===============================================================================
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 July 31, 2002
[ ] 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)
930 Thompson Place, Sunnyvale, CA 94085
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 733-3030
--------------
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 [ ]
At September 12, 2002, 22,523,887 shares of common stock of the Registrant
were outstanding.
===============================================================================
OMNIVISION TECHNOLOGIES, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - July 31, 2002 and
April 30, 2002................................................ 3
Condensed Consolidated Income Statements - Three Months
Ended July 31, 2002 and 2001.................................. 4
Condensed Consolidated Statements of Cash Flows - Three Months
Ended July 31, 2002 and 2001.................................. 5
Notes to Condensed Consolidated Financial Statements............ 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 31
Item 6. Exhibits and Reports on Form 8-K.................................. 31
Signatures................................................................. 32
2
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
July 31, April 30,
2002 2002
---- ----
ASSETS
Current assets:
Cash and cash equivalents................................ $ 56,276 $ 55,803
Short-term investments................................... -- 2,002
Accounts receivable, net................................. 13,574 10,787
Inventories.............................................. 6,075 3,244
Refundable and deferred income taxes..................... 3,066 3,066
Prepaid expenses and other assets........................ 2,278 987
-------- --------
Total current assets................................... 81,269 75,889
Property, plant and equipment, net......................... 7,416 6,164
Other non-current assets................................... 292 288
-------- --------
Total assets........................................... $ 88,977 $ 82,341
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 9,588 $ 5,865
Accrued expenses and other liabilities................... 4,454 4,306
Deferred revenue......................................... 874 651
-------- --------
Total current liabilities.............................. 14,916 10,822
-------- --------
Commitments and Contingencies (Note 8)
Stockholders' equity:
Common stock, $0.001 par value; 100,000 shares authorized;
22,496 and 22,287 shares issued and outstanding........ 22 22
Additional paid-in capital............................... 96,284 95,469
Deferred compensation related to stock options........... (374) (479)
Accumulated deficit...................................... (21,871) (23,493)
-------- --------
Total stockholders' equity............................. 74,061 71,519
-------- --------
Total liabilities and stockholders' equity............. $ 88,977 $ 82,341
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
----------------------
July 31, July 31,
2002 2001
---- ----
Revenues.................................................. $ 16,790 $ 11,161
Cost of revenues*......................................... 10,274 6,133
-------- --------
Gross profit.............................................. 6,516 5,028
-------- --------
Operating expenses:
Research and development*............................... 2,630 1,688
Selling, general and administrative*.................... 2,080 3,239
Stock compensation charge*.............................. 114 158
-------- --------
Total operating expenses.............................. 4,824 5,085
-------- --------
Income (loss) from operations............................. 1,692 (57)
Interest income (expense), net............................ 216 567
-------- --------
Income before income taxes................................ 1,908 510
Provision for income taxes................................ 286 --
-------- --------
Net income................................................ $ 1,622 $ 510
======== ========
Net income per share:
Basic................................................... $ 0.07 $ 0.02
======== ========
Diluted................................................. $ 0.07 $ 0.02
======== ========
Shares used in computing net income per share:
Basic................................................... 22,265 21,693
======== ========
Diluted................................................. 24,137 24,377
======== ========
(*)Stock-based compensation charges included in:
Cost of revenues........................................ $ 3 $ 9
======== ========
Operating expenses:
Research and development.............................. $ 46 $ 87
Selling, general and administrative................... 68 71
-------- --------
$ 114 $ 158
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
4
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
----------------------
July 31, July 31,
2002 2001
---- ----
Cash flows from operating activities:
Net income............................................... $ 1,622 $ 510
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 205 191
Allowance for doubtful accounts and sales returns...... (122) (132)
Amortization of deferred compensation.................. 117 167
Changes in assets and liabilities:
Accounts receivable.................................. (2,665) (115)
Inventories.......................................... (2,831) 1,709
Prepaid expenses and other assets.................... (1,295) (736)
Accounts payable..................................... 3,723 2,141
Accrued expenses and other liabilities............... 148 (281)
Deferred revenue..................................... 223 149
-------- --------
Net cash provided by (used in) operating activities (875) 3,603
-------- --------
Cash flows from investing activities:
Proceeds from sale of short-term investments............. 2,002 --
Purchases of property, plant and equipment............... (1,457) (317)
-------- --------
Net cash provided by (used in) investing activities 545 (317)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net.............. 804 302
Payment for repurchase of common stock, net.............. (1) (4)
-------- --------
Net cash provided by financing activities.......... 803 298
-------- --------
Net increase in cash and cash equivalents.................. 473 3,584
Cash and cash equivalents at beginning of period........... 55,803 51,053
-------- --------
Cash and cash equivalents at end of period................. $ 56,276 $ 54,637
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
5
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months Ended July 31, 2002 and 2001
(unaudited)
Note 1 - Basis of Presentation
- ------------------------------
The accompanying unaudited condensed consolidated financial statements as
of July 31, 2002 and April 30, 2002 and for the three months ended July 31,
2002 and 2001 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, 2002 have been derived from our 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. These financial statements should be read
in conjunction with the annual audited financial statements and notes as of and
for the year ended April 30, 2002, included in the Company's Annual Report on
Form 10-K.
The results of operations for the three months ended July 31, 2002 are not
necessarily indicative of the results that may be expected for the year ending
April 30, 2003 or any other future interim period, and the Company makes no
representations related thereto.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
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 - Revenue Recognition
- ----------------------------
The Company recognizes revenue upon the shipment of its products to the
customer provided that the Company has received a signed purchase order, the
price is fixed, title has transferred, collection of resulting receivables is
considered probable, 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.
Note 3 - Short-term Investments
- -------------------------------
The Company's short-term investments, which are classified as available-
for-sale, are invested in high-grade corporate securities and government bonds
maturing approximately twelve months or less from the date of purchase. These
investments are reported at fair value. 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 covered.
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2002 and 2001
(unaudited)
Note 4 - Balance Sheet Accounts (In Thousands)
- ---------------------------------------------
July 31, April 30,
2002 2002
---- ----
Cash and cash equivalents:
Cash..................................................... $ 3,178 $ 3,625
Money market funds....................................... 33,624 10,303
Commercial paper......................................... 19,474 41,875
-------- --------
$ 56,276 $ 55,803
======== ========
Short-term investments:
Corporate notes.......................................... $ -- $ 2,002
======== ========
Inventories:
Work in progress......................................... $ 4,995 $ 2,361
Finished goods........................................... 1,080 883
-------- --------
$ 6,075 $ 3,244
======== ========
Prepaid expenses and other assets:
Prepaid expenses........................................ $ 1,143 $ 510
Other receivables....................................... 1,135 477
-------- --------
$ 2,278 $ 987
======== ========
Note 5 - Net Income Per Share
- -----------------------------
The following table sets forth the computation of basic and diluted income
per share attributable to common stockholders for the period indicated (in
thousands, except per share data):
Three Months Ended
----------------------
July 31, July 31,
2002 2001
---- ----
Numerator:
Net income.............................................. $ 1,622 $ 510
======== ========
Denominator:
Weighted average shares................................. 22,422 22,066
Weighted average unvested common stock subject to
repurchase............................................ (157) (373)
-------- --------
Denominator for basic net income per share.............. 22,265 21,693
Effect of dilutive securities:
Common stock options.................................. 1,715 2,311
Unvested common stock subject to repurchase........... 157 373
-------- --------
Denominator for dilutive net income per share............. 24,137 24,377
======== ========
Basic net income per share................................ $ 0.07 $ 0.02
======== ========
Diluted net income per share.............................. $ 0.07 $ 0.02
======== ========
Note 6 - Equity
- ---------------
In July 2000, the Company completed its initial public offering of
5,000,000 shares of common stock at $13.00 per share. Net proceeds aggregated
approximately $59.2 million after paying the underwriters' fee and related
expenses. At the closing of the offering, all issued and outstanding shares of
the Company's preferred stock were
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2002 and 2001
(unaudited)
converted into an aggregate of 12,305,001 shares of common stock. In August
2000, the underwriters of the Company's initial public offering exercised their
over-allotment option to purchase an additional 750,000 shares of common stock
at $13.00 per share. Net proceeds aggregated approximately $8.5 million after
paying the underwriters' fee and related expenses.
Note 7 - Segment 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.
The Company sells its products primarily in the United States and to the
Asia Pacific region. Revenues by geographic locations based on the country or
region of the customer were as follows (in thousands):
Three Months Ended
----------------------
July 31, July 31,
2002 2001
---- ----
Hong Kong................................................ $ 7,647 $ 1,368
Taiwan................................................... 4,142 1,471
United States............................................ 2,778 6,489
Japan.................................................... 896 670
Korea.................................................... 569 461
Singapore................................................ -- 315
China.................................................... 427 95
All other................................................ 331 292
-------- --------
$ 16,790 $ 11,161
======== ========
Note 8 - Commitments and Contingencies
- --------------------------------------
In December 2000, the Company established an indirect wholly owned Chinese
subsidiary, HuaWei Semiconductor (Shanghai) Co., Ltd., or HuaWei Semiconductor.
