end-user markets, as the Company's customers sell their products globally. The
revenues by geographic locations in the following table are based on the
country or region in which the customer is located (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Hong Kong.............................. $ 21,828 $ 13,232 $ 40,506 $ 20,878
Taiwan................................. 22,937 5,642 38,541 9,785
China.................................. 15,599 1,134 21,495 1,561
Japan.................................. 865 243 1,191 1,139
United States.......................... 349 388 974 3,166
All other.............................. 6,962 1,104 12,325 2,004
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
In December 2000, the Company formed a subsidiary to conduct testing
operations and other processes associated with the manufacturing of its
products in China. The registered capital of this subsidiary was initially
$12.0 million, of which $3.8 million was funded by the Company in the fiscal
year ended April 30, 2001, as required by Chinese law. The Company funded an
additional $3.7 million during fiscal 2002. In August 2002, the Company
increased the registered capital to $30.0 million and funded an additional $4.0
million during fiscal 2003. A total of $14.0 million of the $30.0 million of
registered capital of the subsidiary had been funded as of October 31, 2003
from the Company's available working capital. The remaining $16.0 million of
registered capital must be funded as follows: $0.7 million by January 2004 and
$15.3 million by January 2005. The $14.0 million invested through October 31,
2003 was used primarily to pay for the construction of a building and
associated building improvements and purchase of machinery and equipment.
The Company's long-lived assets are located in the following countries (in
thousands):
October 31, April 30,
2003 2003
---------- --------
China................................................... $ 12,354 $ 8,968
United States........................................... 5,722 3,588
Taiwan.................................................. 5,234 2,845
All other............................................... 295 278
--------- ---------
Total................................................. $ 23,605 $ 15,679
========= =========
Note 6 -- Employee Stock Option and Stock Purchase Plans
----------------------------------------------
Employee Stock Option Grants
----------------------------
Options to purchase 300,875 and 1,722,300 shares of common stock were
granted to employees during the three and six months ended October 31, 2003,
respectively. As of October 31, 2003, options to purchase 4,888,847 shares of
common stock were outstanding.
2000 Employee Stock Purchase Plan
---------------------------------
As of October 31, 2003, 675,980 shares had been purchased under the 2000
Employee Stock Purchase Plan (the "2000 Purchase Plan").
11
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Fair Value Disclosures
----------------------
Information regarding net income and net income per share, as adjusted, is
required by SFAS 123, which also requires that the information be determined as
if the Company had accounted for its employee stock options granted under the
fair value method. The fair value for these options was estimated using the
Black-Scholes option pricing model. The per share weighted average estimated
fair value for employee options granted was $42.93 and $10.52 during the three
months ended October 31, 2003 and 2002, respectively. The per share weighted
average estimated fair value for employee options granted was $34.57 and $11.92
during the six months ended October 31, 2003 and 2002, respectively. The Black-
Scholes model was developed for use in estimating the fair value of traded
options that have no restrictions and are fully transferable and negotiable in
a free trading market. Black-Scholes does not consider the employment, transfer
or vesting restrictions that are inherent in the Company's employee options.
Use of an option valuation model, as required by SFAS 123, includes highly
subjective assumptions based on long-term predictions, including the expected
stock price volatility and average life of each option grant. Because the
Company's employee options have characteristics significantly different from
those of freely traded options, and because changes in the subjective input
assumptions can materially affect the Company's estimate of the fair value of
those options, in the Company's opinion, the existing valuation models,
including Black-Scholes, are not reliable single measures and may misstate the
fair value of the Company's employee options.
The following weighted average assumptions are included in the estimated
fair value calculations for stock option grants in the three and six months
ended October 31, 2003 and 2002:
Employee Stock Option
---------------------------------------
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Risk-free interest rate................ 2.31% 2.10% 1.74% 2.10%
Expected term of options (in years).... 3.5 3.5 3.5 3.5
Expected volatility.................... 126.6% 134.6% 128.5% 134.6%
Expected dividend yield................ 0% 0% 0% 0%
Using Black-Scholes, the per share weighted average estimated fair value
of rights issued pursuant to the Company's 2000 Purchase Plan during the three
and six months ended October 31, 2003 was $30.92 and $26.23, respectively.
Using Black-Scholes, the per share weighted average estimated fair value of
rights issued pursuant to the Company's 2000 Purchase Plan during the three and
six months ended October 31, 2002 was $8.18 and $9.29, respectively.
12
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The following weighted average assumptions are included in the estimated
grant date fair value calculations for rights to purchase stock under the 2000
Purchase Plan:
Employee Stock Purchase
---------------------------------------
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Risk-free interest rate................ 1.19% 1.80% 1.18% 1.80%
Expected term of options (in years).... 0.25 0.25 0.25 0.25
Expected volatility.................... 126.6% 134.6% 128.5% 134.6%
Expected dividend yield................ 0% 0% 0% 0%
Note 7 -- Commitments and Contingencies
-----------------------------
From time to time, the Company has been subject to legal proceedings and
claims with respect to such matters as patents, product liabilities and other
actions arising out of the normal course of business.
On November 29, 2001, a complaint captioned McKee v. OmniVision
Technologies, Inc., et. al., Civil Action No. 01 CV 10775, was filed in the
United States District Court for the Southern District of New York against
OmniVision, some of the Company's directors and officers, and various
underwriters for the Company's initial public offering. Plaintiffs generally
allege that the named defendants violated federal securities laws because the
prospectus related to the Company's offering failed to disclose, and contained
false and misleading statements regarding, certain commissions purported to
have been received by the underwriters, and other purported underwriter
practices in connection with their allocation of shares in the Company's
offering. The complaint seeks unspecified damages on behalf of a purported
class of purchasers of the Company's common stock between July 14, 2000 and
December 6, 2000. Substantially similar actions have been filed concerning the
initial public offerings for more than 300 different issuers, and the cases
have been coordinated as In re Initial Public Offering Securities Litigation,
21 MC 92. The Company's directors and officers have been dismissed without
prejudice pursuant to a stipulation. On February 19, 2003, the Court granted in
part and denied in part a motion to dismiss brought by defendants including
OmniVision. The order dismisses all claims against the Company except for a
claim brought under Section 11 of the Securities Act of 1933. A proposal has
been made for the settlement and release of claims against the issuer
defendants, including OmniVision. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the Court.
If the settlement does not occur, and litigation against the Company continues,
the Company believes that it has meritorious defenses and intends to defend the
case vigorously.
On August 21, 2002 the Company initiated a patent infringement action in
Taiwan, R.O.C. against IC Media Corporation of San Jose, CA for infringement of
Taiwan patent NI-139439 owned by OmniVision. The action was brought in the
Civil Tribunal of the Shih Lin District Court and assigned Civil Action Number
91 Su-Zi 1074. The patent infringement action seeks damages and injunctive
relief against IC Media Corporation. In response to the Company's patent
infringement action, on October 2, 2002, IC Media Corporation initiated a
cancellation proceeding (Cancellation No. 089123560N01) in the Taiwan
Intellectual Property Office with respect to its Taiwan patent NI139439. On
July 23, 2003, the Taiwan Intellectual Property Office made an initial
determination to grant the cancellation of Taiwan patent NI-139439. The
decision of the Taiwan Intellectual Property Office was upheld by the Taiwan
Ministry of Economic Affairs in November 2003. The Company intends to file an
action with the High Administrative Court of Taiwan to reverse the grant of
cancellation.
