10. Related Party Transactions
During the third quarter of fiscal 2004 and the second quarter of fiscal
2005, the Company invested approximately $1.0 million and $1.0 million,
respectively, in an original equipment manufacturer (the "OEM")
headquartered in Europe. The Company's ownership interest in the OEM was less
than 7% for the quarter ended October 31, 2003 and less than 10% for the quarter
ended October 31, 2004 and is accounted for using the cost method. The Company
had revenue from product sales to this OEM of $2.0 million in the third quarter
of fiscal 2005 and $0.4 million in the same period of fiscal 2004. The Company
had revenue from product sales to this OEM of $4.5 million in the first nine
months of fiscal 2005 and $0.6 million in the same period of fiscal 2004. In
June 2004, the Company accepted a one-time return of certain chipset products
from this OEM in exchange for similar products with an aggregate sales price of
$262,000. The Company had accounts receivable of $2.6 million and $0.3 million
from this OEM at October 31, 2004 and 2003, respectively. One of the Company's
customers is a contract manufacturer that manufactures video equipment for this
OEM. During the third quarter of fiscal 2005, the Company had no revenues from
product sales to this manufacturer and the Company had $24,000 in such revenues for the third quarter of fiscal
2004. Revenues from product sales to this manufacturer totaled $0.3 million
and $1.4 million for the first nine months of fiscal 2005 and 2004,
respectively. The Company had no accounts receivable at October 31, 2004 from
this manufacturer and $500,000 at October 31, 2003. A portion of the Company's
products sold to the contract manufacturer were installed as components in the
video equipment manufactured by the contract manufacturer on behalf of the
OEM.
During the third quarter of fiscal 2003, the Company executed an
agreement to sublease approximately 2,600 square feet of its headquarters'
facility to a start-up company founded by a member of the Company's board of
directors. The term of the sublease is one year at the same market rate as the
Company's operating lease arrangement for the facility. The agreement was
amended during the fourth quarter of fiscal 2004 for an additional year on the
same terms.
11. Product Warranty
In general, the Company sells products with a one-year limited warranty that the
Company's products will be free from defects in materials and workmanship.
Warranty cost is estimated at the time revenue is recognized, based on
historical activity. Accrued warranty cost includes both hardware and software
support costs.
Details of the change in accrued warranty for the three and nine months ended
October 31, 2004 and 2003 are as follows (in thousands):
12. Contingencies
The Company's standard terms and conditions of sale include a patent
infringement indemnification provision for claims from third parties related to
the Company's intellectual property. The terms and conditions of sale generally
limit the scope of the available remedies to a variety of industry-standard
methods, including but not limited to a right to control the defense or
settlement of any claim, procure the right for continued usage, and a right to
replace or modify the infringing products to make them non-infringing. Such
indemnification provisions are accounted for in accordance with SFAS No. 5,
"Accounting for Contingencies." To date, the Company has not incurred
any costs related to any claims under such indemnification provisions.
13. Recently Issued Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board
("FASB") issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," and in
December 2003 issued a revised interpretation of FIN 46 ("FIN 46-R").
FIN 46 requires certain variable interest entities ("VIEs")
to be consolidated by the primary 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 provisions of FIN 46 are effective immediately for all
arrangements entered into after January 31, 2003. The Company has not
invested in any entities it believes are variable interest entities for which it
is the primary beneficiary. The adoption of FIN 46-R had no impact on the
financial position, results of operations or cash flows of the Company.
In May 2003, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," which
requires that certain financial instruments be presented as liabilities, and for
which the financial instruments were previously properly presented as equity or
as temporary equity. Such instruments include mandatory redeemable preferred and
common stock, and certain options and warrants. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003 and
was effective at the beginning of the first interim period beginning after
June 15, 2003. In November 2003, the FASB issued FASB Staff Position
("FSP") No. 150-3, "Effective Date, Disclosures, and
Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic
Entities and Certain Mandatorily Redeemable Noncontrolling Interests under SFAS
No. 150," which defers the effective date for various provisions of
SFAS No. 150. The Company believes that it has properly classified and
measured in its balance sheets and disclosed in its interim consolidated
financial statements certain financial instruments with characteristics of both
liabilities and equity.
In March 2004, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 03-01 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
EITF No. 03-01 provides guidance on recording
other-than-temporary impairments of cost method investments and disclosures
about unrealized losses on available-for-sale debt and equity securities
accounted for under the FASB Statements No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The guidance for evaluating
whether an investment is other-than-temporarily impaired should be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. The additional disclosures for cost method investments are
effective for fiscal years ending after June 15, 2004. For investments accounted
for under SFAS No. 115, the disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003. The adoption of this
rule did not have a material impact on the financial position, results of
operations or cash flows of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion in conjunction with our condensed
consolidated financial statements and related notes. Except for historical
information, the following discussion contains forward-looking statements within
the meaning of Section 27A of the Securities Exchange Act of 1933 and Section
21E of the Securities Exchange Act of 1934. These forward-looking statements,
which include, among other things, statements regarding our capital resources
and needs (including the adequacy of our current cash reserves
and access to our lines of credit) and statements
regarding our anticipated revenues from sales of our board,
chipset and other products in general and more particularly to customers in the internet protocol (IP) video application market,
advanced DVD/media player market, high definition television (HDTV) market and
personal computer (PC) add-in and other markets; gross
margins; sales and marketing expenses; research and
development expenses and general and administrative expenses,
and statements involving our expected future receipt of incentive payments,
involve risks and uncertainties.
Our actual results may differ significantly from those projected
in the forward-looking statements. Factors that might cause future results to
differ materially from those discussed in the forward-looking statements
include, but are not limited to, those discussed in "Certain Factors
Affecting Business, Operating Results, and Financial Condition" in this
document as well as other information found in the documents we file from time
to time with the Securities and Exchange Commission, including our Form 10-K for
the year ended January 31, 2004 and our subsequent reports on Form 10-Q.