HuaWei Semiconductor is a wholly owned subsidiary of HuaWei Technology
International, Ltd., or HuaWei, a Cayman Islands company that is itself wholly
owned by OmniVision. The Company established HuaWei Semiconductor as part of
its efforts to reduce the costs associated with the testing of its CMOS image
sensors. The Company currently anticipates that in addition to using HuaWei
Semiconductor as a testing facility, the Company may expand the scope of its
operations at HuaWei Semiconductor to include other processes associated with
the manufacturing of its products, such as color filter applications. The
Company recently increased the registered capital of HuaWei Semiconductor to
$30.0 million, from an initial $12.0 million commitment. Of HuaWei
Semiconductor's $30.0 million in registered capital, $7.5 million had been
funded as of July 31, 2002. HuaWei made this investment in HuaWei Semiconductor
through capital provided by the Company from the Company's available working
capital. Of the remaining $22.5 million of registered capital for HuaWei
Semiconductor, which is an obligation of HuaWei, $4.5 million must be funded by
January 2004 and $18.0 million must be funded by January 2005. Of the $7.5
million invested in HuaWei Semiconductor through July 31, 2002, $5.5 million
was used to pay for land use rights and to building contractors in partial
payment for the construction of the facility, $0.7 million was expended for
general operating expenses and $1.3 million remained available for future use.
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.
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the Three Months Ended July 31, 2002 and 2001
(unaudited)
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 the
Company, some of its directors and officers, and various underwriters for its
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 its 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 issuers in the coordinated action
have recently filed a consolidated motion to dismiss.
In March 2000, the Company received written notice from Koninklijke
Philips N.V. ("Philips") in which Philips claimed to have patent rights in a
serial bus system for data transmission, known as the I2C bus system. Although
the Company does not believe that any of its products infringe any Philips
patent, the Company is currently discussing possible royalty or licensing
arrangements as a means of business resolution. In the meantime, the Company
has completed implementation of a new serial bus system for its products.
9
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 development of new products in new and existing markets, the
expansion of the range of picture resolutions offered in our products, the
development of new products which require only three volts for portable
applications, the improvement of image quality, the integration of additional
functions and the continued improvement to the interface chip in the second
paragraph under "Overview;" the statements relating to the generation of
revenues from five-volt and three-volt products in the remainder of fiscal year
2003 in the third paragraph under "Overview;" the statements relating to
technology leadership and increase in research and development expenses in the
seventh paragraph under "Overview;" the statements regarding the expansion of
the scope of our operations at HuaWei Semiconductor, the additional capital
expenditures required by HuaWei Semiconductor, the future funding sources for
HuaWei and the potential nature of future third party funding of HuaWei
Semiconductor in the last paragraph under "Overview;" the statements regarding
the expected increases of research and development costs under "Research and
Development;" the statements regarding increases in selling, general and
administrative expenses under "Selling, General and Administrative;" the
statements regarding the size of and amortization of compensation charges under
"Stock Compensation Charge;" the statements regarding the effect of our
obligations and commitments on liquidity and capital resources; the expansion
of the scope of our operations at HuaWei Semiconductor; the additional capital
expenditures required for the development of HuaWei Semiconductor; the future
funding sources for HuaWei and the potential nature and availability of future
third party funding of HuaWei Semiconductor in the first paragraph under
"Contractual Obligations and Commercial Commitments;" the statements regarding
cash resources available to meet capital requirements in the second paragraph
under "Contractual Obligations and Commercial Commitments;" the statements
regarding the effect of and exposure to foreign currency exchange rate risk
under "Foreign Currency Exchange Risk;" and the statements regarding the
effect of and exposure to market interest rate risk under "Quantitative and
Qualitative Discussion of Market Interest Rate Risk;" 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, high quality, highly
integrated and cost efficient semiconductor image sensor devices. Our main
product, an image sensing device called a CameraChip(tm), is used to capture an
image in cameras and camera related products in high-volume imaging
applications such as personal computer cameras, digital still cameras, security
and surveillance cameras, personal digital assistant cameras and mobile phone
cameras and cameras for automobiles and toys for both still picture and live
video applications. Our CameraChips are designed to use the complementary metal
oxide semiconductor, or CMOS, fabrication process. Our single chip CameraChips
can allow our customers to build cameras that are smaller, require fewer chips,
consume less power and cost less to build than cameras using traditional charge
coupled device, or CCD, technology, or multiple chip CMOS image sensors. Unlike
some competitive image sensors, which require multiple chips to achieve the
same functions, we are able to integrate nearly all camera functions into a
single chip. We believe that we supply one of the most highly integrated single
chip CMOS image sensor solutions available today.
Image sensors are characterized by several important attributes such as
picture resolution, color, lens size, voltage requirements and type of video
output. We intend to continue developing new CameraChips aimed at new and
existing markets. We plan to expand the range of picture resolutions we offer,
provide additional CameraChips that require only three volts for portable
applications and further improve image quality and integrate additional
functions into our CameraChips. In addition, we developed and market a family
of interface chips that include
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
compression capabilities and which connect a camera to the universal serial bus
on personal computers, and we plan to continue to make improvements to that
product as well.
Our first image sensor was a low resolution, black and white sensor
introduced in 1996. We introduced an improved version of this sensor in early
1997. In addition, we introduced color and digital image sensors in 1997 and
higher resolution and higher quality image sensors in 1998 and 1999. For Fiscal
Years 2002, 2001 and 2000, the majority of our revenues were generated from
sales of our five-volt color image sensors. Given the growth of the Internet
and multimedia applications which allow for digital images to be captured,
stored and transported, we expect that an equally significant portion of our
revenues in the fiscal year ending April 30, 2003, or Fiscal Year 2003, will be
generated from three-volt color image sensors which are used primarily in
digital still cameras, personal computer cameras and cellular phone accessories
and also from our five-volt color image sensors, which are used primarily in
affordable and easy to use personal computer cameras as well as security and
surveillance cameras.
We sell our products worldwide through a direct sales force and indirectly
through distributors and manufacturers' representatives. Our CameraChips are
sold to camera manufacturers who market camera products under their own brand.
We also sell to large manufacturing companies that produce camera products for
others to market under different brand names.
We outsource all of our semiconductor manufacturing and assembly. This
approach allows us to focus our resources on the design, development and
marketing of our products and significantly reduces our capital requirements.
We outsource our wafer manufacturing to Taiwan Semiconductor Manufacturing
Company, or TSMC, and Powerchip Semiconductor Company, or PSC. A majority of
our unit sales of CameraChips for the three months ended July 31, 2002 are
color image sensors. These require a color filter to be applied to the wafer
before packaging. We outsource the application of this color filter to Toppan
Printing Co., or Toppan, and TSMC. We outsource the packaging of our image
sensors to Kyocera Corporation, or Kyocera, Pan Pacific Semiconductor Co.,
Ltd., or PPSC, and Alphatec Semiconductor Packaging Co., or Alphatec. Outside
testing services do not offer suitable tests for the key parameter of product
performance and image quality. Therefore, we design and produce our own
automatic testing equipment specifically for image sensor testing, and we do
substantially all of our testing in house. Our control over the testing process
helps us maintain consistent product quality and identify areas to improve
product quality and reduce costs.
Sales of our CameraChips are subject to seasonality. Some of the products
using our CameraChips such as personal computer video cameras and digital still
cameras are consumer electronics goods. Typically, these goods are subject to
seasonality with generally increased consumer sales in November and December
due to the holidays. As a result, product sales are impacted by seasonal
purchasing patterns with higher sales generally occurring in the second half of
the calendar year. In addition, we typically experience a decrease in orders in
the quarter ended January 31 from our Chinese and Taiwanese customers primarily
due to the Chinese New Year.
We intend to maintain our technology leadership by continuing to develop
our core technology through our in house research and development efforts. As a
result, we expect that our future research and development expenses will
increase in absolute dollars and may increase as a percentage of revenues as we
design and develop our next generation of image sensor products during Fiscal
Year 2003.
In December 2000, we established an indirect wholly owned Chinese
subsidiary, HuaWei Semiconductor (Shanghai) Co., Ltd., or HuaWei Semiconductor,
as part of our efforts to reduce the costs associated with the testing of our
CMOS image sensors. HuaWei Semiconductor is a wholly owned subsidiary of HuaWei
Technology International, Ltd., or HuaWei, a Cayman Islands company that is
itself wholly owned by us. We currently anticipate that in addition to using
HuaWei Semiconductor as a testing facility, we may expand the scope of our
operations at HuaWei Semiconductor to include other processes associated with
the manufacturing of our products, such as color filter applications. We
recently increased the registered capital of HuaWei Semiconductor to $30.0
million, from an initial $12.0 million commitment. Of HuaWei Semiconductor's
$30.0 million in registered capital, $7.5 million had been funded as of July
31, 2002. HuaWei made this investment in HuaWei Semiconductor through capital
provided by us from our available working capital. Of the remaining $22.5
million of registered capital for HuaWei Semiconductor, which is an obligation
of HuaWei, $4.5 million must be funded by January 2004 and $18.0 million
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
must be funded by January 2005. We currently anticipate that development
efforts for HuaWei Semiconductor will require additional capital expenditures
of approximately $30.0 million through April 30, 2003. We expect to fund
HuaWei Semiconductor through a combination of funds invested directly through
HuaWei from our available working capital and by investments from third
parties. Third party financing for HuaWei Semiconductor could include debt
financing from banking institutions or an equity financing transaction.