On October 11, 2002, the Company filed a complaint against IC Media
Corporation in Superior Court of California, Santa Clara County (Case No. CV
811866). In its complaint, the Company alleges misappropriation of trade
secrets, unfair competition and other business torts, and seek damages and
injunctive relief. IC Media Corporation has answered the complaint by denying
the allegations and raising various defenses; no counterclaims have been
13
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
asserted against the Company by IC Media. In accordance with the Alternative
Dispute Resolution practices of the Superior Court of California, Santa Clara
County, this matter has been submitted for non-binding arbitration.
On June 30, 2003, Mr. Chia-Chin Ku filed a complaint in Santa Clara County
Superior Court against the Company and its president and chief executive
officer, Mr. Shaw Hong. The complaint alleges that, by forming OmniVision in
1995, Mr. Hong breached a fiduciary duty owed to HK Technology, Inc., a
privately-held corporation Mr. Hong and others founded in 1988. The complaint
further alleges that the Company "misappropriated and converted" assets and
technology belonging to HK Technology, Inc. The complaint seeks damages in an
unspecified amount. The Company believes that it has meritorious defenses to
the allegations and claims and intends to defend itself vigorously. The Company
understands that HK Technology, Inc. has not engaged in significant substantive
operations since the early 1990s. The Company also understands that HK
Technology Inc.'s primary line of business was the design of chipsets for
personal computers, and that it did not engage in any business concerning image
sensors, which is OmniVision's primary line of business. The Company does not
believe that OmniVision's technology or products incorporate or use any
proprietary technology of HK Technology, Inc.
On July 14, 2003, Sunex, Inc. filed a complaint against OmniVision in San
Diego County Superior Court. Sunex was a supplier of optical lenses and lens
holders for one of the Company's cell phone products. Under its complaint,
Sunex is seeking to recover approximately $1.8 million plus interest and
attorney's fees. Sunex's complaint relates to parts delivered by Sunex to
OmniVision in the quarters ended January 31, 2003 and April 30, 2003 and the
Company's cancellation in that quarter of additional purchase orders it had
previously placed with Sunex. In October 2003, the Superior Court granted
Sunex's request for a prejudgment writ of attachment. The parties stipulated to
the filing of a bond in lieu of an attachment which OmniVision posted with the
Superior Court in the approximate amount of $1.1 million. The attachment order
and subsequent filing of the bond are not reflective of the merits of the case
and are expressly prohibited from being referred to at the time of trial. The
Company intends to defend itself vigorously and has filed a counterclaim
against Sunex in which the Company alleges breach of contract and breach of
warranties, and seeks damages in an amount yet to be determined. The Company
believes that any amount it may ultimately owe Sunex in excess of the amount it
had accrued as of April 30, 2003 will not have a material adverse affect on its
financial condition, results of operations or cash flows.
In October 2003, the Company entered into a Shareholders' Agreement with
Taiwan Semiconductor Manufacturing Company, or TSMC, pursuant to which the
Company agreed with TSMC to form VisEra Technology Company, or VisEra, a joint
venture in Taiwan, for the purposes of providing manufacturing services and
automated final testing services. The Company has committed with TSMC and
certain employees and affiliates of VisEra to provide an aggregate of $50.0
million in total capital to VisEra, which commitments may be made in the form
of cash or asset contributions. The Company and TSMC will have equal interests
in VisEra. The Company's share of this capital commitment to VisEra is $23.5
million and becomes due in stages as VisEra's business and service capabilities
develop over a number of years. The Company's net cash commitment to VisEra is
approximately $4.5 million. OmniVision will also contribute approximately $19.0
million of assets to the joint venture, including technology, plant and
equipment currently owned by the Company or to be purchased with funds for
existing commercial commitments. (See Note 5.)
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors that include, but are not
limited to, the risks discussed in "Factors Affecting Future Results." These
forward-looking statements include, but are not limited to: the statements
relating to the transition of our testing operations to China and the expansion
of our testing capabilities in the seventh paragraph under "Overview;" the
statements relating to the our commitments and TSMC's commitments to VisEra in
the eighth, ninth and tenth paragraphs under "Overview;" the statements
relating to the future revenues from sales of CameraChips for digital
applications in the third paragraph under "Revenues;" the statements relating
to research and development expenses during the remainder of fiscal 2004 in the
second paragraph under "Research and Development;" the statements relating to
future selling, general and administrative expenses in the second paragraph
under "Selling, General and Administrative;" the statements relating to the
expected effective tax rate for fiscal 2004 under "Provision for Income Taxes;"
the statements relating to increased future revenues made in the second
paragraph under "Liquidity and Capital Resources;" the statements relating to
research and development expenses during the remainder of fiscal 2004 and to
selling, general and administrative expenses during the remainder of fiscal
2004 in the third paragraph under "Liquidity and Capital Resources;" the
statements relating to our capital commitments to VisEra in the footnote to the
table in "Contractual Obligations and Commercial Commitments;" the statements
relating to our efforts to increase capacity and reduce cost through the
establishment of a Chinese subsidiary in the second paragraph under
"Contractual Obligations and Commercial Commitments;" the statements relating
to the our commitments and TSMC's commitments to VisEra in the second paragraph
in "Contractual Obligations and Commercial Commitments;" the statements
relating to third party financing, the issuance of equity securities and the
issuance of debt securities in the fourth paragraph under "Contractual
Obligations and Commercial Commitments;" the statements relating to the
expected effect of our contractual obligations and commercial commitments on
our liquidity and cash flows in future periods in the fifth paragraph under
"Contractual Obligations and Commercial Commitments;" the statements relating
to the effect of and exposure to foreign currency exchange rate risk under
"Foreign Currency Exchange Risk;" the statements relating to the effect of and
exposure to market interest rate risk under "Quantitative and Qualitative
Discussion of Market Interest Rate Risk;" and the statements relating to the
effect that the implementation of a new enterprise resource planning system
will have on our internal controls in the third paragraph under "Controls and
Procedures;" among others. These forward-looking statements are based on
current expectations and entail various risks and uncertainties that could
cause actual results to differ materially from those projected in the forward-
looking statements. Such risks and uncertainties are set forth below under
"Factors Affecting Future Results." All subsequent written and oral forward-
looking statements by or attributable to us or persons acting on our behalf are
expressly qualified in their entirety by such factors.
Overview
- --------
We design, develop and market high performance, highly integrated and cost
efficient semiconductor image sensor devices. Our main product, an image
sensing device called the CameraChip(tm), is used to capture an image in a
number of consumer and commercial mass market applications. Our CameraChips are
designed to use the complementary metal oxide semiconductor, or CMOS,
fabrication process. We have designed our CameraChip as a single chip solution
that integrates several distinct functions including image capture, image
processing, color processing and the conversion and output of a fully processed
image or video stream. Our highly integrated CMOS CameraChips help enable mass
market camera device manufacturers to build camera applications that generally
have high image quality and resolution, are low cost and small in size and
consume low amounts of power.