RESULTS OF OPERATIONS
Overview. We reported net income of $525,000, or $0.03 per basic
share and $0.02 per diluted share on net revenues of $7,677,000 for the quarter
ended October 31, 2004, compared to net income of $149,000, or $0.01 per basic
and diluted share on net revenues of $7,470,000 for the same quarter in the
prior year. For the nine months ended October 31, 2004, we reported net income
of $1,857,000, or $0.09 per basic share
and $.08 per diluted share on net revenues
of $23,549,000, compared to net income of $1,246,000, or $0.07 per basic share
and $0.06 per diluted share on net revenues of $23,179,000 for the same period
in the prior year.
Our primary product groups include boards, chipsets and other. Our
board products consist primarily of a series of PC based solutions using the
NetStream and Xcard brand names, as well as certain customized development
boards that are sold into the Internet Protocol (IP) video application market,
advanced DVD/media player market and PC add-in market. Our chipset products
consist primarily of video and audio decoding chips under the names of EM8400
series, EM8500 series, EM8610 series and EM8620 series for the IP video
application market, advanced DVD/media player market as well as the PC add-in
market. Products in the "other product" group consist primarily of
development kits, engineering support services, and engineering development for
customization of chipsets.
Our primary market segments are the IP video application market, advanced
DVD/media player market, PC add-in and other markets, and HDTV product market.
The IP video application market consists primarily of a range of consumer and
commercial products that perform the distribution and receiving of streaming
video using IP. The advanced DVD/media player market consists primarily of a
range of set-top and portable products that perform playback of local digital
media stored on optical or hard disk formats. The
PC add-in and other markets consist primarily of a range of decoding solutions
for PC-based DVD playback and streaming video. The HDTV product market consists
primarily of a range of digital television sets offering high definition
capability.
Net Revenues. Net revenues for the third quarter and the first nine
months of fiscal 2005 increased 3% and 2%, respectively, as compared to the same
periods last year. The increase in net revenues for the third quarter of fiscal
2005 was primarily attributable to the increased engineering development
revenues partially offset by decreased revenues from our board and chipset
products. The increase in net revenue for the first nine months of fiscal 2005
was primarily attributable to the increased engineering development revenues as
well as increased revenues from board products, partially offset by decreased
revenues from our chipset products.
During the third quarter of fiscal 2004 and the second quarter of fiscal 2005,
we invested approximately $1.0 million and $1.0 million, respectively, in an
original equipment manufacturer (the "OEM") headquartered in Europe.
Our ownership interest in the OEM was less than 7% for the quarter ended October
31, 2003 and less than 10% for the quarter ended October 31, 2004 and is
accounted for using the cost method. We had revenue from product sales to this
OEM of $2.0 million in the third quarter of fiscal 2005 and $0.4 million in the
same period of fiscal 2004. We had revenue from product sales to this OEM of
$4.5 million in the first nine months of fiscal 2005 and $0.6 million in the
same period of fiscal 2004. In June 2004, we accepted a one-time return of
certain chipset products from this OEM in exchange for similar products with an
aggregate sales price of $262,000. We had accounts receivable of $2.6 million
and $0.3 million from this OEM at October 31, 2004 and 2003, respectively. One
of our customers is a contract manufacturer that manufactures video equipment
for this OEM. There were no revenues from product
sales to this manufacturer during the third quarter of fiscal 2005
and the Company had $24,000 in such revenues for the third quarter of fiscal 2004.
Revenues from product sales to this manufacturer totaled $0.3 million, and $1.4
million for the first nine months of fiscal 2005 and 2004, respectively. We had
no accounts receivable from this manufacturer at October 31, 2004 and $500,000
at October 31, 2003. A portion of our products sold to the contract
manufacturer were installed as components in the video equipment manufactured by
the contract manufacturer on behalf of the OEM.
The following table sets forth our net revenues in each product group (in
thousands):
|
|
Three months ended
October 31,
|
|
Nine months ended
October 31,
|
|
|
2004
|
|
2003
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
Boards |
$ 650 |
|
$ 860 |
|
$ 2,764 |
|
$ 2,341 |
|
Chipsets |
6,175 |
|
6,337 |
|
19,268 |
|
19,683 |
|
Other |
852
|
|
273
|
|
1,517
|
|
1,155
|
|
|
|
|
|
|
|
|
|
|
Total net revenues |
$ 7,677
|
|
$ 7,470
|
|
$ 23,549
|
|
$ 23,179
|
Sales of MPEG board products for the third quarter of fiscal 2005 decreased 24%
to $650,000 as compared to $860,000 for the corresponding period in the prior
year. MPEG-based board
product net revenues for the first nine months of fiscal 2005 increased 18% to
$2,764,000, as compared to $2,341,000 for the corresponding period in the prior
year. Sales from MPEG chipset products for the third quarter of fiscal 2005
decreased 3% to $6,175,000, as compared to $6,337,000 for the same period last
year. MPEG chipset net revenues for the first nine months of fiscal 2005
decreased 2% to $19,268,000, as compared to $19,683,000 for the same period last
year. Sales of other products for the third quarter of fiscal 2005 increased
212% to $852,000 as compared to $273,000 for the corresponding period in the
prior year. Other net revenues for the first nine months of fiscal 2005
increased 31% to $1,517,000, as compared to $1,155,000 for the same period last
year. Sales of MPEG-based boards and chipsets together
represented 89% and 96% of net revenues for the quarters ended October 31, 2004
and 2003, respectively. Other products represented 11% and 4% of net revenues
for the quarters ended October 31, 2004 and 2003, respectively. For the nine
months ended October 31, 2004, MPEG-based boards and chipsets represented 94% of net
revenues, and other products represented 6% of net revenues. For the nine months
ended October 31, 2003, MPEG-based boards and
chipsets represented 95% of net revenues, and other products represented 5% of
net revenues.