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, 2002.
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
----------------------
July 31, July 31,
2002 2001
---- ----
Revenues.................................................. 100.0% 100.0%
Cost of revenues.......................................... 61.2 55.0
------ ------
Gross profit............................................ 38.8 45.0
------ ------
Operating expenses:
Research and development................................ 15.6 15.1
Selling, general and administrative..................... 12.4 29.0
Stock compensation charge............................... 0.7 1.4
------ ------
Total operating expenses.............................. 28.7 45.5
------ ------
Income (loss) from operations............................. 10.1 (0.5)
Interest income (expense), net............................ 1.3 5.1
------ ------
Income before income taxes................................ 11.4 4.6
Provision for income taxes................................ 1.7 --
------ ------
Net income................................................ 9.7% 4.6%
====== ======
Three Months Ended July 31, 2002 as Compared to Three Months Ended July 31,
- ---------------------------------------------------------------------------
2001
- ----
Revenues
- --------
We derive revenues from the sale of our CameraChip products and other
companion circuits for use in a variety of high-volume applications. Revenues
for the three months ended July 31, 2002 increased 50% to approximately $16.8
million from $11.2 million for the three months ended July 31, 2001. The
increase in revenues during the three months ended July 31, 2002 was primarily
due to sharply increased demand by our contract manufacturing customers which
are engaged in the manufacturing of digital still cameras, increases in toy
camera revenues and increased cell phone camera revenues. These increases were
partially offset by decreases in revenues from PC video camera sensors which
declined for the three months ended July 31, 2002 from the same period in
fiscal 2001.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The major product families and their related primary applications for the
three months ended July 31, 2002 and 2001, respectively, were as follows (in
thousands):
Three Months Ended
----------------------
July 31, July 31,
Product Family Primary Application 2002 2001
- ------------------------ -------------------------------- ---- ----
Analog - high resolution. Security and surveillance, toy
cameras, automotive.............. $ 6,466 $ 8,246
Digital - high resolution Digital still cameras, cell phone
cameras, PC cameras.............. 6,108 757
Digital - low resolution. Cell phone cameras, video phone,
PC cameras....................... 1,875 619
Analog - low resolution.. Security and surveillance, toy
cameras.......................... 1,830 1,187
Other.................... Interface chips.................. 511 352
-------- --------
$ 16,790 $ 11,161
======== ========
Domestic and international revenues for the three months ended July 31,
2002 were $2.8 million and $14.0 million, respectively, as compared to $6.5
million and $4.7 million, respectively, for the three months ended July 31,
2001, representing a shift from the year ago quarter in our revenue by
geographic region from domestic to Asia-Pacific manufacturers. Because of the
preponderance of Asia Pacific manufacturers and the fact that virtually all
purchasers of the Company's image sensors sell their products globally, such
figures do not reflect geographic distribution of sales into end-user markets.
For the three months ended July 31, 2002, no single original equipment
manufacturing, or OEM, customer accounted for 10% or more of revenues. For the
three months ended July 31, 2001, one of our security camera manufacturer
customers, X10 Wireless Technology, Inc., or X10, represented approximately 54%
of revenues. No other single OEM customer accounted for 10% or more of revenues
in the three months ended July 31, 2001. Our two largest distributors during
the three months ended July 31, 2002 were Gain Tune, Ltd, or Gain Tune, based
in Hong Kong, and World Peace Industrial Co. Ltd., or World Peace,
headquartered in Taiwan, which accounted for 13.7% and 10.7% of revenues,
respectively. Gain Tune is an affiliated entity of World Peace. Our two largest
distributors during the three months ended July 31, 2001 were World Peace which
accounted for 8% of revenues and SEC Development Co. Ltd., or SEC,
headquartered in Hong Kong, which accounted for 6% of revenues.
Gross Profit
- ------------
Gross margins for the three months ended July 31, 2002 and 2001 were 38.8%
and 45.0% of revenues, respectively. The decrease in gross margin for the three
months ended July 31, 2002 was primarily due to the proportionately greater
beneficial impact in the year ago period from the sale of previously written-
off inventory and a one-time $0.6 million payment to secure additional
production capacity. Gross profit for the first quarter of fiscal 2003 included
a gross profit of approximately $0.8 million from the sale of inventory that we
had written-off in prior years, offset in part by the $0.6 million one-time
payment to secure additional production capacity. For the three months ended
July 31, 2001, $1.1 million of the margin was attributable to gross profit from
the sale of inventory that we had written-off in prior years. Excluding the
gross profit from the sale of the written-off inventory and the one-time
payment to secure additional production capacity, the gross margin would have
been 39.2% of revenues for the quarter ended July 31, 2002 as compared to 34.8%
of revenues in the corresponding quarter of the previous fiscal year. The
increase in gross margin on an adjusted basis for the three months ended July
31, 2002 was due to component cost reductions and yield improvements partially
offset by changes in product mix.
Research and Development
- ------------------------
Research and development expenses for the three months ended July 31, 2002
and 2001 were approximately $2.6 million and $1.7 million, respectively. As a
percentage of revenues, research and development expenses for the three months
ended July 31, 2002 and 2001 represented 15.6% and 15.1%, respectively. Our
research and development expenses for the three months ended July 31, 2002
increased by approximately $1.0 million from the same period in the prior year
due to a $0.6 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 salaries and payroll-related
expenses associated with additional personnel. Research and development
expenses consist primarily
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
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, all of which may fluctuate
significantly from period to period as a result of our product development
cycles. We expect that our future research and development expenses may
increase in absolute dollars and as a percentage of revenues as we design and
develop our next generation of CameraChip products.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses for the three months ended
July 31, 2002 and 2001 were approximately $2.1 million and $3.2 million,
respectively. The decrease in selling, general and administrative expenses of
approximately $1.1 million for the three months ended July 31, 2002 from the
same period in the prior year was a result primarily of the approximately $1.7
million decrease in legal expenses associated with patent litigation in fiscal
year 2002. The decrease in legal expenses was partially offset by a $0.2
million increase in commissions related to increased revenues and $0.2 million
in increased salaries and payroll related expenses associated with additional
personnel. As a percentage of revenues, selling, general and administrative
expenses for the three months ended July 31, 2002 and 2001 represented 12.4%
and 29.0%, respectively. Selling, general and administrative expenses decreased
as a percentage of revenues for the three months ended July 31, 2002 from the
three months ended July 31, 2001 as a result primarily of the decrease in legal
expenses associated with patent litigation combined with the increase in
revenues. We expect that our future selling, general and administrative
expenses may increase in absolute dollars and may decrease as a percentage of
revenues.
Stock Compensation Charge
- -------------------------
We incurred stock compensation charges of approximately $0.1 million and
$0.2 million for the three months ended July 31, 2002 and 2001, respectively.
As of July 31, 2002, deferred compensation totaled approximately $5.2 million
and represents the difference between the deemed fair market value of our
common stock on the date of grant and the exercise price of stock options to
purchase our common stock on the date of grant, is amortized on an accelerated
basis as the options vest. We expect deferred compensation charges of
approximately $0.4 million as of July 31, 2002 are to be amortized on an
accelerated basis over the vesting period of the stock options of generally
five years.
Stock Option Exchange Program
- -----------------------------
On November 1, 2001, we announced a voluntary stock option exchange
program for our employees. Under the program, our employees were given the
opportunity to elect to cancel outstanding stock options held by them in
exchange for an equal number of new options to be granted on June 5, 2002. The
exchange program was not available to our executives, directors or any of our
employees who live or work outside the United States. These elections were
required to be made by December 3, 2001. On June 5, 2002, we issued options to
purchase 46,400 shares of common stock at an exercise price equal to the
closing price of our common stock on June 4, 2002. We did not record any
compensation expenses associated with this exchange program.
Interest Income (Expense), Net
- ------------------------------
Interest income and interest expense, net for the three months ended July
31, 2002 and 2001 were income of approximately $0.2 million and $0.6 million,
respectively. Interest income and interest expense, net, decreased for the
three months ended July 31, 2002 primarily due to a decline in interest rates.
These funds are invested in interest-bearing accounts consisting primarily of
high-grade corporate securities and money market accounts maturing
approximately twelve months or less from the date of purchase.
Provision for Income Taxes
- --------------------------
We generated approximately $1.9 million and $0.5 million in income before
income taxes for the three months ended July 31, 2002 and 2001, respectively.
We recorded a provision for income taxes for the three months ended
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
July 31, 2002 of approximately $0.3 million and we had no provision for income
taxes in the comparable prior year period after taking into consideration the
utilization of the prior years' net operating loss carryforwards and credits.
Liquidity and Capital Resource
- ------------------------------
Principal sources of liquidity at July 31, 2002 consisted of cash and cash
equivalents of $56.3 million.
Our working capital increased by approximately $1.3 million to $66.4
million as of July 31, 2002 from $65.1 million as of April 30, 2002. The
increase was primarily attributable to a $2.8 million increase in both
inventories and accounts receivable, consistent with the increase in revenues
from prior year levels during the three months ended July 31, 2002, and a $1.3
million increase in prepaid expenses and other assets, partially offset by a
$2.0 million decrease in short-term investments and a $3.7 million increase in
accounts payable.