Our CameraChips are currently used in a number of consumer applications
including digital still and video cameras, cell phones, personal computers and
toys and games such as interactive video games.
Our CameraChips are sold to customers who incorporate them in either
digital or analog mass market applications. Some examples of digital mass
market applications that currently incorporate our CameraChips are digital
still cameras, cell phone cameras and personal computer camera applications.
Some examples of analog applications that currently incorporate our CameraChips
are security and surveillance cameras and toy cameras.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
We sell our products worldwide directly to original equipment
manufacturers, or OEMs, which include branded customers and contract
manufacturers, and value added resellers, or VARs, and indirectly through
distributors.
We currently outsource the wafer fabrication, color filter application and
packaging of our CameraChip products. This approach allows us to focus our
resources on the design, development and marketing of our products and
significantly reduces our capital requirements.
We have designed and developed a complete PC-based system for the testing
of our CameraChips. This system has automatic handling capability, an image
source, a lighting and lens system and automatic output sorting capability. We
believe that this proprietary testing process helps us to reduce our testing
costs, maintain consistent product quality, and identify areas for continued
improvement in product quality.
We have initiated the process of relocating some of our automated image
testing equipment from the United States to China. We anticipate that we will
substantially complete this transition prior to the end of fiscal 2004. In
addition, we also expect to expand testing capabilities with additional
automated testing equipment, which will also be located in China.
In October 2003, we entered into a Shareholders' Agreement with Taiwan
Semiconductor Manufacturing Company, or TSMC, pursuant to which we agreed with
TSMC to form VisEra Technology Company, or VisEra, a joint venture in Taiwan,
for the purposes of providing manufacturing services and automated final
testing services. In connection with the formation of VisEra, OmniVision and
TSMC have separately agreed to enter into nonexclusive license agreements with
VisEra pursuant to which OmniVision and TSMC shall license certain intellectual
property to VisEra relating to manufacturing services and automated final
testing services. Once VisEra has the capability to deliver high quality
manufacturing services and automated final testing services, we have committed
to direct a substantial portion of our requirements in these areas to VisEra,
subject to pricing and technology requirements. Our company and TSMC have also
committed not to compete directly or indirectly in the future with VisEra in
the fields of certain manufacturing services and automated final testing
services.
We have committed with TSMC and certain employees and affiliates of VisEra
to provide an aggregate of $50.0 million in total capital to VisEra, which
commitments may be made in the form of cash or asset contributions. Our company
and TSMC will have equal interests in VisEra. Our share of this capital
commitment to VisEra is $23.5 million and becomes due in stages as VisEra's
business and service capabilities develop over a number of years. Our net cash
commitment to VisEra is approximately $4.5 million. We will also contribute
approximately $19.0 million of assets to the joint venture, including
technology, plant and equipment currently owned by us or to be purchased with
funds for existing commercial commitments.
Historically, we have relied upon TSMC to provide us with a substantial
proportion of our wafers, but we have never before entered into a long-term
supply agreement with TSMC and instead have traditionally secured manufacturing
availability on a purchase order basis. As a part of the Shareholders'
Agreement, TSMC has agreed to commit substantial wafer manufacturing capacity
to us for a period of time in exchange for our commitment over this time period
to purchase a substantial portion of our wafers from TSMC, subject to pricing
and technology requirements.
As of October 31, 2003, we had approximately $173.8 million in cash and
cash equivalents and approximately $11.5 million in short-term investments. To
mitigate credit risk related to short-term investments, we have an investment
policy designed to preserve the value of capital and to generate interest
income from these investments without undue exposure to market fluctuations.
Market risk is the potential loss due to the change in value of a financial
instrument due to changes in interest rates or bond prices. Our policy is to
invest in financial instruments with short durations, limiting interest rate
exposure, and to measure performance against comparable benchmarks. We maintain
our portfolio of cash equivalents and short-term investments in a variety of
securities, including both government and corporate obligations with ratings of
A or better and money market funds.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Recent Events
-------------
In June 2003, we purchased approximately 27% of the equity of a privately
held company based in Taiwan for a total of $2.0 million in cash. The Taiwan
company provides plastic packaging services, and we will be a major customer.
We have accounted for this investment using the equity method. In November
2003, we increased our investment in this privately held company by an
additional $0.8 million to maintain our equity ownership percentage in this
company.
Critical Accounting Policies
----------------------------
For a discussion of the critical accounting policies, please see the
discussion in our Annual Report on Form 10-K for the fiscal year ended April
30, 2003.
Results of Operations
- ---------------------
The following table sets forth the results of our operations as a
percentage of revenues. Our historical operating results are not necessarily
indicative of the results for any future period.
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues............................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues....................... 62.0 60.1 62.3 60.6
------ ------ ------ ------
Gross profit......................... 38.0 39.9 37.7 39.4
------ ------ ------ ------
Operating expenses:
Research and development............. 4.6 11.4 5.9 13.3
Selling, general and administrative.. 8.3 12.5 8.8 12.4
Stock compensation charge............ 0.2 0.7 0.2 0.7
------ ------ ------ ------
Total operating expenses........... 13.1 24.6 14.9 26.4
------ ------ ------ ------
Income from operations................. 24.9 15.3 22.8 13.0
Interest income, net................... 0.8 1.0 0.7 1.1
------ ------ ------ ------
Income before income taxes............. 25.7 16.3 23.5 14.1
Provision for income taxes............. 8.7 2.4 8.0 2.1
------ ------ ------ ------
Net income............................. 17.0% 13.9% 15.5% 12.0%
====== ====== ====== ======
Three and Six Months Ended October 31, 2003 as Compared to Three and Six Months
- -------------------------------------------------------------------------------
Ended October 31, 2002
- ----------------------
Revenues
- --------
We derive revenues from the sale of our CameraChip products for use in a
wide variety of consumer and commercial mass market applications including
digital still cameras, cell phones, video game consoles and security and
surveillance cameras. Revenues for the three months ended October 31, 2003 and
2002 were approximately $68.5 million and $21.7 million, respectively. Revenues
for the six months ended October 31, 2003 and 2002 were approximately $115.0
million and $38.5 million, respectively.
Revenues from Sales of CameraChips for Digital as Compared to Analog
--------------------------------------------------------------------
Applications.