The decrease in net revenues from MPEG-based board products for the quarter
ended October 31, 2004 compared to the same period
last year is mainly attributable to decreased unit sales of project-based board
products for IP video applications. The increase in net revenues from
MPEG-based board products for the first nine months compared to the same period last
year is mainly attributable to increased unit sales of project-based board
products for IP video applications. We expect our revenues from board products
to be relatively flat or decrease in future periods due to our decision to focus
on the chipset products in the IP video application market and advanced
DVD/media player market. The decrease in net revenues from MPEG-based chipsets
for the three months and nine months ended October 31, 2004 compared to the same
quarter last year is largely due to decreased units sales, and the lower average
selling prices of our chipsets into the advanced DVD player market, partially
offset by the increased sales of our new Window Media Video (WMV9) chipset products to the IP video
application market.
We expect that net revenues from chipset products will
continue to fluctuate, primarily due to the changes in demand from our customers
in the advanced DVD/media player market which remains in an emerging phase.
If, however, these declines in unit sales and average selling prices for our chipset products were to continue, it would likely harm our revenues and profitability.
The "Other" category primarily includes revenue from Netstream consoles
for the IP video application market, development kits, set-top box products and
accessories, engineering support services for both hardware and software,
engineering development for customization of chipsets, and freight fees. The
increase in net revenues from other products for
the quarter and nine months ended October 31, 2004, compared to the same periods
last year are primarily attributable to the increase in engineering development
projects. Development fees totaled approximately $698,000 and $801,000 for the
three months and nine months ended October 31, 2004, respectively, as compared
to $153,000 and $699,000, respectively, for the same periods last year. We
expect that net revenues from other products will continue to fluctuate mainly
due to the timing and complexity of engineering development required by our
customers.
The following table sets forth our net revenues by market segment (in
thousands):
|
|
Three months ended
October 31,
|
|
Nine months ended
October 31,
|
|
|
2004
|
|
2003
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
IP video application market |
$ 3,740 |
|
$ 3,928 |
|
$ 12,948 |
|
$ 10,641 |
|
Advanced DVD/media player market |
2,664 |
|
2,869 |
|
8,187 |
|
9,424 |
|
HDTV product market |
249 |
|
7 |
|
309 |
|
30 |
|
PC add-in and other markets |
1,024
|
|
666
|
|
2,105
|
|
3,084
|
|
|
|
|
|
|
|
|
|
|
Total net revenues |
$ 7,677
|
|
$ 7,470
|
|
$ 23,549
|
|
$ 23,179
|
For the three months ended October 31, 2004, revenues from sales
of our products to the IP video application market decreased 5% to $3,740,000,
from $3,928,000 for the same quarter of last year. Revenues from sales of our
products to the advanced DVD/media player market decreased 7% to $2,664,000,
from $2,869,000 for the same quarter of last year. Revenues from sales to the PC
add-in and other markets increased 54% to $1,024,000 from $666,000 for the same
quarter of last year. For the nine months ended October 31, 2004, revenues from
sales of our products to the IP video application market increased 22% to
$12,948,000, from $10,641,000 for the same period of last year. During that same
period, revenues from sales of our products to the advanced DVD/media player
market decreased 13% to $8,187,000, from $9,424,000 for the same period last
year, and revenues from sales to the PC add-in and other markets decreased 32%
to $2,105,000 from $3,084,000 for the same period last year.
The decrease in revenues from sales of our products to the IP video
application market in the third quarter of fiscal 2005 as compared to the same
period of fiscal 2004 is mainly attributable to lower unit sales of our
project-based board products. The increased in revenues for the nine months ended
October 31, 2004 as compared to the same period of last year is mainly
attributable to increased unit sales due to the increase in internet protocol
television (IPTV) and digital media adapter (DMA) deployment. We expect our
revenues from the IP video application market to fluctuate in future periods due
to the uneven pace of IPTV service deployments.
The decrease in revenues from sales of our products to the advanced DVD/media
player market for the quarter and nine months ended October 31, 2004 as compared
to the same periods of fiscal 2004 is attributable to decreased unit sales and
lower selling price of our MPEG chipsets to advanced DVD player manufacturers, partially
offset by increased revenues from sales of our new Window Media Video (WMV9)
chipsets. We expect revenues from sales of our products to the advanced
DVD/media player market will continue to fluctuate, primarily due to changes in
demand from our customers.
If, however, these declines in unit sales and average selling prices for our products being sold
into the advanced DVD/media player market were to continue, it could harm our revenues and profitability.
We began the shipment of HDTV applications during
the second quarter of fiscal 2004, and expect revenues in the HDTV product
market to increase slowly over the near term. The category "PC add-in and
other markets" in the above table consists of PC add-in board and chipset
products, engineering support services for both hardware and software,
engineering development for customization of chipsets, and freight fees. The
increases in revenues from sales of our products to the PC add-in and other
markets in the third quarter of fiscal 2005 as compared to the same period of
fiscal 2004 is due the increase in engineering development projects, partially offset by
decreased unit sales of our chipsets to the PC add-in market. The decreased
revenues for the nine months ended October 31, 2004 as compared to the same
period of fiscal 2005 is due to the decreased unit sales of our chipsets to the
PC add-in market, partially offset by increased revenues in engineering development
projects. We expect our revenues from sales to the PC add-in markets to continue to be
small due to the generally declining demand and our revenues from engineering development
to fluctuate in future periods due to the timing and complexity of the projects
required by our customers.