For the three months ended July 31, 2002, our use of cash in operating
activities totaled approximately $0.9 million as compared to cash provided by
operating activities of $3.6 million for the similar period in the prior year,
primarily due to a $2.8 million increase in inventories to support future sales
and a $2.8 million increase in accounts receivable consistent with the increase
in current quarter revenues, and a $1.3 million increase in prepaid expenses
and other assets, which were partially offset by net income of approximately
$1.6 million for the three months ended July 31, 2002 and $3.7 million increase
in accounts payable.
For the three months ended July 31, 2002, our cash provided by investing
activities increased to approximately $0.5 million from a use of $0.3 million
for the similar period in the prior year, primarily due to $2.0 million in
proceeds from the sale of short-term investments, partially offset by $1.5
million in purchases of property, plant and equipment. Net cash used for
investing activities of $0.3 million for the three months ended July 31, 2001,
resulted from purchases of property, plant and equipment.
For the three months ended July 31, 2002, net cash provided by financing
activities increased to approximately $0.8 million from $0.3 million for the
similar period in the prior year. The increase was primarily due to an increase
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 which totaled $0.8 million during the three months ended July 31,
2002 as compared to $0.3 million for the similar period in the prior year.
Contractual Obligations and Commercial Commitments
- --------------------------------------------------
The following summarizes our contractual obligations and commercial
commitments as of July 31, 2002 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............. $ 1,478 $ 758 $ 720 $ -- $ --
Other Commercial Commitments
- ----------------------------
Investment in China.......... 22,500 -- 22,500 -- --
-------- ------ -------- ----- -------
Total contractual obligations
and commercial commitments. $ 23,978 $ 758 $ 23,220 $ -- $ --
======== ====== ======== ===== =======
The $22.5 million commercial commitment referenced in the table above
regarding our investment in China relates to the remaining $22.5 million of
registered capital for HuaWei Semiconductor, which is an obligation of HuaWei.
We established HuaWei Semiconductor as part of our efforts to reduce the costs
associated with the testing of our CMOS image sensors. We currently anticipate
that in addition to using HuaWei Semiconductor as a testing facility, we may
expand the scope of our operations at HuaWei Semiconductor to include other
processes associated with the manufacturing of our products, such as color
filter applications. We currently anticipate that development
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
efforts for HuaWei Semiconductor will require additional capital expenditures
of approximately $30.0 million through April 30, 2003. We expect to fund HuaWei
Semiconductor through a combination of funds invested directly through HuaWei
from our available working capital and by investments from third parties. Third
party financing for HuaWei Semiconductor could include debt financing from
banking institutions or an equity financing transaction. 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 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 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 foreseeable working
capital requirements. 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.
Other Matters
- -------------
The Audit Committee approved the non-audit services and associated fees to
be performed by PricewaterhouseCoopers LLP.
Internal Controls
- -----------------
We perform an ongoing review of internal controls as appropriate for our
accounting and reporting requirements. Subsequent to the date of our latest
evaluation of internal controls, there were no significant changes in our
internal controls or other factors that could significantly affect these
controls.
FACTORS AFFECTING FUTURE RESULTS
You should carefully consider these risk factors, together with all of the
other information included in this Quarterly Report on Form 10-Q. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently deem
immaterial may also harm our business.
We have a history of losses, and in future periods we may not be able to
- ------------------------------------------------------------------------
achieve or sustain profitability.
- --------------------------------
We incurred net losses of approximately $1.3 million in fiscal 2002 and
$11.6 million in fiscal 2001. In fiscal 2000, the only year in which we were
profitable on a fiscal year basis, our net income was approximately $3.4
million. In the three months ended July 31, 2002, our net income was $1.6
million. We may not be able to achieve profitability in future periods,
including subsequent quarters or on an annual basis in fiscal 2003 and beyond.
In the future, we expect to incur significant expenses, including expenses
related to our research and development efforts, including the development of
new products and expenses related to the funding of HuaWei Semiconductor, which
could impair our ability to achieve and sustain profitability. In addition, as
we hire additional personnel and possibly engage in larger business
transactions, we expect selling, general and administrative expenses to
increase. We will also incur substantial noncash charges relating to the
amortization of unearned compensation. Other risks, such as product yields and
competition, associated with our business described elsewhere in this section,
many of which are beyond our control, could also affect our ability to achieve
and sustain profitability. If our revenues do not increase, we may not
subsequently achieve or sustain profitability.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The continued economic slowdown has adversely affected our revenues and may
- ---------------------------------------------------------------------------
continue to do so in the future.
- -------------------------------
Since the third quarter of fiscal 2001, our customers and distributors,
primarily our PC video camera customers and distributors, have been impacted by
significantly lower demand for camera related products, which forced them to
unexpectedly reschedule or cancel orders for our products. As a result, our
revenues and earnings have been adversely affected. If the macroeconomic
climate, especially with respect to investments in technology such as ours,
does not improve, our revenues and operating results may continue to be
adversely affected. In addition, if the demand for our products, and in
particular our camera-related products such as PC video cameras, does not
increase as we expect, or if it were to lessen for any reason, we may not be
able to meet analysts' projections for future operating results, which would
likely cause our stock price to decline, potentially significantly.
Problems with wafer manufacturing yields could result in higher operating
- -------------------------------------------------------------------------
costs, and could impair our ability to meet customer demands for our products.
- -----------------------------------------------------------------------------
The fabrication of our products requires wafers to be produced in a highly
controlled and clean environment. Semiconductor companies that supply our
wafers sometimes have experienced problems achieving acceptable wafer
manufacturing yields. Semiconductor manufacturing 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. Yield problems may not be determined or improved
until an actual image sensor is made and can be tested. As a result, yield
problems may not be identified until the wafers are well into the production
process. We only test our products after they are assembled, as their optical
nature makes earlier testing difficult and expensive. The risks associated with
yields are even greater 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. If the foundries cannot
achieve the planned yields, this will result in higher costs and reduced
product availability. Problems with wafer manufacturing yields may also impair
our ability to timely deliver products to our customers which could adversely
affect our customer relations and make it more difficult to sustain and grow
our business.
We may not adequately forecast the number of wafers we need, and therefore we
- -----------------------------------------------------------------------------
may not be able to react to fluctuations in demand for our products, which
- --------------------------------------------------------------------------
could adversely affect our operating results.
- --------------------------------------------
We must forecast the number of wafers we need from each of our foundries.
However, if customer demand falls below our forecast and we are unable to
reschedule or cancel our wafer orders, we may retain excess wafer inventories,
which could adversely affect our operating results, including a reduction in
our gross margins. Conversely, if customer demand exceeds our forecasts, we may
be unable to obtain an adequate supply of wafers to fill customer orders, which
could result in lost sales which could harm our relationship with existing
customers and potential customers and impair our ability to grow our business.
We have experienced problems with accurately estimating wafer requirements in
the past. For example, as a consequence of a product order forecast which
proved to be greater than market demand for our products, we recognized an
$18.7 million inventory adjustment in fiscal 2001.
We face intense competition in our markets from more established CCD image
- --------------------------------------------------------------------------
sensor manufacturers and CMOS image sensor manufacturers, and, if we are unable
- -------------------------------------------------------------------------------
to compete successfully, we will not achieve our financial objectives.
- ---------------------------------------------------------------------
The image sensor market is intensely competitive. These markets are
characterized by rapid technological change, evolving standards, short product
life cycles and decreasing prices. Our current products face competition from a
number of sources including companies which sell CCD image sensors as well as
other companies which sell multiple chip CMOS image sensors. We cannot assure
you that we can compete successfully against current or potential competitors,
or that competition will not seriously harm our business by reducing sales of
our products, reducing our profits and reducing our market share. We expect
competition in our markets to increase.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Many of our competitors have longer operating histories, greater presence
in key markets, greater name recognition, larger customer bases 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
product than we may. Our competition includes CCD image sensor manufacturers,
including Fuji Corporation, or Fuji, Matsushita Electric Industrial, or
Matsushita, Nippon Electric Corporation or NEC, Sharp Corporation, or Sharp,
Sony Corporation, or Sony, and Toshiba Corporation, or Toshiba, as well as CMOS
image sensor manufacturers such as Agilent Technologies, Inc., Conexant
Systems, Inc., Hyundai Electronics Industries Co. Ltd., IC Media, Mitsubishi
Electronic, Motorola, Inc., National Semiconductor, ST Microelectronics and
Toshiba Corporation. In addition, there are a large number of smaller startup
companies, including Photobit Corporation and Zoran Corporation, which may or
do compete with us. In particular, Hyundai and Agilent Technologies ship
significant volumes of multiple chip CMOS image sensors.
In addition, for competitive reasons, or otherwise, some of our
competitors may acquire or enter into strategic or commercial agreements or
arrangements with our foundries or third party providers of color filter
processing, assembly services or packaging services. As a result of such
agreements or arrangements, our ability to secure sufficient capacity from
these manufacturers and service providers to meet our customer demands may be
impaired. In addition, competitors may enter into exclusive relationships with
product distributors, which could impair our ability to sell our products and
grow our business. We have experienced these types of competitive pressures in
the past. In 1999, we had to replace one of our largest distributors with
Wintek Electronics Co., Ltd., because that distributor decided to distribute a
competitor's products.