------------
Our CameraChips are sold to customers who incorporate them into either
digital or analog applications. Examples of digital applications that
incorporate our CameraChips are digital still cameras, cellular phone cameras,
personal computer camera applications and digital toy cameras. Examples of
analog applications that incorporate our CameraChips are security and
surveillance cameras and toy cameras. We sell a large portion of our products
through VARs and distributors, and often we do not know the identity of the
manufacturer who is embedding our CameraChips into their products. As a result
of our sales to VARs and distributors and because our CameraChips can be used
in a wide variety of digital or analog products, we cannot accurately confirm
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
the distribution of our revenues across specific product categories. However,
we are able to confirm the distribution of our revenues by digital and analog
product categories and they are as follows (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Digital image sensors.................. $ 61,174 $ 16,121 $ 99,721 $ 24,615
Analog image sensors................... 7,366 5,622 15,311 13,918
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
Digital Revenues. For the three months ended October 31, 2003, revenues
----------------
from sales of CameraChips for digital applications increased 279.5% to
approximately $61.2 million from $16.1 million for the three months ended
October 31, 2002. Revenues from sales of CameraChips for digital applications
represented 89.3% and 74.1% of revenues for the three months ended October 31,
2003 and 2002, respectively. For the six months ended October 31, 2003,
revenues from sales of CameraChips for digital applications increased 305.1% to
approximately $99.7 million from $24.6 million for the six months ended October
31, 2002. Revenues from sales of CameraChips for digital applications
represented 86.7% and 63.9% of revenues for the six months ended October 31,
2003 and 2002, respectively. The increase in revenues from sales of CameraChips
for digital applications for the three and six months ended October 31, 2003
was due to increased unit sales and to a shift in product mix toward higher
resolution products, which, in general, carry higher average sales prices than
lower resolution products. The increased unit sales resulted from heightened
demand for CameraChips for digital still cameras, cell phones, and interactive
video games. We expect revenues from sales of CameraChips for digital
applications to increase in the third quarter of fiscal 2004 primarily as a
result of increased sales to the digital still camera and cell phone markets.
Analog Revenues. For the three months ended October 31, 2003, revenues
---------------
from sales of CameraChips for analog applications increased 31.0% to
approximately $7.4 million from $5.6 million for the three months ended October
31, 2002. Revenues from sales of CameraChips for analog applications
represented 10.7% and 25.9% of revenues for the three months ended October 31,
2003 and 2002, respectively. For the six months ended October 31, 2003,
revenues from sales of CameraChips for analog applications increased 10.0% to
approximately $15.3 million from $13.9 million for the six months ended October
31, 2002. Revenues from sales of CameraChips for analog applications
represented 13.3% and 36.1% of revenues for the six months ended October 31,
2003 and 2002, respectively. The increase in revenues from sales of CameraChips
for analog applications for the three and six months ended October 31, 2003 was
due primarily to increased demand for CameraChips for use in cameras for toys
and games.
Revenues from Sales to OEMs and VARs as Compared to Distributors
----------------------------------------------------------------
We sell our CameraChips either directly to OEMs and VARs or through
distributors. The following table illustrates the percentage of revenues from
sales to OEMs and VARs as compared to distributors in the three and six months
ended October 31, 2003 and 2002:
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
OEMs and VARs.......................... 70.8% 68.9% 66.7% 64.9%
Distributors........................... 29.2 31.1 33.3 35.1
------ ------ ------ ------
Total................................ 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
OEMs and VARs. In the three months ended October 31, 2003, Aiptek
International, Inc., or Aiptek, headquartered in Taiwan, accounted for 11.5% of
revenues, and Nam Tai Electronics, Inc., or Nam Tai, headquartered in Hong
King, accounted for 10.4% of revenues. In the three months ended October 31,
2002, Concord Camera HK Limited, or Concord, headquartered in Hong Kong,
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
accounted for 19.5% of revenues, and Aiptek accounted for 12.7% of revenues. In
the six months ended October 31, 2003, Aiptek accounted for 10.5% of revenues.
In the six months ended October 31, 2002, Concord accounted for 12.2% of
revenues. No other OEM or VAR customer accounted for 10% or more of revenues
during any of these periods.
Distributors. In the three months ended October 31, 2003, World Peace
------------
Industrial Co. Ltd., or World Peace, headquartered in Taiwan, accounted for
18.9% of revenues. In the three months ended October 31, 2002, World Peace
accounted for 20.5% of revenues, including sales to World Peace's subsidiary,
GainTune, based in Hong Kong. In the six months ended October 31, 2003, World
Peace accounted for 22.9% of revenues, including sales to GainTune. In the six
months ended October 31, 2002, World Peace accounted for 22.2% of revenues,
including sales to GainTune. No other distributor accounted for 10% or more of
revenues during any of these periods.
Revenues from Domestic Sales as Compared to Foreign Sales
---------------------------------------------------------
The following table illustrates the percentage of revenues from sales of
our CameraChip products to domestic customers as compared to foreign customers
for the three and six months ended October 31, 2003 and 2002:
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Domestic sales......................... 0.5% 1.8% 0.9% 8.2%
Foreign sales.......................... 99.5 98.2 99.1 91.8
------ ------ ------ ------
Total................................ 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
The majority of our foreign sales are attributable to sales made to
customers in Asia and, to a lesser extent, in Europe. Over time, our sales to
Asia-Pacific customers have increased primarily as a result of the continuing
trend of outsourcing production to Asian manufacturers and facilities. Because
of the preponderance of Asia-Pacific manufacturers and the fact that virtually
all products incorporating our CameraChips are sold globally, we believe that
such figures do not accurately reflect geographic distribution of sales of our
products into end-user markets.
Gross Profit
- ------------
Gross margins for the three months ended October 31, 2003 and 2002 were
38.0% and 39.9% of revenues, respectively. Gross margins for the six months
ended October 31, 2003 and 2002 were 37.7% and 39.4% of revenues, respectively.
The decrease in gross margins for the three and six months ended October 31,
2003, as compared to the corresponding periods in the prior year, was primarily
due to a reduction in sales of previously written off inventory. For the three
months ended October 31, 2003, approximately $0.4 million of gross profit was
attributable to the sale of previously written off inventory. For the six
months ended October 31, 2003, approximately $0.8 million of gross profit was
attributable to the sale of previously written off inventory. Excluding the
revenues and gross profit from the sale of previously written off inventory,
the gross margin for the three months ended October 31, 2003 would have been
approximately 37.6% of revenues, as compared to 37.2% of revenues during the
comparable period in the prior year. Excluding the revenues and gross profit
from the sale of previously written off inventory, the gross margin for the six
months ended October 31, 2003 would have been approximately 37.3% of revenues,
as compared to 36.6% of revenues during the comparable period in the prior
year.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
The following table summarizes the effect of sales of previously written-
off inventory on gross profits for the three and six months ended October 31,
2003 and 2002 (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Sales of all products.................. $ 68,540 $ 21,743 $115,032 $ 38,533
Gross profit........................... $ 26,064 $ 8,680 $ 43,428 $ 15,196
Gross margin........................... 38.0% 39.9% 37.7% 39.4%
Sales excluding products for which the
costs were previously written off.... $ 68,099 $ 20,786 $114,248 $ 36,781
Gross profit excluding the effect of
sales of products for which the costs
were previously written off.......... $ 25,623 $ 7,723 $ 42,644 $ 13,444
Gross margin excluding the effect of
sales of products for which the costs
were previously written off.......... 37.6% 37.2% 37.3% 36.6%
Research and Development
- ------------------------
Research and development expenses consist primarily of compensation and
personnel related expenses and costs for purchased materials, designs and
tooling, depreciation of computers and workstations, and amortization of
computer aided design software, some of which may fluctuate significantly from
period to period as a result of our product development cycles. Research and
development expenses for the three months ended October 31, 2003 and 2002 were
approximately $3.2 million and $2.5 million, respectively. As a percentage of
revenues, research and development expenses for the three months ended October
31, 2003 and 2002 represented 4.6% and 11.4%, respectively. Research and
development expenses for the six months ended October 31, 2003 and 2002 were
approximately $6.8 million and $5.1 million, respectively. As a percentage of
revenues, research and development expenses for the six months ended October
31, 2003 and 2002 represented 5.9% and 13.3%, respectively.