The following table sets forth our net revenues by geographic region (in
thousands):
|
|
Three months ended
October 31,
|
|
Nine months ended
October 31,
|
|
|
2004
|
|
2003
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
North America |
$ 1,312 |
|
$ 1,194 |
|
$ 3,523 |
|
$ 3,373 |
|
Asia & other regions |
3,709 |
|
5,537 |
|
13,945 |
|
15,575 |
|
Europe |
2,656
|
|
739
|
|
6,081
|
|
4,231
|
|
|
|
|
|
|
|
|
|
|
Total net revenues |
$ 7,677
|
|
$ 7,470
|
|
$ 23,549
|
|
$ 23,179
|
Revenues from North America represented 17% of net revenues for the quarter and
15% for the nine months ended October 31, 2004, respectively, as compared with
16% and 15% in the comparable periods of the prior year. Our international sales
represented 83% of net revenues for the quarter and 85% for the nine months
ended October 31, 2004, respectively, as compared with 84% and 85% in the
comparable periods of the prior year.
North America revenues increased 10% to $1,312,000 for the three months ended
October 31, 2004 compared to $1,194,000 for the three months ended October 31,
2003, and increased 4% to $3,523,000 for the nine months ended October 31, 2004
compared to $3,373,000 for the nine months ended October 31, 2003. The increase
for the three months and nine months ended October 31, 2004 is largely due to
increased engineering development fees and increased unit sales of chipset
products in the IP video application markets, partially offset by lower unit
sales of our board products into the IP video application market, lower unit
sales of our chipset products and board products into the PC add-in market.
Total revenues from Asia for the three months ended October 31, 2004 decreased
33% to $3,709,000 from $5,537,000 for the three months ended October 31, 2003,
and decreased 10% to $13,945,000 for the nine months ended October 31, 2004
compared to $15,575,000 for the nine months ended October 31, 2003. The decrease
from revenues from Asia for the three months and nine months ended October 31,
2004 is largely due to the decreased sales of our chipset products to the
advanced DVD/media player market, partially offset by the increased sales of our chipset
products to the IP video application market. Revenues from Europe increased 259%
to $2,656,000 from $739,000 for the three months ended October 31, 2004, and
increased 44% to $6,081,000 for the nine months ended October 31, 2004 compared
to $4,231,000 for the nine months ended October 31, 2003. The increase in
revenues from Europe for the three months and nine months ended October 31, 2004
is primarily attributable to the increased sales of our chipset products in the
IP video application and advanced DVD/media player market.
Our Asia revenues in the third quarter and first nine months of
fiscal 2005 were derived predominantly from customers in Korea, China, and
Taiwan. Revenues generated from Korea, China and Taiwan for the quarter ended
October 31, 2004 accounted for 17%, 13%, and 11% of our total net revenues, as
compared to 14%, 7%, and 33% for the quarter ended October 31, 2003,
respectively. Revenues generated from Korea, China and Taiwan for the nine
months ended October 31, 2004 accounted for 15%, 16%, and 15% of our total net
revenues, as compared to 13%, 10% and 23% for the nine months ended October 31,
2003, respectively. Our Europe revenues in the third quarter and first nine
months of fiscal 2005 were derived predominantly from a customer in Denmark (see
Note 10 above).
Revenues
generated from Denmark for the quarter ended October 31, 2004 accounted for 26%
of our total net revenues, as compared to 5% for the quarter ended October 31,
2003. Revenues generated from Denmark for the nine months ended October 31, 2004
accounted for 20% of our total net revenues as compared to 9% for the nine
months ended October 31, 2003.
No sales to any U.S. customers accounted for more than 10% of total
revenues for the quarter and nine months ended October 31, 2004 and October 31,
2003. Sales to two international customers accounted for 26% and 17% of our
total revenue during the third quarter of fiscal 2005, as compared with sales to
two international customers which accounted for approximately 14% and 11% of
total net revenues for the same quarter of fiscal 2004. Sales to two
international customers accounted for 19% and 14% of our total revenue during
the first nine months of fiscal 2005, as compared with no sales to any
international customer in excess of 10% of total net revenues for the same
period of fiscal 2004.
Gross Margin. Our gross margins for the quarter and nine
months ended October 31, 2004 were 72% and 70%, respectively as compared to 62%
for both periods last year. This improvement was due to a shift in our product
mix toward newer media processors and increased engineering development revenues,
as to which the related costs were included in research and development
expenses. This improvement also resulted from a reduction in a royalty payment
as a result of a licensing settlement. In addition, the provisions for inventory
obsolescence which were included in cost of revenues increased to $185,000 and
decreased to $276,000 in the third quarter and first nine months of fiscal
2005, respectively, as compared to $150,000 and $497,000 in the third quarter
and first nine months of fiscal 2004, respectively. Also costs related to
support service revenues were included in sales and marketing expense, such
service is provided by our integration engineers in our sales department. We expect
our gross margins will vary from period to period due to changes in the mix of
product sales, volume discounts, our costs, and provisions for inventory
obsolescence. Because average selling prices of our products typically decline
over the life of a product, if we are unable to reduce costs faster than the
rate of such decline or introduce new products with higher average selling
prices, our gross margins will decline.
Costs and Expenses. Sales and marketing expenses decreased by $88,000
or 7%, during the third quarter of fiscal 2005, and decreased by $20,000, or 1%
during the first nine months of fiscal 2005, as compared to the same periods in
fiscal 2004. The overall decrease in sales and marketing expenses compared to
last year resulted from a reduction of trade show and travel expenses. Going
forward, we expect our sales and marketing expenses will increase in absolute
dollars year-over-year as we intend to continue to expand our sales and
marketing organization. Research and development expenses increased by $250,000,
or 10%, during the third quarter of fiscal 2005, and increased by $1,128,000, or
15% during the first nine months of fiscal 2005, as compared to the same periods
in fiscal 2004. These increases in research and development expenses compared to
last year resulted from the additions of engineering staff at our headquarters,
our Hong Kong and France office, costs related to customization services, and
mask charges and tape out costs of our new silicon. As a result of our
continuing efforts in the development of and our proprietary MPEG and WMV9 based
products, research and development expenses are likely to continue to increase
in absolute dollars year-over-year. General and administrative expenses
increased by $434,000, or 59%, during the third quarter of fiscal 2005, and
increased by $927,000, or 49%, during the first nine months of fiscal 2005 as
compared to the same periods in fiscal 2004.