We depend on a limited number of third party wafer foundries to manufacture a
- -----------------------------------------------------------------------------
substantial majority of our products, which reduces our ability to control the
- ------------------------------------------------------------------------------
manufacturing process.
- ---------------------
We do not own or operate a semiconductor fabrication facility. We rely on
TSMC and PSC to produce a substantial majority of our wafers and final
products. Our reliance on these 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; and
o unavailability of, or delayed access to, next generation or key process
technologies.
We do not have long term supply agreements with any of our foundries and
instead secure manufacturing availability on a purchase order basis. These
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. Our requirements represent a small portion of the
total production capacities of these foundries and TSMC or PSC may reallocate
capacity to other customers, even during periods of high demand for our
products. If any of our foundries were to become unable or unwilling to
continue manufacturing our wafers in the required volumes, at acceptable
quality, yields and costs and in a timely manner, our business would be
seriously harmed. As a result, we would have to identify and qualify substitute
foundries, which would be time consuming and difficult and could result in
unforeseen manufacturing and operations problems. In addition, if competition
for foundry capacity increases, our product costs may increase, and we may be
required to pay or invest significant amounts to secure access to manufacturing
services. We are also exposed to additional risks if we decide to transfer our
production of semiconductors from one foundry to another. We may qualify
additional foundries in the future, which is a time consuming and difficult
process that could result in unforeseen product or operation problems. If we do
not qualify additional foundries, we may be exposed to increased risk of
capacity shortages due to our complete dependence on our foundries.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Our reliance on third party vendors for color filter processing services could
- ------------------------------------------------------------------------------
adversely affect our ability to deliver our products to our customers and
- -------------------------------------------------------------------------
reduces our control over delivery schedules, product quality and cost.
- ---------------------------------------------------------------------
After our wafers are produced, they are color filter processed by two
independent vendors, TSMC and Toppan. We do not have long-term agreements with
any of these vendors and typically obtain services from them on a purchase
order basis. If for any reason one or more of our current vendors was unable or
unwilling to continue to provide color filter processing services and deliver
products of acceptable quality, at acceptable costs and in a timely manner,
this could severely impair our ability to deliver our products to our customers
which would harm our operating results and prospects. We would also have to
identify and qualify substitute vendors, which could be time consuming and
difficult and result in unforeseen operations problems. If competition for
color filter processing capacity increases, our product costs may increase, and
we may be required to pay or invest significant amounts to secure access to
these services. There are a limited number of companies that provide these
services, and in the event our current providers of color filtering processing
services refuse or are unable to continue to provide these services to us, we
may not be able to procure these services from alternate service providers.
Furthermore, if customer demand for our products increases, we may not be able
to secure sufficient additional capacity from our current service providers on
commercially reasonable terms, if at all. Moreover, our reliance on third party
vendors to provide color filter processing services involves risks such as
reduced control over delivery schedules, quality assurance and costs. These
risks could result in product shortages or could increase our costs of
manufacturing, assembling or testing our products.
We rely on a limited number of third party vendors to provide packaging
- -----------------------------------------------------------------------
services for our CMOS image sensors.
- -----------------------------------
We have historically outsourced our entire packaging requirement for our
image sensors to Kyocera, PPSC and Alphatec. Kyocera is currently our sole
provider of ceramic chip packages which are generally used in our higher-priced
products. In addition, PPSC is currently the sole provider of plastic chip
packages, which are generally used in our lower-priced product lines. Plastic
packaging services are important to our ability to reduce costs because plastic
packaging is less expensive than ceramic packaging and, consequently, our
industry is evolving to rely more heavily on plastic packaging. We do not
currently have long-term agreements with any of these vendors and typically
obtain services from them on a purchase order basis. If one or more of these
current vendors was unable or unwilling to continue to provide these packaging
services for any reason, our ability to deliver our CMOS image sensors could be
materially adversely affected which would harm our operating results and
prospects. If competition for packaging capacity increases, our product costs
may increase, and we may be required to pay or invest significant amounts to
secure access to these services. We would also have to identify and qualify
substitute vendors, which could be time consuming and difficult and result in
unforeseen operations problems. There are a limited number of companies that
provide these services, and in the event our current packaging service
providers refuse or are unable to continue to provide these services to us, we
may not be able to procure these services from alternate third party service
providers. Furthermore, if customer demand for our products increases, we may
not be able to secure sufficient additional capacity from our current packaging
service providers on commercially reasonable terms, if at all. Moreover, we
rely on these packaging vendors for quality assurance purposes, which affects
our yields. If we experience quality control problems with the packaging of our
products, this could result in product shortages or could increase the costs of
manufacturing, assembling and testing our products, which would adversely
affect our gross margins.
Our ability to deliver products that meet our customers' requirements is
- ------------------------------------------------------------------------
dependent upon our ability to meet new and changing requirements for color
- --------------------------------------------------------------------------
filter processing and assembly and product packaging.
- ----------------------------------------------------
We expect that, as our products develop to meet new and changing industry
and customer requirements, our requirements for color filter processing and
ceramic and plastic packaging services will also evolve. We expect that our
industry will continue to evolve to adopt to incorporate new technologies and
materials that improve the quality of image sensor products and also reduce
manufacturing costs. Our ability to deliver products that meet customer demands
and our ability to attain and sustain profitability is dependant upon our
ability to procure services that meet these new requirements on a cost-
effective basis. We have historically relied exclusively on third parties to
provide
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
these services, and there can be no assurances that these third parties will be
able to provide services that meet new requirements. Furthermore, even if these
third party vendors are able to provide services that meet the new and evolving
requirements, these services may not be available on a cost basis that enables
us to achieve or sustain profitability.
We do not have long-term commitments from our customers, and we allocate
- ------------------------------------------------------------------------
resources based on our estimates of customer demand, which could lead to excess
- -------------------------------------------------------------------------------
inventory and lost revenue opportunities.
- ----------------------------------------
Our sales are generally made on the basis of purchase orders rather than
long-term purchase commitments. In addition, our customers may cancel or defer
purchase orders. We manufacture our products according to our estimates of
customer demand, which are based on historical trends. This process requires us
to make multiple demand forecast assumptions, each of which may introduce error
into our estimates. If we overestimate customer demand, we may allocate
resources to manufacturing products that we may not be able to sell or we may
have to sell our products to other customers for lower prices. As a result, we
would have excess inventory, which would have an adverse impact on our results
of operations. For example, one customer, Creative, unexpectedly cancelled its
purchase orders for one of our products in the second quarter of fiscal 2001,
which resulted in our shipping substantially fewer quantities to them in the
third and fourth quarters of fiscal 2001 and contributed to a higher than
expected inventory position. Conversely, if we underestimate customer demand or
if sufficient manufacturing capacity is unavailable, we may forego revenue
opportunities, lose market share and damage our customer relationships.
Fluctuations in our quarterly operating results make it difficult to predict
- ----------------------------------------------------------------------------
our future performance and may result in volatility in the market price of our
- ------------------------------------------------------------------------------
common stock.
- ------------
Our quarterly operating results have varied significantly from quarter to
quarter in the past and are likely to vary significantly in the future based on
a number of factors , many of which are beyond our control. These factors, many
of which are more fully discussed in other risk factors, include:
o our ability to manage our product transitions;
o our ability to accurately forecast the number of wafers we need;
o our ability to achieve acceptable wafer manufacturing yields;
o the mix of the products we sell and the distribution channels through
which they are sold; and
o the availability of production capacities at the semiconductor foundries
that manufacture our products or components of our products.
In the past, our introduction of new products and our product mix have
affected our quarterly operating results. Changes in our product mix could
adversely affect our operating results because some products provide higher
margins than others. We typically experience lower yields in the manufacturing
of newer products, and consequently our gross margins with new products have
historically been lower than our gross margins from our older, more established
products. We also anticipate that the rate of orders from our customers may
vary significantly from quarter to quarter. Our expenses, including our future
capital commitments such as those with HuaWei Semiconductor, and our inventory
levels are based on our expectations of future revenues and are relatively
fixed. Consequently, if revenues in any quarter do not occur when expected,
expenses and inventory levels could be disproportionately high and our
operating results for that quarter and, potentially future quarters, may be
harmed.
Certain other factors have in the past caused and are likely in the future
to cause fluctuations in our quarterly operating results. These factors are
industry risks over which we have little or no control. These factors include:
o the growth of the market for products and applications using CMOS image
sensors;
o the timing and amount of orders from our customers, including camera
manufacturers and distributors;
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
o the deferral of customer orders in anticipation of new products, designs
or enhancements by us or our competitors; and
o the announcement and introduction of products and technologies by our
competitors.
Any one or more of these factors is difficult to forecast and could result
in fluctuations in our quarterly operating results. Our revenue or operating
results in a given quarter could be substantially less than anticipated by
market analysts, which could result in a substantial decline in our stock
price. In addition, quarter-to-quarter variations, such as those recently
experienced, could create uncertainty about the direction or progress of our
business, which could also result in a decline in the price of our common
stock. Our revenues and operating results will vary from quarter to quarter for
many reasons beyond our control, including those described in this section. As
a result, our quarterly revenues and operating results are not predictable with
any significant degree of accuracy. In addition, historical revenue growth
rates will not necessarily be sustainable in the future or indicative of future
growth rates. If our revenue growth rates slow or our revenues decline, our
operating results could be seriously impaired because many of our expenses are
fixed and cannot be easily or quickly changed, which could lead to a dramatic
decline in our stock price. Fluctuations in our quarterly operating results
could adversely affect the price of our common stock in a manner unrelated to
our long-term operating performance.