The increase in research and development expenses of approximately $0.7
million, or 27.5%, for the three months ended October 31, 2003 from the similar
period in the prior year resulted primarily from a $0.4 million increase in
expenses related to new product development required to improve our current
product line and support new product introductions and a $0.3 million increase
in salary and payroll-related expenses associated with additional personnel.
Examples of new product development expenses include tape-out and prototype
runs with our wafer manufacturers. The decline in research and development as a
percentage of revenues for the three months ended October 31, 2003 was due to
the proportionately greater increase in revenues from levels in the prior year.
The increase in research and development expenses of approximately $1.7
million, or 31.9%, for the six months ended October 31, 2003 from the similar
period in the prior year resulted primarily from an $0.8 million increase in
salary and payroll-related expenses associated with additional personnel, $0.5
million in expenses related to new product development required to improve our
current product line and support new product introductions and $0.1 million
each in expenses for patent prosecution, engineering supplies and software,
respectively. The decline in research and development as a percentage of
revenues was due to the proportionately greater increase in revenues for the
six months ended October 31, 2003 from levels in the prior year. We anticipate
that our research and development expenses will increase in the remainder of
fiscal 2004 as we develop our next generation of CameraChip products and as we
continue to grow our business, including our research and development team.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses consist primarily of
compensation and personnel related expenses, commissions paid to distributors
and manufacturers' representatives, and insurance and legal expenses. Selling,
general and administrative expenses include some of the expenses associated
with the startup of our Chinese subsidiary. Selling, general and administrative
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
expenses for the three months ended October 31, 2003 and 2002 were
approximately $5.7 million and $2.7 million, respectively. As a percentage of
revenues, selling, general and administrative expenses for the three months
ended October 31, 2003 and 2002 represented 8.3% and 12.5%, respectively.
Selling, general and administrative expenses for the six months ended October
31, 2003 and 2002 were approximately $10.2 million and $4.8 million,
respectively. As a percentage of revenues, selling, general and administrative
expenses for the six months ended October 31, 2003 and 2002 represented 8.8%
and 12.4%, respectively.
The increase in selling, general and administrative expenses of
approximately $3.0 million for the three months ended October 31, 2003 from the
similar period in the prior year resulted primarily from a $1.0 million
increase in commissions associated with increased revenues, a $0.9 million
increase in provisions for bad debts related to the increase in accounts
receivable, a $0.6 million increase in employment expenses and a $0.5 million
increase in legal and accounting expenses. Selling, general and administrative
expenses decreased as a percentage of revenues in the three months ended
October 31, 2003 as compared to the similar period in the prior year as a
result of the proportionately greater increase in revenues. The increase in
selling, general and administrative expenses of approximately $5.4 million for
the six months ended October 31, 2003 from the similar period in the prior year
resulted primarily from a $1.8 million increase in commissions associated with
increased revenues, a $1.4 million increase in salary and payroll-related
expenses, a $1.3 million increase in provisions for bad debts related to the
increase in accounts receivable and a $1.0 million increase in legal and
accounting expenses. Selling, general and administrative expenses decreased as
a percentage of revenues for the six months ended October 31, 2003, as compared
to the similar period in the prior year, as a result of the proportionately
greater increase in revenues. We anticipate that our future selling, general
and administrative expenses will increase in absolute dollars as we continue to
grow our business.
Interest Income, Net
- --------------------
Our cash, cash equivalents and short-term and long-term investments are
invested in interest-bearing accounts consisting primarily of money market
accounts and high-grade corporate securities and government bonds maturing
approximately twelve months or less from the date of purchase. Interest income,
net, increased for the three months ended October 31, 2003 from the similar
period in the prior year to approximately $0.5 million. Interest income, net,
increased for the six months ended October 31, 2003 from the similar period in
the prior year to approximately $0.8 million. Increased interest income, net,
resulted from increased investments in interest-bearing accounts resulting from
approximately $113.2 million in net proceeds from the issuance of common stock
in our follow-on public offering in July 2003 and cash provided by operating
activities.
Provision for Income Taxes
- --------------------------
We generated approximately $17.6 million and $3.5 million in income before
income taxes for the three months ended October 31, 2003 and 2002,
respectively. We recorded provisions for income taxes for the three months
ended October 31, 2003 and 2002 of approximately $6.0 million and $0.5 million,
respectively. We generated approximately $27.1 million and $5.5 million in
income before income taxes for the six months ended October 31, 2003 and 2002,
respectively. We recorded provisions for income taxes for the six months ended
October 31, 2003 and 2002 of approximately $9.2 million and $0.8 million,
respectively. We anticipate the effective tax rate for fiscal 2004 will
increase as compared to fiscal 2003 but will be less than the combined federal
and state statutory rate for fiscal 2004. The increase in tax rate is due to
the anticipated mix of income between domestic and foreign entities for the
fiscal year. Achieving an effective tax rate in fiscal 2004 that is less than
the combined federal and state statutory rates is principally contingent upon
our foreign affiliates generating income.
Liquidity and Capital Resources
- -------------------------------
Principal sources of liquidity at October 31, 2003 consisted of cash, cash
equivalents and short-term investments of $185.3 million.
Our working capital increased by approximately $127.3 million to $208.2
million as of October 31, 2003 from $80.9 million as of April 30, 2003. The
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
increase was primarily attributable to a $123.3 million increase in cash and
cash equivalents principally resulting from our follow-on public offering of
common stock in July 2003, a $20.5 million increase in accounts receivable,
net, consistent with the increase in revenues from prior year levels during the
six months ended October 31, 2003, a $15.7 million increase in inventories to
support future sales, a $1.3 million increase in short-term investments, a $1.1
million increase in restricted cash and a $0.5 million increase in prepaid
expenses and other assets, partially offset by a $27.5 million increase in
accounts payable, a $4.9 million increase in accrued liabilities to support
increased levels of operations and a $1.5 million increase in deferred income.
The $20.5 million increase in accounts receivable, net, reflects the sharply
higher level of sales during the six months ended October 31, 2003 and an
increase in days of sales outstanding to 53 days as of October 31, 2003 from 43
days as of April 30, 2003. The increase in accounts receivable, net, was
partially offset by a $3.0 million increase in the reserve for sales returns,
which rose as a result of the sharp increase in revenues for the six months
ended October 31, 2003, and by a $1.4 million increase in the allowance for
doubtful accounts, which rose as a result of the sharp increase in accounts
receivable balances. The $15.7 million increase in inventories is attributable
to higher inventory levels to support future sales. Inventory turns, calculated
based on the fiscal quarters ended October 31, 2003 and April 30, 2003,
decreased to 5.8 as of October 31, 2003 as compared to 7.2 as of April 30,
2003, in anticipation of increased future revenues.