The increase in the third quarter and the first nine months of
fiscal 2005 was primarily a result of the costs related to Sarbanes Oxley compliance, additional bad debt expenses, and
legal and settlement costs related to the lawsuit filed in August 2005 by several motion pictures companies in an
action titled Paramount Pictures Corp., et al. v. Sigma Designs, Inc.
We expect our general and administrative expenses to increase in
future periods in absolute dollars due to increasing costs of insurance,
professional services and other expenditures associated with our business.
Other income. During the second quarter of fiscal 2005, we received a
$373,000 incentive from the tax authority in France for the recovery of
qualifying research and development expenditures incurred by our French
subsidiary in fiscal 2001. We expect we will continue to receive incentives
each year as the amount is based on the incremental level of qualified research
and development expenditures year over year.
LIQUIDITY AND CAPITAL RESOURCES
As of October 31, 2004, our principal sources of liquidity consisted of cash and cash
equivalents and marketable securities of $17.4 million, which represents a decrease of $1.6
million compared with $19.0 million at January 31, 2004. This decrease resulted
from capital equipment expenditures of $0.4 million, an equity investment of
$1.0 million in a local wireless technology company, and another $1.0 million
equity investment in an OEM customer headquartered in Europe,
in addition to the initial $1.0 million
invested during the third quarter of fiscal 2004, which was
partially offset by
$0.8 million from the exercise of stock options by employees.
We do not have guaranteed price or quantity commitments with any of our
suppliers. The following table sets forth the amounts (in thousands) of payments
due under specified contractual obligations, aggregated by category of
contractual obligation as of January 31, 2004.
Contractual Obligations
Payments Due by Period
|
|
Total
|
|
Capital
Leases
|
|
Operating
Leases
|
|
|
|
|
|
|
|
|
|
1 year or less |
|
$ 692 |
|
$ 5 |
|
$ 687 |
|
1-3 years |
|
1,336 |
|
- |
|
1,336 |
|
4-5 years |
|
433 |
|
- |
|
433 |
|
More than 5 years |
|
-
|
|
-
|
|
-
|
|
|
|
|
|
|
|
|
|
Total |
|
$ 2,461
|
|
$ 5
|
|
$ 2,456
|
On October 29, 2004, we entered into an amended and restated
revolving line of credit, expiring in October 2005, which is primarily
collateralized by our accounts receivable and under which we can draw down a maximum of $3.0
million. As of October 31, 2004, we had availability to draw down approximately
$1.4 million. In addition, we have a bank line of credit of $3.0 million that
expires in October 2005, which line is secured by substantially all of our
assets. The entire $3.0 million of bank line is available for borrowing. As of October 31,
2004, we had no borrowings outstanding under any line of credit. Under the agreements and the notes for these
lines of credit, we are subject to certain financial covenants. As of October
31, 2004, we were in compliance with these covenants.
Our primary sources of funds to date have been proceeds from preferred and
common stock issuances, and borrowings under bank lines of credit. In certain
periods, cash generated from operations has also been a source of funds. While
we generated cash from operations in the three and nine months ended October 31, 2004, it
is possible that our operations will consume cash in future periods. Other than the obligations under
certain contractual agreements shown on the above table, we currently have no
long-term debt. Based on our currently anticipated cash needs, we believe that
our current reserve of cash and cash equivalents, including the proceeds from
our private placements of common stock during the first half of fiscal 2004,
will be sufficient to meet our primary uses of cash, which include our
anticipated working capital requirements, obligations, capital expenditures,
strategic investments, and other cash needs for the next twelve months. In
addition, we believe that we will be able to comply with or make modifications
to the current covenants under our existing asset-based banking agreements, and to renew those lines of credit
upon their expiration, in order to
maintain the availability of funds under these agreements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards
Board ("FASB") issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," and in
December 2003 issued a revised interpretation of FIN 46 ("FIN 46-R").
FIN 46 requires certain variable interest entities ("VIEs")
to be consolidated by the primary 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 provisions of FIN 46 are effective immediately for all
arrangements entered into after January 31, 2003. We have not invested in
any entities we believe are variable interest entities for which we are the
primary beneficiary. The adoption of FIN 46-R had no impact on our financial
position, results of operations or cash flows.
In May 2003, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," which
requires that certain financial instruments be presented as liabilities, and for
which the financial instruments were previously properly presented as equity or
as temporary equity. Such instruments include mandatory redeemable preferred and
common stock, and certain options and warrants. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003 and
was effective at the beginning of the first interim period beginning after
June 15, 2003. In November 2003, the FASB issued FASB Staff Position
("FSP") No. 150-3, "Effective Date, Disclosures, and
Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic
Entities and Certain Mandatorily Redeemable Noncontrolling Interests under SFAS
No. 150," which defers the effective date for various provisions of
SFAS No. 150. We believe that we have properly classified and measured in
our balance sheets and disclosed in our interim consolidated financial
statements certain financial instruments with characteristics of both
liabilities and equity.