Declines in our average sales prices may result in declines in our gross
- ------------------------------------------------------------------------
margins.
- -------
Because the image sensor market is characterized by intense competition,
and price reductions for our products are necessary to meet consumer price-
points, we expect to experience market driven pricing pressures. We expect that
there will be a continued decline in average sales prices for many of our
products. We believe that we can offset declining average sales prices.
However, if we are unable to achieve cost reductions by achieving manufacturing
cost efficiencies and technological advances, or are unable to timely introduce
new products that incorporate more advanced technology and include more
advanced features that can be sold at stable average gross margins, we will
lose revenues and gross margins will decline.
We depend on the acceptance of CMOS technology for mass market image sensor
- ---------------------------------------------------------------------------
applications, and any delay in the widespread acceptance of this technology
- ---------------------------------------------------------------------------
could adversely affect our ability to increase our revenues and improve our
- ---------------------------------------------------------------------------
earnings.
- --------
Our business strategy depends on the rapid and widespread adoption of the
CMOS fabrication process for image sensors and the acceptance of our single
chip technology. The image sensor market has been dominated by CCD technology
for over 25 years. Although CMOS technology has been available for over 20
years, CMOS technology has only recently been used in image sensors. Along with
the other risk factors described in this section, the following are examples of
factors may delay the widespread adoption of the CMOS fabrication process and
our single chip technology, the occurrence of any of which could adversely
affect our ability to increase our revenues and earnings:
o the failure of the emergence of a universal platform for imaging
solutions for computers and the Internet;
o improvements or cost reductions to CCD image sensors, which could slow
the adoption of CMOS image sensors in markets already dominated by CCD
image sensors, such as the security and surveillance market.
o the failure of development of user friendly and affordable products; and
o the limited availability of bandwidth to run CMOS image sensor
applications; and
o the uncertainty of emerging markets for products incorporating CMOS
technology.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
If the demand for our products in current markets and emerging markets fails to
- -------------------------------------------------------------------------------
increase as we anticipate, our growth prospects would be diminished.
- -------------------------------------------------------------------
Our success depends in large part on the continued growth of various
markets, in particular the markets for digital still cameras, video phones,
including video cell phones, and security and surveillance products that use
our products and the emergence of new markets for our products. The current
markets that use our products include digital still cameras, personal computer
cameras, personal digital assistant cameras, mobile phone cameras, cameras for
security and surveillance systems, closed circuit television systems, cameras
for toys and games and automotive applications. Emerging markets for our
products include cameras for personal identification systems, medical imaging
devices, machine control systems, and videophones. If these markets do not
continue to grow and develop, the need for cameras which are lower in cost,
smaller, lighter in weight, more reliable and which consume less power might
not fully develop. In such case, it would be unlikely that our products would
achieve commercial success.
Failure to obtain design wins could cause our revenues to level off or decline.
- ------------------------------------------------------------------------------
Our future success will depend on camera manufacturers designing our image
sensors into their systems. To achieve design wins, which are decisions by
those manufacturers to design our products into their systems, we must define
and deliver cost effective, innovative and integrated semiconductor solutions.
Once a manufacturer has designed a supplier's products into its systems, the
manufacturer may be reluctant to change its source of components due to the
significant costs associated with qualifying a new supplier. Accordingly, the
failure to achieve design wins with key camera manufacturers could decrease our
market share or revenues.
Historically, our revenues have been dependent upon a few key customers and
- ---------------------------------------------------------------------------
distributors, and the loss of any of them could significantly reduce our
- ------------------------------------------------------------------------
revenues.
- --------
Historically a relatively small number of customers and distributors have
accounted for a significant portion of our product revenues, however, for the
three months ended July 31, 2002, no single OEM customer accounted for 10% or
more of revenues. For the three months ended July 31, 2001, one of our security
camera manufacturer customers, X10, represented approximately 54% of revenues.
Our two largest distributors during the three months ended July 31, 2002 were
Gain Tune and World Peace, which accounted for 13.7% and 10.7% of revenues,
respectively. Gain Tune is an affiliated entity of World Peace. Our two largest
distributors during the three months ended July 31, 2001 were World Peace,
which accounted for 8% of revenues, and SEC, which accounted for 6% of
revenues.
A significant reduction, delay or cancellation of orders from our key
customers or distributors, or a decision by them to select or distribute
products manufactured by a competitor could seriously harm our business. For
example, in 1999, we had to replace one of our largest distributors with Wintek
Electronics Co., Ltd., because that distributor decided to distribute a
competitor's products. We expect our operating results to continue to depend on
sales to or design decisions of a relatively small number of distributors and
camera manufacturers.
Seasonality in our business will cause our results of operations to fluctuate
- -----------------------------------------------------------------------------
from period to period and could cause our stock price to fluctuate or decline.
- -----------------------------------------------------------------------------
Sales of our image sensors are subject to seasonality. Some of the
products using our image sensors, such as personal computer video cameras and
digital still cameras, are consumer electronics goods. Typically, these goods
are subject to seasonality with generally increased consumer sales in November
and December due to the holidays. As a result, product sales are impacted by
seasonal purchasing patterns with higher sales generally occurring in the
second half of the calendar year. In addition, we typically experience a
decrease in orders in the quarter ended January 31 from our Chinese and
Taiwanese customers primarily due to the Chinese New Year. As a result, we
believe product sales are impacted by seasonal purchasing patterns with higher
sales generally occurring in the second half of the calendar year.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Our lengthy manufacturing, packaging and assembly cycle, in addition to our
- ---------------------------------------------------------------------------
customers' design cycle, may result in uncertainty and delays in generating
- ---------------------------------------------------------------------------
revenues.
- --------
Manufacturing our image sensors requires a lengthy manufacturing,
packaging and assembly process, typically lasting four months or more. It can
take additional time before a customer commences volume shipments of products
that incorporate our image sensors. Even when a manufacturer decides to design
our image sensors into its products, the manufacturer may never ship final
products incorporating our image sensors. Given this lengthy cycle, we
experience a delay between the time we incur expenditures for research and
development and sales and marketing efforts and the time we generate revenues,
if any, from these expenditures. As a result, our revenues and profits could be
seriously harmed if a significant customer reduces or delays orders or chooses
not to release products incorporating our products.
Our dependence on selling through distributors increases the complexity of our
- ------------------------------------------------------------------------------
business which may increase our operating costs and may reduce our ability to
- -----------------------------------------------------------------------------
forecast revenues.
- -----------------
Our revenues depend on design wins with new camera manufacturers. These
camera manufacturers rely on third party manufacturers or distributors to
provide inventory management and purchasing functions. Selling through
distributors reduces our ability to forecast sales and increases the complexity
of our business, requiring us to, among other matters:
o manage a more complex supply chain;
o manage the level of inventory at each distributor;
o provide for credits, return rights and price protection;
o estimate the impact of credits, return rights, price protection and
unsold inventory at distributors; and
o monitor the financial condition and credit worthiness of our
distributors.
Any failure to manage these challenges could reduce impair our ability to
achieve market acceptance for our products, thereby adversely affecting our
revenues and operating results.
We may never achieve the anticipated benefits from our planned operations in
- ----------------------------------------------------------------------------
Shanghai. In addition, our Shanghai operations involve substantial capital
- ---------------------------------------------------------------------------
expenditures.
- ------------
In December 2000, we established HuaWei Semiconductor as part of our
efforts to reduce the costs associated with the testing of our CMOS image
sensors. We currently anticipate that in addition to using HuaWei
Semiconductor as a testing facility, we may expand the scope of our operations
at HuaWei Semiconductor to include other processes associated with the
manufacturing of our products, such as color filter applications. We may never
achieve the anticipated benefits from our planned operations in Shanghai.
Because of potential problems with establishing a testing facility or with
expanding the operations of HuaWei Semiconductor to include other processes
associated with manufacturing our products, including technology and
infrastructure risks, we may not be able to lower the costs of manufacturing
our products. In addition, there may be significant administrative, legal and
governmental barriers in China, which may harm us or prevent us from beginning
operation of this Chinese subsidiary. If our ongoing investment in the Chinese
subsidiary does not result in offsetting gains in the form of operating cost
reductions, whether because of the risks and difficulties entailed by foreign
operations or for other reasons, our business and financial condition will be
adversely affected.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Our operating through HuaWei Semiconductor will involve substantial risks
that could increase our operating expenses and adversely affect our operating
results, financial condition, ability to deliver our products and grow our
business, including:
o difficulties in staffing and managing foreign operations, in particular
attracting and retaining qualified, personnel in designing, selling and
supporting CMOS image sensors;
o difficulties in integrating our operations in Shanghai with those in
Sunnyvale, California;
o disruption of our current business operations, including diversion away
from other business issues;
o difficulty in maintaining uniform standards, controls, procedures and
policies;
o political and economic instability which may have an adverse impact on
foreign exchange rates in Asia, and could impair our ability to conduct
our business in the affect foreign locations; and
o inadequacy of local infrastructure.