For the six months ended October 31, 2003, net cash provided by operating
activities totaled approximately $17.2 million as compared to our use of cash
for operating activities of $2.3 million for the similar period in the prior
year, primarily due to net income of approximately $17.9 million for the six
months ended October 31, 2003 as compared to $4.6 million for the similar
period in the prior year, a $27.5 million increase in accounts payable, a $4.9
million increase in accrued expenses and other liabilities, a $1.5 million
increase in deferred income, and a $1.2 million decrease in refundable and
deferred income taxes, which were partially offset by a $20.5 million increase
in accounts receivable, net, a $15.7 million increase in inventories to support
future sales and a $0.5 million increase in prepaid expenses and other assets.
For the remainder of fiscal 2004, we anticipate that our research and
development expenses will increase as we develop our next generation of
CameraChip products and as we continue to grow our business. We also anticipate
that our selling, general and administrative expenses will increase for the
remainder of fiscal 2004 as we continue to grow our business.
For the six months ended October 31, 2003, our cash used in investing
activities increased to approximately $11.0 million from $2.8 million for the
similar prior year period, due to $6.6 million in purchases of property, plant
and equipment, $3.3 million in purchases of short-term and long-term marketable
investments and a $1.1 million increase in restricted cash. Net cash used in
investing activities of $2.8 million for the six months ended October 31, 2002,
resulted from purchases of property, plant and equipment. The $6.6 million
increase in property, plant and equipment was due to the additional investment
in buildings, building improvements and machinery and equipment to support the
expanding operations of our Chinese subsidiary.
For the six months ended October 31, 2003, net cash provided by financing
activities increased to approximately $117.2 million from $0.7 million for the
similar period in the prior year. The increase was primarily due to
approximately $113.2 million in net proceeds resulting from our follow-on
public offering of common stock in July 2003 and $4.0 million in proceeds from
the issuance and sale of common stock pursuant to the exercise of stock options
and from employee purchases through the employee stock purchase plan during the
six months ended October 31, 2003 as compared to $1.3 million for the similar
period in the prior year. Proceeds from the issuance and sale of common stock
for the six months ended October 31, 2002 were partially offset by $0.6 million
in refunded deposits related to investments from third parties in our Chinese
subsidiary, HuaWei Semiconductor.
In June 2003, we purchased approximately 27% of the equity of a privately
held company based in Taiwan for a total of $2.0 million in cash. The Taiwan
company provides plastic packaging services, and we will be a major customer.
We have accounted for this investment using the equity method. In November
2003, we increased our investment in this privately held company by an
additional $0.8 million to maintain our equity ownership percentage in this
company.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Contractual Obligations and Commercial Commitments
- --------------------------------------------------
The following summarizes our contractual obligations and commercial
commitments as of October 31, 2003 and the effect such obligations and
commitments are expected to have on our liquidity and cash flows in future
periods (in thousands):
Less than 1-3 4-5 After
Total 1 Year Years Years 5 Years
----- ------ ------ ------ -------
Contractual Obligations
- -----------------------
Operating leases................ $ 4,640 $ 1,275 $ 2,281 $ 839 $ 245
Noncancelable orders............ 40,900 40,900 -- -- --
------- ------- ------- ------- -------
Total contractual obligations. 45,540 42,175 2,281 839 245
------- ------- ------- ------- -------
Other Commercial Commitments
- ----------------------------
Investment in China............. 16,000 700 15,300 -- --
Joint Venture with TSMC......... 4,500 1 1,000 3,500 -- --
------- ------- ------- ------- -------
Total commercial commitments.. 20,500 1,700 18,800 -- --
------- ------- ------- ------- -------
Total contractual obligations
and commercial commitments.. $66,040 $43,875 $21,081 $ 839 $ 245
======= ======= ======= ======= =======
- -------------------------
1 Pursuant to the Shareholders' Agreement with TSMC, our share of the
capital commitment to VisEra is $23.5 million, which becomes due in
stages as VisEra's business and service capabilities develop over a
number of years. Our net cash investment to the joint venture will
approximate $4.5 million. We will also contribute approximately $19.0
million of assets to the joint venture, including technology, plant
and equipment currently owned by us or to be purchased with funds for
existing commercial commitments. Our cash and asset contributions
will be made in three phases. In the first phase, we shall contribute
$1.5 million in cash to VisEra and a non-exclusive license to certain
of our manufacturing and automated final testing technologies and
patents. In the second phase, we shall contribute $9.5 million in cash
to VisEra and a non-exclusive license to certain of our manufacturing
and automated final testing technologies and patents.
In the third phase, we shall contribute $12.5 million in cash and
assets to VisEra and receive back from VisEra an aggregate cash payment
of $17.5 million.
The $16.0 million cash payment referenced in the table above relates to
the remaining $16.0 million of registered capital for our Chinese subsidiary.
We established this subsidiary as part of our efforts to increase capacity and
reduce costs for testing our CameraChips.
In October 2003, we entered into a Shareholders' Agreement with TSMC
pursuant to which we agreed with TSMC to form VisEra, a joint venture in
Taiwan, for the purposes of providing manufacturing services and automated
final testing services. We have committed with TSMC and certain employees and
affiliates of VisEra to provide an aggregate of $50.0 million in total capital
to VisEra, which commitments may be made in the form of cash or asset
contributions. Our company and TSMC will have equal interests in VisEra. Our
share of this capital commitment to VisEra is $23.5 million and becomes due in
stages as VisEra's business and service capabilities develop over a number of
years. Our net cash commitment to VisEra is approximately $4.5 million. We will
also contribute approximately $19.0 million of assets to the joint venture,
including technology, plant and equipment currently owned by us or to be
purchased with funds for existing commercial commitments. The $4.5 million
commercial commitment referenced in the table above refers to the remaining
$4.5 million of net cash capital contributions to VisEra.
We expect to fund the capital commitment to our Chinese subsidiary and to
our joint venture with TSMC through a combination of funds from our available
working capital, investments from third parties, or equity or debt financing.
Third party financing may not be available to us when and as required or on
terms that are favorable to our stockholders and us. In addition, Chinese law
may limit the sources that may be eligible to invest in our Chinese subsidiary.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
In the event we are unable to obtain financing from third parties, the issuance
of our equity securities, including securities convertible into our equity
securities, would dilute the ownership interests of our existing stockholders,
and the issuance of debt securities could increase the risk or the perceived
risk of our business. Issuance of debt securities could also impair our
financial condition, and interest payments could have an adverse effect on our
results of operation.
We currently expect our available cash, cash equivalents, and short-term
investments, together with cash that we anticipate to be generated from
business operations, to be sufficient to satisfy our working capital
requirements for the next twelve months. Our ability to generate cash from
operations is subject to substantial risks described below under the caption
"Factors Affecting Future Results." We encourage you to review these risks
carefully. If we are unable to generate sufficient cash from our operations, it
would have a material adverse effect on our business and financial condition.
Factors Affecting Future Results
- --------------------------------
This Quarterly Report on Form 10-Q, including this Management's Discussion
and Analysis, contains forward-looking statements. These forward-looking
statements are subject to substantial risks and uncertainties that could cause
our future business, financial condition or results of operations to differ
materially from our historical results or currently anticipated results,
including those set forth below.