In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on
Issue No. 03-01 "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." EITF No. 03-01 provides guidance on
recording other-than-temporary impairments of cost method investments and
disclosures about unrealized losses on available-for-sale debt and equity
securities accounted for under the FASB Statements No. 115, Accounting for
Certain Investments in Debt and Equity Securities. The guidance for
evaluating whether an investment is other-than-temporarily impaired should be
applied in other-than-temporary impairment evaluations made in reporting periods
beginning after June 15, 2004. The additional disclosures for cost method
investments are effective for fiscal years ending after June 15, 2004. For
investments accounted for under FAS 115, the disclosures are effective in annual
financial statements for fiscal years ending after December 15, 2003. The
adoption of this rule did not have a material impact on our financial position,
results of operations or cash flows.
CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL
CONDITION
You should carefully consider the risks described below
before making an investment decision. The risks and uncertainties described
below are not the only ones facing Sigma Designs, Inc. Additional risks and uncertainties
not presently known to us or that we currently deem immaterial may also impair
our business operations.
If any of the following risks actually occur, our business, financial
condition and results of operations could be materially adversely affected. In
such case, the trading price of our common stock could decline, and you could
lose all or part of your investment.
Our business is highly dependent on the expansion of
young and rapidly evolving segments of the consumer electronics market.
The majority of our current revenues come from
the sale of chipsets for use in emerging consumer applications, including IP video
set-top boxes, advanced DVD/media players, and high definition televisions. We
expect that the consumer digital home entertainment market will continue to
account for a significant portion of our net revenues for the foreseeable
future. Our ability to sustain and increase revenues is in large part dependent
on the continued growth of these young and rapidly evolving market segments, whose future is largely uncertain.
Many factors could impede or interfere with the expansion of these consumer market
segments, including general
economic conditions, other
competing consumer electronic products, delays in the deployment of telecommunications video
services and insufficient interest in new technology innovations. In addition,
even if these consumer market segments expand, manufacturers of products in
these segments may not choose to utilize our products in their products.
Moreover, market acceptance of the products of manufacturers that do utilize our
products may not occur as expected. In any such case, our business would likely
be harmed.
We have a history of operating losses and we
could sustain future losses. We cannot assure you that we will be able to
sustain profitable operations in the future.
We incurred significant operating losses in
fiscal 1995, 1996, 1998, 2001, 2002 and 2003 and had negative cash flow in
fiscal 1995, 1998, 2002 and 2003. Since our introduction of the
REALmagic® MPEG product line in November 1993, we have made
significant investments in marketing and technological innovation for our
REALmagic products. As a result of our investments, we experienced significant
losses through fiscal 1996. Fiscal 1995, 1996 and 1998 also included
significant losses associated with products other than those related to our
REALmagic technology. Fiscal 2001, 2002 and 2003 included significant losses
associated with a decline in
demand for our REALmagic products.
Since our inception through October 31, 2004, our total accumulated deficit is
$59,106,000. We cannot assure you that we will not incur operating losses in any
future fiscal quarter or fiscal year.
Our operating results are subject to significant fluctuations due to
many factors and any of these factors could adversely affect our stock
price.
Our operating results have fluctuated in the past and may continue to
fluctuate in the future due to a number of factors, including but not limited
to:
- new product introductions by us and our competitors;
- changes in our pricing models and product sales mix;
- unexpected reductions in unit sales, average selling prices and/or gross margins, particularly if they occur precipitously;
- market acceptance of the technology embodied in our products generally and our
products in particular;
- the level of acceptance of our products by our OEM customers, and acceptance of
our OEM customers' products by their end user customers;
- shifts in demand for the technology embodied in our products generally and our
products in particular and those of our competitors;
- gains or losses of significant customers;
- the timing of, and potential unexpected delays in our customer orders and
product shipments;
- reduction in average selling prices and gross margins, which could occur either
gradually or precipitously;
- inventory obsolescence;
- write-downs of accounts receivable;
- an interrupted or inadequate supply of semiconductor chips or other materials
included in our products, for
example, our source of supply for silicon wafers was, and may in the future be
affected by earthquakes in Taiwan;
- our inability to protect our intellectual property;
- loss of key personnel;
- technical problems in the development, ramp up, and manufacturing of products
which could cause shipping delays;
- the effect of terrorist attacks and any related conflicts or similar events
worldwide;
- availability of third-party manufacturing capacity for production of certain
products;
- the impact of a recurrence of severe acute respiratory syndrome, or SARS, upon
our revenues and our supply sources for our products; and
- the impact of potential economic instability in the Asia-Pacific region.
Sales risks and volatility of OEM customer sales and resale
distribution may harm our business.
Our ability to increase sales and achieve continued profitability
depends substantially on our ability to achieve a sustained high level of sales
to our OEM customers. We have not executed volume purchase agreements with any
of our current customers. Our customers are not under any obligation to purchase
any minimum quantity of our products. Also, even if we achieve new design wins,
we cannot assure you that these manufacturers will purchase our products in
substantial volumes. Sales to any particular OEM customer fluctuate
significantly from quarter to quarter and are subject to severe price pressures
by competitors. Any reductions in those sales could seriously harm our business.
Based on our experience in the industry, we expect that our actual sales to OEM
customers will continue to experience significant fluctuations. Also, estimates
of future sales to any particular customer or groups of customers are inherently
uncertain.
Because we depend on a limited number of major customers, the
reduction, delay or cancellation of orders from these customers or the loss of
these customers may adversely affect our business.
In the third quarter of fiscal 2005, one customer based in Europe
and two customers based in Asia totally accounted for 50% of our total net revenues,
as compared with three customers based in Asia which totally accounted for
approximately 32% of total net revenues for the same quarter of fiscal 2004. In
the first nine months of fiscal 2005, two customers based in Asia and one
customer based in Europe totally accounted for 42% of our total net revenues, as
compared with three customers based in Asia which totally accounted for
approximately 25% of total net revenues for the same period of fiscal 2004.