We also face potential risks associated with capital requirements for
HuaWei Semiconductor. Of HuaWei Semiconductor's $30.0 million in registered
capital, $7.5 million had been funded as of July 31, 2002. HuaWei made this
investment in HuaWei Semiconductor through capital provided by us from our
available working capital. Of the remaining $22.5 million of registered capital
for HuaWei Semiconductor, which is an obligation of HuaWei, $4.5 million must
be funded by January 2004 and $18.0 million must be funded by January 2005. We
currently anticipate that development efforts for HuaWei Semiconductor will
require additional capital expenditures of approximately $30.0 million through
April 30, 2003. We expect to fund HuaWei Semiconductor through a combination of
funds invested directly through HuaWei from our available working capital and
by investments from third parties. Third party financing for HuaWei
Semiconductor could include debt financing from banking institutions or an
equity financing transaction. Third party financing may not be available to us
when and as required or on terms that are favorable to us and our stockholders.
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, of would dilute the ownership interests of our existing
stockholders and the issuance of debt securities could increase the risk or
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. In addition, Chinese law may prevent the use of
capital committed to HuaWei Semiconductor outside of China.
In addition to risks we face in connection with our planned operations in
- -------------------------------------------------------------------------
Shanghai, we face foreign business, political and economic risks because a
- --------------------------------------------------------------------------
majority of our products, and our customers' products are manufactured and sold
- -------------------------------------------------------------------------------
outside of the United States.
- ----------------------------
Historically, the manufacturing, processing and assembly of our products
has principally been conducted by foreign third-party manufacturers and service
providers. Because our headquarters are located in Sunnyvale, California we
face difficulties in managing our third party foundries, color filtering
application service providers and ceramic and plastic service providers, which
are all located in Asia, and our foreign distributors. In addition, potential
political and economic instability, may have an adverse impact on foreign
exchange rates in Asia, and could impair the ability of important manufacturing
and other service providers from providing the services that we need.
Potential adverse effects of tariffs, duties, price controls or other
restrictions that impair trade, which could result in regulations which impair
our ability to conduct business or could result in increased and unforeseen
costs.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
In addition, many of our customers are camera manufacturers or are the
manufacturers or suppliers for camera manufacturers and are located in Hong
Kong, Japan, Korea and Taiwan. In addition, sales outside of the United States
accounted for approximately 83% of our revenues for the three months ended July
31, 2002 and 74% of our revenues for fiscal 2002. We anticipate that sales
outside of the United States will continue to account for a substantial portion
of our revenue in future periods. Dependence on sales to foreign customers
involves certain risks, including:
o longer payment cycles;
o the adverse effects of tariffs, duties, price controls or other
restrictions that impair trade; and
o difficulties in accounts receivable collections.
In addition, camera manufacturers who design our solutions into their
products sell them outside of the United States. This exposes us indirectly to
foreign risks. Because sales of our products have been denominated to date
exclusively in United States dollars, increases in the value of the United
States dollar will increase the price of our products so that they become
relatively more expensive to customers in the local currency of a particular
country, leading to a reduction in revenues and profitability in that country.
A portion of our international revenues may be denominated in foreign
currencies in the future, which will subject us to risks associated with
fluctuations in those foreign currencies.
Our success depends on the development and introduction of new products, which
- ------------------------------------------------------------------------------
we may not be able to do in a timely manner because the process of developing
- -----------------------------------------------------------------------------
products using CMOS image sensors is complex and costly.
- -------------------------------------------------------
The development of new products is highly complex, and we have experienced
delays in completing the development and introduction of new products on
several occasions in the past, some of which exceeded six months. As our
products integrate new and more advanced functions, they become more complex
and increasingly difficult to design and debug. Successful product development
and introduction depend on a number of factors, including:
o accurate prediction of market requirements and evolving standards,
including pixel resolution, output interface standards, power
requirements, optical lens size, input standards and operating systems
for personal computers and other platforms;
o development of advanced technologies and capabilities;
o definition of new products which satisfy customer requirements;
o timely completion and introduction of new product designs;
o use of leading edge foundry processes and achievement of high
manufacturing yields; and
o market acceptance of the new products.
Accomplishing all of this is extremely challenging, time consuming and
expensive. We cannot assure you that any new products or product enhancements
will be developed in time to capture market opportunities or achieve a
significant or sustainable level of acceptance in new and existing markets. The
failure to successfully develop new products that achieve market acceptance
would adversely affect our operating results and impact our ability to grow our
business.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
The high level of complexity and integration of functions of our products
- -------------------------------------------------------------------------
increases the risk of latent defects which could damage customer relationships
- ------------------------------------------------------------------------------
and increase our costs.
- ----------------------
Because we integrate many functions on a single chip, our products are
complex. The greater integration of functions and complexity of operations of
our products, the greater the risk that latent defects or subtle faults could
be discovered by customers or end users after volumes of product have been
shipped. Although we test our products, they may contain defects and errors. In
the past we have encountered defects and errors in our products. Delivery of
products with defects or reliability, quality or compatibility problems may
damage our reputation and our ability to retain existing customers and attract
new customers. In addition, product defects and errors could result in
additional development costs, diversion of technical resources, delayed product
shipments, increased product returns, product warranty costs for recall and
replacement and product liability claims against us which may not be fully
covered by insurance.
We maintain a backlog of customer orders which is subject to cancellation or
- ----------------------------------------------------------------------------
delay in delivery schedules, and any cancellation or delay may result in lower
- ------------------------------------------------------------------------------
than anticipated revenues.
- -------------------------
We manufacture and market primarily standard products. Our sales are
generally made pursuant to standard purchase orders. We include in our backlog
only those customer orders for which we have accepted purchase orders and
assigned shipment dates within the upcoming 12 months. Although our backlog is
typically filled within two to four quarters, orders constituting our current
backlog are subject to cancellation or changes in delivery schedules, and
backlog may not necessarily be an indication of future revenue. In addition,
the current backlog will not necessarily lead to revenues in any future period.
Any cancellation or delay in orders which constitute our current or future
backlog may result in lower than expected revenues. Our bookings visibility
continues to be limited with a substantial majority of our quarterly product
revenues coming from orders that are received and fulfilled in the same
quarter.
Our business could be harmed if we lost the services of one or more members of
- ------------------------------------------------------------------------------
our senior management team.
- --------------------------
The loss of the services of one or more of our executive officers or key
employees, or the decision of one or more of these individuals to join a
competitor, could adversely affect our business and harm our operating results
and financial condition. Our success depends to a significant extent on the
continued service of our senior management and other key technical personnel.
None of our senior management is bound by an employment or non-competition
agreement. We do not maintain key man life insurance on any of our employees.
We must attract and retain qualified personnel to be successful, and
- --------------------------------------------------------------------
competition for qualified personnel is intense in our market.
- ------------------------------------------------------------
Our success depends to a significant extent upon the continued
contributions of our key management, technical and sales personnel, many of
whom would be difficult to replace. The loss of one or more of these employees
could seriously harm our business. We do not have key person life insurance on
any of our key personnel. We have no term employment agreements with our
employees. Our success also depends on our ability to identify, attract and
retain qualified technical (particularly analog or mixed signal design
engineers), sales, marketing, finance and management personnel. Competition for
qualified personnel is intense in our industry and in Silicon Valley,
California. This is due to a number of factors, including the high
concentration of established and emerging growth technology companies. This
competition makes it difficult to retain our key personnel and to recruit new
qualified personnel. We have experienced, and may continue to experience,
difficulty in hiring and retaining candidates with appropriate qualifications.
If we do not succeed in hiring and retaining candidates with appropriate
qualifications, our revenues and product development efforts could be harmed.
We may be unable to adequately protect our intellectual property and therefore
- ------------------------------------------------------------------------------
we may lose some of our competitive advantage.
- ---------------------------------------------
We rely on a combination of patent, copyright, trademark and trade secret
laws, as well as nondisclosure agreements and other methods to protect our
proprietary technologies. We have been issued patents and have a number of
pending United States and foreign patent applications. However, we cannot
assure you that any patent will
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
issue as a result of any applications or, if issued, that any claims allowed
will be sufficiently broad to protect our technology. In addition, it is
possible that existing or future patents may be challenged, invalidated or
circumvented. It may be possible for a third party to copy or otherwise obtain
and use our products, or technology without authorization, develop
corresponding technology independently or design around our patents. Effective
copyright, trademark and trade secret protection may be unavailable or limited
in foreign countries. These disputes may result in costly and time consuming
litigation or the license of additional elements of our intellectual property
for free.
We could become subject to litigation regarding intellectual property, which
- ----------------------------------------------------------------------------
could divert management attention, be costly to defend and prevent us from
- --------------------------------------------------------------------------
using or selling the challenged technology.