Risks Related to Our Business
-----------------------------
We face intense competition in our markets from more established CCD and
------------------------------------------------------------------------
CMOS image sensor manufacturers, and if we are unable to compete
----------------------------------------------------------------
successfully we may not be able to maintain or grow our business.
----------------------------------------------------------------
The image sensor market is intensely competitive and we expect
competition in this industry to continue to increase. This competition has
resulted in rapid technological change, evolving standards, reductions in
product sales prices and rapid product obsolescence. If we are unable to
successfully meet these competitive challenges, we may be unable to maintain
and grow our business. Any failure to compete successfully would also adversely
affect our results of operation and impair our financial condition.
Our CameraChips face competition from a number of sources, including
companies that sell CCD image sensors, as well as other companies that sell
CMOS image sensors. Many of our competitors have longer operating histories,
greater presence in key markets, greater name recognition, larger customer
bases, more established strategic and financial relationships and significantly
greater financial, sales and marketing, manufacturing, distribution, technical
and other resources than we do. As a result, they may be able to adapt more
quickly to new or emerging technologies and customer requirements or devote
greater resources to the promotion and sale of their products. Our competitors
include CCD image sensor manufacturers such as Fuji, Matsushita, NEC, Sharp,
Sony, Sanyo and Toshiba, as well as established CMOS image sensor manufacturers
such as Agilent, ESS, Fujitsu, Hynix, Micron, Mitsubishi Electronic, Motorola,
National Semiconductor, Samsung, Sharp, Sony, STMicroelectronics and Toshiba.
In addition, we compete with a large number of smaller CMOS manufacturers
including Foveon, IC Media Corporation, PixArt and Zoran.
Our competitors may acquire or enter into strategic or commercial
agreements or arrangements with foundries or providers of color filter
processing, assembly or packaging services. These strategic arrangements
between our competitors and third party service providers could involve
preferential or exclusive arrangements for our competitors. As a result, these
strategic alliances could impair our ability to secure sufficient capacity from
foundries and service providers to meet our demand for wafer manufacturing,
color filter processing, assembly or packaging services, adversely affecting
our ability to meet customer demand for our products. In addition, competitors
may enter into exclusive relationships with distributors, which could reduce
available distribution channels for our products and impair our ability to sell
our products and grow our business.
In addition, some of our customers may also be developers of image
sensors, and this could potentially adversely affect our results of operations,
business and prospects. Samsung, for example, is a current customer that uses
our CMOS products in certain of its products, but also independently
manufactures CMOS image sensors. A customer such as Samsung that develops its
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
own image sensors may reduce or cease purchases from us, and this could
materially and adversely affect our ability to sustain and grow our business
and could impair our financial results. Samsung is also a third party service
provider that has fabricated, and may in the future fabricate, our interface
chips or other products. If Samsung were to decide not to fabricate our
interface chips for competitive or other reasons, that could impair our ability
to meet customer demand for our products.
Problems with wafer manufacturing yields could result in higher operating
-------------------------------------------------------------------------
costs and could impair our ability to meet customer demand for our products.
---------------------------------------------------------------------------
If the foundries manufacturing the wafers used in our products cannot
achieve expected yields, we may incur higher per unit costs and reduced product
availability. Any reduction in our ability to timely deliver products to
customers could adversely affect our customer relations and make it more
difficult to sustain and grow our business. Foundries that supply our wafers
have experienced problems in the past achieving acceptable wafer manufacturing
yields. Wafer yields are a function of both our design technology and the
particular foundry's manufacturing process technology. Low yields may result
from design errors or manufacturing failures in new or existing products. We
perform a final test of our products after they are assembled, as their optical
nature makes earlier testing difficult and expensive. As a result, yield
problems may not be identified until our products are well into the production
process. The risks associated with low yields are exacerbated because we rely
on third party offshore foundries for our wafers, which increases the effort
and time required to identify, communicate and resolve manufacturing yield
problems.
We depend on the increased acceptance of CMOS technology for mass market
------------------------------------------------------------------------
image sensor applications, and any delay in the acceptance of this
------------------------------------------------------------------
technology could adversely affect our ability to grow our business and
----------------------------------------------------------------------
increase our revenues.
---------------------
Our business strategy depends in large part on the continued growth of
various markets into which we sell our CameraChips, including the markets for
digital still and video cameras, cell phones, personal computers, toys and
games, including interactive video games, and commercial and home security and
surveillance applications. Our ability to sustain and grow our business also
depends on the emergence of new markets for our products such as cameras for
automotive applications, personal identification systems and medical imaging
devices. If these current and new markets do not grow and develop as
anticipated, we may be unable to sustain or grow the sales of our products.
Although CMOS technology has been available for over 20 years, CMOS
technology has been used in image sensors only relatively recently. Along with
the other risk factors described in this section, the following are examples of
factors that may delay the increasing adoption of the CMOS fabrication process
and our single chip technology for mass market image sensor applications:
o the failure of the emergence of a universal platform for imaging solutions
for computers and the Internet;
o improvements in or price reductions for CCD image sensors, which could
slow the adoption of CMOS image sensors in markets already dominated by
CCD image sensors or prevent or delay the adoption of CMOS image sensors
in emerging markets; and
o the failure to develop easy to use and affordable products using CMOS
image sensors.
The occurrence of any of these factors could adversely affect our ability
to sustain and grow our business and increase our revenues and earnings.
In addition, the market price of our common stock may be adversely
affected if certain of these new markets do not emerge or develop as expected,
such as the markets for image sensor products in automobiles and personal
identification systems. Securities analysts may have already factored revenue
from such new markets into their future estimates of our financial performance
and any failure for such markets to develop as expected by such security
analysts may adversely affect the trading price of our common stock.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
If we do not forecast customer demand correctly, our business could be
----------------------------------------------------------------------
impaired as a result of excess inventory or the loss of existing or
-------------------------------------------------------------------
potential customers.
-------------------
Our sales are generally made on the basis of purchase orders rather than
long-term purchase commitments, and we manufacture products and build inventory
based on our estimates of customer demand. Accordingly, we must rely on
multiple assumptions concerning forecasted customer demand. In addition, our
customers may cancel or defer orders at any time. If we overestimate customer
demand, we may manufacture products that we may be unable to sell, or we may
have to sell our products to other customers at lower prices. This could
materially and adversely affect our results of operation and financial
condition. We have experienced problems with accurately forecasting customer
demand in the past. For example, beginning in the third quarter of fiscal 2001,
the demand for our CameraChips for use in PC cameras decreased significantly
and one of our significant OEM customers unexpectedly cancelled its purchase
orders. If we underestimate customer demand, we may be unable to manufacture
sufficient product quickly enough to meet actual demand, causing us to lose
customers and impairing our ability to grow our business. In recent periods,
due to customer demand we have had relatively low levels of inventory, and we
have turned over our inventory several times per year. Low levels of inventory
could materially impair our ability to meet customer demand for our CameraChip
products. As we build our inventory levels, this subjects us to the product
obsolescence risks described above.
Sales of our CameraChips for digital still cameras have accounted for a
-----------------------------------------------------------------------
significant portion of our revenues on both a quarterly and annual basis,
-------------------------------------------------------------------------
and any decline in sales to the digital still market or failure for this
------------------------------------------------------------------------
market to continue to grow as we expect could adversely affect our results
--------------------------------------------------------------------------
of operations.