In fiscal 2004, no
customer accounted for more than 10% of our total net revenues; however, two
customers based in Europe and four customers based in Asia accounted for 40% of
our total net revenues. In fiscal 2003, one customer based in Europe, two
customers based in the U.S. and two customers based in Asia accounted for 47% of
our total revenues, among these customers, one customer based in Europe
accounted for 19% of our total net revenues. In fiscal 2002, three customers
based in the U.S. and one customer based in Europe accounted for 49% of our
total net revenues, and among these customers, three U.S.
customers represented 15%, 14% and 11% of our total net revenues,
respectively. Our dependence on a few major customers will likely continue despite other changes in the
composition of our customer base. The reduction, delay or cancellations of
orders from major customers or the loss of major customers could materially and
adversely affect our business, financial condition and results of operations. In
addition, any difficulty in collection from key customers could harm our
business.
Our international operations are subject to certain risks.
Our international sales represented 83% of net revenues for the
quarter and 85% for the nine months ended October 31, 2004, as compared with 84%
and 85% in the comparable periods of the prior year, respectively. During fiscal
2004, 2003, and 2002, sales to international customers accounted for
approximately 86%, 67%, and 42% of our total net revenues, respectively. We
anticipate that sales to international customers will continue to constitute a substantial percentage
of our net revenues. Also, one of the foundries that manufacture our products
and components is located in Asia.
Due to the concentration of international sales
and the manufacturing capacity in Europe and Asia, we are subject to the risks
of conducting business internationally. These risks include unexpected changes
in regulatory requirements and fluctuations in the U.S. dollar that could
increase the sales price in local currencies of our products in international
markets, or make it difficult for us to obtain price reductions from our
foundries. Overseas sales and purchases
to date have been denominated in U.S. dollars. We do not currently engage in any hedging activities to
reduce our exposure to exchange rate risks. Our results of operations could be
adversely affected by exchange rate fluctuations.
We derive a substantial portion of our revenues from
sales to the Asia Pacific region. This region of the world is subject to
increased levels of economic instability, and this instability could seriously
harm our results of operations. Further, the economic impact of a recurrence of
SARS or a similar event in this
region could adversely affect our revenues and our business as a whole.
The timing of our customer orders and
product shipments can adversely affect our operating results and stock
price.
Our quarterly revenues and operating results depend upon the
volume and timing of customer orders received during a given quarter and the
percentage of each order that we are able to ship and recognize as revenue
during each quarter, each of which is extremely difficult to forecast. The
majority of our orders in a given quarter historically have been shipped in the
last months of that quarter. This trend is likely to continue, and any failure
or delay in the closing of orders during the last part of a quarter would
adversely affect our operating results, as occurred in the third quarter of
fiscal 2004. Further, to the extent we receive orders late in any given quarter,
we may be unable to ship products to fill those orders during the same quarter
in which we received the corresponding order, which would have an adverse impact
on our operating results for that quarter.
Our products are subject to increasing
price pressures.
Some of our markets, especially the DVD segments, are
characterized by intense price competition. The willingness of customers to
design our chips into their products depends to a significant extent, upon our
ability to sell our products at competitive prices. We expect the average
selling price of our existing products to decline significantly over the life of
each product as the markets for our products mature, new technologies emerge, and
competition increases. If we are unable to reduce our costs sufficiently to
offset declines in product prices or are unable to introduce more advanced
products with higher margins in a
timely manner, we could see declines in our market share or gross margins.
If we fail to comply with or obtain waivers for covenants
under our loan obligations, our financial condition could be harmed.
We have two lines of credit with a bank
which allow for borrowings of $3.0 million and $3.0 million, respectively.
Under the agreements for these lines of credit, which expire in October 2005, we
are subject to certain financial covenants. In the past, we had, on occasion,
been in violation of some of the covenants and in all cases, obtained waivers
releasing us from our obligation to meet these covenants as of previous dates.
It is possible that we may need such a waiver for future non-compliance and we
cannot assure you that our bank will grant these waivers. If we do not meet
these covenants and cannot obtain waivers, the lender could accelerate payments
of any amounts due under the lines. To the extent we had
borrowed amounts under these lines and were required to repay them on an
accelerated basis, it could substantially weaken our
financial condition. If we do not have sufficient funds available to make full
payment of the lines when
required, the bank could foreclose on our accounts receivable, inventories,
general intangibles, equipment and tangible assets that collateralize the notes,
which would harm our business. As of October 31, 2004, we had no borrowings
outstanding under any line of credit.
Our industry is highly competitive and we cannot assure
you that we will be able to effectively compete. If we fail to compete
effectively, our growth could be substantially affected.
The market for multimedia products is highly competitive and includes
embedded processors provided by multiple companies. Processors have, in recent
years, included increased graphics functionality. Other companies with more
experience and financial resources may develop a competitive product that could
inhibit future growth in sales of products utilizing our REALmagic technology.
Increased competition may be generated from several major computer product
manufacturers that have developed products and technologies that could compete
directly with REALmagic products. These competitors include:
- Analog Devices;
- ATI Technologies;
- Broadcom;
- Cirrus Logic;
- Conexant Systems;
- Equator Technologies;
- ESS Technology;
- LSI Logic/C-Cube;
- Mediatek;
- Phillips;
- STMicroelectronics;
- Texas Instruments; and
- Zoran Corporation.
In addition, for some applications, video decoding is done in software
operating on today's more powerful CPUs. Most of our competitors have
substantial experience and expertise in audio, video and multimedia technology
and in producing and selling consumer products through retail distribution and
OEM channels. These companies also have substantially greater engineering,
marketing and financial resources than we have. Our competitors could form
cooperative relationships that could present formidable competition to us. We
cannot assure you that our REALmagic technology will continue to achieve
commercial success or that it will compete effectively against other interactive
multimedia products, services and technologies that currently exist, are under
development, or may be announced by competitors. Also, we anticipate that our
competitors will, over time, introduce features that have been unique to Sigma
Designs, such as WMV9 decoding. We cannot assure you that we will not lose
market share or suffer price erosion in each of our market segments, as a result
of the introduction of competitive products with similar features.