-------------
We derive a substantial portion of our revenues from sales to the digital
still camera market. Although we can only estimate the percentages of our
products that are used in the digital still camera market due to the
significant amount of our CameraChips that are sold through distributors and
value added resellers, we believe that the digital still camera market
accounted for approximately 42% of our revenue in fiscal 2003 and 44% of our
revenue in the three months ended October 31, 2003. We expect that revenues
from sales of our CameraChips to the digital still camera market will continue
to account for a substantial portion of our revenues during fiscal 2004 and for
each of our fiscal quarters during such year. Sales of our CameraChips for the
digital still camera market are subject to seasonal fluctuations. Any factors
adversely affecting the demand for our CameraChips in the digital still camera
market could cause our business to suffer and adversely affect our results of
operations. The digital image sensor market for digital still cameras is
extremely competitive, and we expect to face increased competition in this
market in the future. If we fail to continue to receive design wins with key
digital still camera manufacturers, our market share or revenues could
decrease. In addition, digital still camera manufacturers typically purchase
digital image sensors through distributors, and we do not have contracts with
any distributor that obligate them to sell our products. Such distributors may
also sell products of our competitors. We may not be able to successfully
increase or maintain the rate of sales of our CameraChip products for digital
still cameras through distributors in the future. The image sensor market for
digital still cameras is also subject to frequent technology change. In order
to compete successfully in such market, we will have to correctly forecast
customer demand for technological improvements and be able to deliver such
products on a timely basis at competitive costs. If we fail to do this, our
results of operation, business and prospects would be materially adversely
affected. In the past, we have experienced problems accurately forecasting
customer demand in other markets. For example, beginning in the third quarter
of fiscal 2001, the demand for our CameraChips for use in PC cameras decreased
significantly and one of our significant OEM customers unexpectedly cancelled
its purchase orders. If customer demand in the digital still camera market were
to fall suddenly due to oversupply of product or for any other reason, we will
be subject to excess inventory risks.
We depend on a limited number of third party wafer foundries, which reduces
---------------------------------------------------------------------------
our ability to control our manufacturing process.
------------------------------------------------
We do not own or operate a semiconductor fabrication facility. Instead, we
primarily rely on TSMC, Powerchip Semiconductor Company, or PSC, and other
subcontract foundries to produce substantially all of our wafers. Samsung has
fabricated and may in the future fabricate one of our interface chips on its
standard fabrication line. Historically, we have relied upon TSMC to provide us
with a substantial majority of our wafers, but we have never entered into a
long-term supply agreement with TSMC and instead have traditionally secured
manufacturing availability on a purchase order basis. As a part of the
Shareholders' Agreement for the formation of the TSMC and OmniVision joint
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
venture, VisEra, TSMC has agreed to commit substantial wafer manufacturing
capacity to us for a period of time in exchange for our commitment over this
time period to purchase a substantial portion of our wafers from TSMC, subject
to pricing and technology requirements. We do not have long-term supply
agreements with any other foundries and instead secure manufacturing
availability on a purchase order basis. These other foundries have no
obligation to supply products to us for any specific period, in any specific
quantity or at any specific price, except as set forth in a particular purchase
order. In general, our reliance on third party foundries involves a number of
significant risks, including:
o reduced control over delivery schedules, quality assurance, manufacturing
yields and production costs;
o lack of guaranteed production capacity or product supply;
o unavailability of, or delayed access to, next generation or key process
technologies; and
o financial difficulties or disruptions in the operations of third party
foundries due to causes beyond our control.
If TSMC or any of our other foundries were to become unable to continue
manufacturing our wafers in the required volumes, at acceptable quality, yields
and costs, and in a timely manner, we would have to identify and qualify
substitute foundries, which would be time consuming and difficult, and could
increase our costs or result in unforeseen manufacturing and operations
problems. In addition, if competition for foundry capacity increases we may be
required to pay increased amounts for manufacturing services. We are also
exposed to additional risks if we transfer our production of semiconductors
from one foundry to another as such transfer could interrupt our manufacturing
process. Further, some of our foundries, such as Samsung, are also developers
of image sensor products. If Samsung or one of our other foundries were to
decide not to fabricate our interface chips for competitive or other reasons,
we would have to identify and qualify additional foundries.
We rely on third party service providers for color filter application and
-------------------------------------------------------------------------
packaging services, which reduces our control over delivery schedules,
----------------------------------------------------------------------
product quality and cost, and could adversely affect our ability to deliver
---------------------------------------------------------------------------
products to customers.
---------------------
We rely on TSMC and Toppan for the color filter processing of our
completed wafers. In addition, we rely on Kyocera and Sun Yang Digital Image,
or SYDI, for substantially all of our ceramic chip packages, which are
generally used in our higher-priced products, another service provider for our
plastic chip packages, which are generally used in our lower-priced products,
and yet another service provider for chip scale packages, which are generally
used in our products designed for the smallest form factor applications. We do
not have long-term agreements with any of these service providers and typically
obtain services on a purchase order basis. If for any reason one or more of
these service providers becomes unable or unwilling to continue to provide
color filter processing or packaging services of acceptable quality, at
acceptable costs and in a timely manner, our ability to deliver our products to
our customers could be severely impaired. We would quickly have to identify and
qualify substitute service providers, which could be time consuming and
difficult and could result in unforeseen operational problems. Substitute
service providers might not be available or, if available, might be unwilling
or unable to offer services on acceptable terms.
In addition, if competition for color filter processing or packaging
capacity increases, we may be required to pay or invest significant amounts to
secure access to these services, which could adversely impact our operating
results. There are a limited number of companies that provide these services,
some of which have limited operating histories and financial resources. In the
event our current providers refuse or are unable to continue to provide these
services to us, we may be unable to procure services from alternate service
providers. Furthermore, if customer demand for our products increases, we may
be unable to secure sufficient additional capacity from our current service
providers on commercially reasonable terms, if at all. Moreover, our reliance
on a limited number of third party service providers to provide color filter
processing services subjects us to reduced control over delivery schedules,
quality assurance and costs. This lack of control may cause us to incur
unforeseen product shortages or may increase our costs of manufacturing,
assembling or testing our products, which would adversely affect our operating
results.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Historically, our revenues have been dependent upon a few key customers, the
----------------------------------------------------------------------------
loss of one or more of which could significantly reduce our revenues.
--------------------------------------------------------------------
Historically, a relatively small number of original equipment
manufacturers, or OEMs, value added resellers, or VARs, and distributors have
accounted for a significant portion of our revenues. Any material delay,
cancellation or reduction of purchase orders from one of our major customers or
distributors could result in our failure to achieve anticipated revenue for the
period. If we are unable to retain one or more of our largest OEM, distributor
or VAR customers, or if we are unable to maintain our current level of revenues
from one or more of these significant customers, our business and results of
operation would be impaired and our stock price could decrease, potentially
significantly. In fiscal 2003, our only OEM or VAR customer that accounted for
more than 10% of our revenues was Primax Electronics Products Huizhou based in
China, which accou