Our future revenue growth depends in large part on the
adoption of MPEG technology and new CODECs.
Our business strategy is, and has been, to focus on our REALmagic
products by investing heavily in video decoding technology. We have made substantial investments in product
development based on the latest MPEG technology, WMV9. Though WMV9 has gained
some market acceptance, there is increasing competition from the ISO H.264
standard, a next generation video CODEC that forms an extension of MPEG-4.
Though we intend to support new CODEC technologies as they become commercially
viable, there is no guarantee that we can successfully develop these
technologies in a timely manner or that competitors will not gain market share at our expense with
these new technologies.
Our failure to keep pace with technological change will seriously harm
our business.
Our success depends, among other things, on our ability to achieve
and maintain technological leadership and to remain competitive in terms of
price and product performance.
Our technological leadership depends on our continued technological
advancements, as well as research and development investments in the area of
MPEG video and audio decoding. These advancements include the following:
- Compatibility with emerging standards and multiple platforms; and
- Improvements to our silicon architecture.
We cannot assure you that we will be able to make these advancements
to our REALmagic technology. Even if we do make these advances, we cannot assure
you that we will be able to achieve and maintain technological leadership. Any
material failure by us or OEMs and software developers to develop or incorporate
any required improvement could adversely affect the continued acceptance of our
technology and the introduction and sale of future products based on our
technology. We cannot assure you that products or technologies developed by
others will not render our technology and the products based on our technology
obsolete.
To be competitive, we must anticipate the needs of the market and successfully
develop and introduce innovative new products in a timely fashion. We cannot
assure you that we will be able to successfully complete the design of our new
products, have these products manufactured at acceptable manufacturing yields,
or obtain significant purchase orders for these products. The introduction of
new products may adversely affect sales of existing products and contribute to
fluctuations in operating results from quarter to quarter. Our introduction of
new products also requires that we carefully manage our inventory to avoid
inventory surplus and obsolescence. Our failure to do so could adversely impact
our results of operations. For example, during fiscal 2004 and 2003, we wrote
down our inventory in the amount of approximately $0.6 million and $0.8 million
respectively, because of a continuing decline in demand for certain of our PC-
related products. In addition, new products, as opposed to more mature
products, typically have higher initial component costs. These higher costs
could result in downward pressures on our gross margins.
We face many risks because of our heavy
reliance on certain manufacturers and suppliers that could harm our business and
financial condition.
Our products and components are presently manufactured entirely by outside suppliers or
foundries. We do not have long-term contracts with these suppliers. We conduct
business with our suppliers on a written purchase order basis. Our reliance on
independent suppliers subjects us to several risks. These risks include:
- the absence of adequate capacity;
- the unavailability of, or interruptions in access to,
certain process technologies; and
- reduced control over delivery schedules,
manufacturing yields and costs.
We obtain some of our components from a single source.
Other delays or interruptions have not occurred to date, but any delay or
interruption in the supply of any of the components required for the production
of our REALmagic silicon or our REALmagic multimedia cards currently obtained
from a single source, including delays resulting from a recurrence of SARS, earthquakes or other business interruptions could have a material adverse impact on our sales of
REALmagic products, and on our business.
We must provide our suppliers with sufficient lead-time to meet our
forecasted manufacturing objectives. Any failure to properly forecast such
quantities could materially and adversely affect our ability to produce
REALmagic products in sufficient quantities. We cannot assure you that our
forecasts regarding new product demand will be accurate, particularly because we
sell our REALmagic products on a purchase order basis. Manufacturing REALmagic
chipsets is a complex process, and we may experience short-term difficulties in
obtaining timely deliveries. This could affect our ability to meet customer
demand for our products. Any such delay in delivering products in the future
could materially and adversely affect our operating results. Also, should any of
our major suppliers become unable or unwilling to continue to manufacture our
key components in required volumes, we will have to identify and qualify
acceptable additional suppliers. This qualification process could take up to
three months or longer and additional sources of supply may not be in a position
to satisfy our requirements on a timely basis.
In the past, we have experienced production delays and other difficulties, and
we could experience similar problems in the future. In addition, product defects
may occur and they may escape identification at the factory. This could result
in unanticipated costs, cancellations, deferrals of purchase orders, or costly
recall of products from customer sites.
Loss of key personnel could cause our business to
suffer.
Our future success depends in large part on the continued
service of our key technical, marketing, sales and management personnel. Given
the complexity of REALmagic technology, we are dependent on our ability to
retain and motivate highly skilled engineers involved in the ongoing hardware
and software development of REALmagic products. These engineers are required to
refine the existing hardware system and application programming interface and to
introduce enhancements in future applications. Despite incentives we provide,
our current employees may not continue to work for us, and if additional
personnel were required for our operations, we may not be able to obtain the
services of additional personnel necessary for our growth.
Our ability to compete may be affected by our ability to protect our
proprietary information. We currently hold twenty-eight patents covering the
technology underlying the REALmagic products. We have filed certain patent
applications and are in the process of preparing others. We cannot assure you
that any additional patents for which we have applied will be issued or that any
issued patents will provide meaningful protection of our product innovations.
Like other emerging multimedia companies, we rely primarily on trade secrets and
technological know-how in the conduct of our business. We also rely, in part, on
copyright law to protect our proprietary rights with respect to our REALmagic
technology. We use measures such as confidentiality agreements to protect our
intellectual property. These methods of protecting our intellectual property may
not be sufficient.