- ------------------------------------------
In recent years, there has been significant litigation in the United
States involving intellectual property rights, including rights of companies in
the semiconductor industry. From time to time, we have 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. We
expect these claims to increase as OmniVision and its intellectual property
portfolio become larger. Intellectual property claims against us, and any
resulting lawsuit, may result in our incurring significant expenses and could
subject us to significant liability for damages and invalidate what we
currently believe are our proprietary rights. These lawsuits, regardless of
their success, would likely be time-consuming and expensive to resolve and
could divert management's time and attention. Any potential intellectual
property litigation against us could also force us to do one or more of the
following:
o cease selling, incorporating or using products or services that
incorporate the infringed intellectual property;
o obtain from the holder of the infringed intellectual property a license
to sell or use the relevant technology, which license may not be
available on acceptable terms, if at all; or
o redesign those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses.
If we are subject to a successful claim of infringement and we fail to
develop non-infringing intellectual property or license the infringed
intellectual property on acceptable terms and on a timely basis, our revenues
could decline or our expenses could increase. We may in the future initiate
claims or litigation against third parties for infringement of our intellectual
property rights or to determine the scope and validity of our proprietary
rights or the proprietary rights of competitors. These claims could also result
in significant expense and the diversion of technical and management
personnel's attention.
If we do not effectively manage our growth could adversely affect our ability
- -----------------------------------------------------------------------------
to increase our revenues and improve our earnings.
- -------------------------------------------------
Our growth has placed, and will continue to place, a significant strain on
our management and other resources. We expect that we will continue to face
challenges regarding managing our growth in connection with the expansion of
our operations through HuaWei Semiconductor. To manage our growth effectively,
we must, among other things:
o implement and improve operational and financial systems;
o train and manage our employee base; and
o attract and retain qualified personnel with relevant experience.
We must also manage multiple relationships with customers, business
partners and other third parties, such as our foundries and process and
assembly vendors. Moreover, our growth may significantly overburden our
management and financial systems and other resources. We also cannot assure you
that we have made adequate allowances for the costs and risks associated with
our expansion. In addition, our systems, procedures or controls may not be
adequate to support our operations, and we may not be able to expand quickly
enough to capitalize on
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
potential market opportunities. Our future operating results will also depend
on expanding sales and marketing, research and development and administrative
support.
We may experience integration or other problems with potential acquisitions,
- ----------------------------------------------------------------------------
which could have an adverse effect on our business or results of operations.
- ----------------------------------------------------------------------------
New acquisitions could dilute the interests of existing stockholders, and the
- -----------------------------------------------------------------------------
announcement of new acquisitions could result in a decline in the price of our
- ------------------------------------------------------------------------------
common stock.
- ------------
We may in the future make acquisitions of, or large investments in,
businesses that offer products, services, and technologies that we believe
would complement our products. We may also make acquisitions of, or
investments in, businesses that we believe could expand our distribution
channels. Even though we announce an acquisition, we may not be able to
complete it. Any future acquisition or substantial investment would present
numerous risks. The following are examples of these risks:
o difficulty in combining the technology, operations or work force of the
acquired business,
o disruption of our on-going business,
o difficulty in realizing the potential financial or strategic benefits of
the transaction,
o difficulty in maintaining uniform standards, controls, procedures and
policies,
o possible impairment of relationships with employees and customers as a
result of integration of new businesses and management personnel, and
o impairment of assets related to resulting goodwill, and reductions in
our future operating results from amortization of intangible assets.
We expect that future acquisitions could provide for consideration to be
paid in cash, shares of our common stock, or a combination of cash and our
common stock. If the consideration for the transaction were paid in common
stock, this would further dilute our existing stockholders.
Provisions in our charter documents and Delaware law, as well as our
- --------------------------------------------------------------------
stockholders rights plan, could prevent or delay a change in control of us and
- ------------------------------------------------------------------------------
may reduce the market price of our common stock.
- -----------------------------------------------
Provisions of our certificate of incorporation and bylaws may discourage,
delay or prevent a merger or acquisition that a stockholder may consider
favorable. These provisions include:
o adjusting the price, rights, preferences, privileges and restrictions of
preferred stock without stockholder approval;
o providing for a classified board of directors with staggered, three year
terms;
o requiring supermajority voting to amend some provisions in our
certificate of incorporation and bylaws;
o limiting the persons who may call special meetings of stockholders; and
o prohibiting stockholder actions by written consent.
Provisions of Delaware law also may discourage, delay or prevent another
company from acquiring or merging with us. Our board of directors adopted a
Preferred Stock Rights Agreement in August 2001, the Rights Agreement.
Pursuant to the Rights Agreement, our board of directors declared a dividend of
one right, a right, to purchase one one-thousandth share of our Series A
Participating Preferred Stock for each outstanding share of our common stock.
The dividend was paid on September 28, 2001 to stockholders of record as of the
close of business on that date.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
Each right entitles the registered holder to purchase from us one one-
thousandth of a share of Series A Preferred at an exercise price of $40.00,
subject to adjustment. The exercise of the rights could have the effect of
delaying, deferring or preventing a change of control of us, including, without
limitation, discouraging a proxy contest or making more difficult the
acquisition of a substantial block of our common stock. The Rights Agreement
could also limit the price that investors might be willing to pay in the future
for our common stock.
Our stock has been and will likely continue to be subject to substantial price
- ------------------------------------------------------------------------------
and volume fluctuations due to a number of factors, many of which will be
- -------------------------------------------------------------------------
beyond our control, that may prevent our stockholders from reselling our common
- -------------------------------------------------------------------------------
stock at a profit.
- -----------------
The market price of our common stock has fluctuated substantially, and
there can be no assurance that such volatility will not continue. From the
completion of our initial public offering in July 2000 through July 31, 2002,
the closing sales price of our common stock has ranged from a high of $47.25
per share to a low of $2.70 per share. The securities markets have experienced
significant price and volume fluctuations in the past and the market prices of
the securities of semiconductor companies have been especially volatile. This
market volatility, as well as general economic, market or political conditions,
could reduce the market price of our common stock in spite of our operating
performance. The market price of our common stock may fluctuate significantly
in response to a number of factors, including:
o actual or anticipated fluctuations in our operating results;
o changes in expectations as to our future financial performance;
o changes in financial estimates of securities analysts;
o release of lock-up or the transfer restrictions on our outstanding
shares of common stock or sales of additional shares of common stock;
o changes in market valuations of other technology companies; and
o announcements by us or our competitors of significant technical
innovations, design wins, contracts, standards or acquisitions.
Due to these factors, the price of our stock may decline and investors may
be unable to resell their shares of our stock for a profit. In addition, the
stock market experiences extreme volatility that often is unrelated to the
performance of particular companies. These market fluctuations may cause our
stock price to decline regardless of our performance.
Class action litigation due to stock price volatility could lead to substantial
- -------------------------------------------------------------------------------
costs and divert our management's attention and resources.
- ---------------------------------------------------------
In the past, securities class action litigation often has been brought
against a company following periods of volatility in the market price of its
securities. Companies in the semiconductor industry and other technology
industries are particularly vulnerable to this kind of litigation due to the
high volatility of their stock prices. Accordingly, we may in the future be the
target of securities litigation. Securities litigation could result in
substantial costs and could divert our management's attention and resources.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
------------------------------
We are an international company, selling our products globally, in
particular, in China, Hong Kong, Japan, Korea and Taiwan. Although we transact
our business in U.S. dollars, future fluctuations in the value of the U.S.
dollar may affect the competitiveness of our products, gross profits realized,
and results of operations. Further, we incur expenses in Japan, Korea, Taiwan,
Thailand, China and other countries that are denominated in currencies other
than the U.S. dollar. We cannot estimate the effect that an immediate 10%
change in foreign currency exchange rates would have on our future operating
results or cash flows as a direct result of changes in exchange rates. However,
we do not believe that we currently have any significant direct foreign
currency exchange rate risk, and we have not hedged exposures denominated in
foreign currencies or any other derivative financial instruments.
Quantitative and Qualitative Discussion of Market Interest Rate Risk
--------------------------------------------------------------------
Our cash equivalents and short-term investments are exposed to financial
market risk due to fluctuation in interest rates, which may affect our interest
income and, in the future, the fair market value of our investments. We manage
our exposure to financial market risk by performing ongoing evaluations of our
investment portfolio. We presently invest in short term bank market rate
accounts, certificates of deposit issued by banks, high-grade corporate
securities and government bonds maturing approximately 12 months or less from
the date of purchase. Due to the short maturities of our investments, the
carrying value should approximate the fair market value. In addition, we do not
use our investments for trading or other speculative purposes. Due to the short
duration of our investment portfolio, we do not expect that an immediate 10%
change in interest rates would have a material effect on the fair market value
or our portfolio. Therefore, we would not expect our operating results or cash
flows to be affected to any significant degree by the effect of a sudden change
in market interest rates.
30
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 the
Company, some of its directors and officers, and various underwriters for its
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 its 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 issuers in the coordinated action
have recently filed a consolidated motion to dismiss.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
Exhibit
Number Description
------ -------------------------------------------------------------
10.20 Shanghai Foreign Investment Committee Official Reply to the
Request for Increase in Investment and Investor Name
Change of HuaWei Semiconductor (Shanghai) Co., Ltd.
dated December 10, 2001.
99.1 Certification Of Chief Executive Officer And Chief Financial
Officer Pursuant To 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002.
(b) Reports on Form 8-K
-------------------
The Company did not file any reports on Form 8-K during the three months
ended July 31, 2002.
31
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OMNIVISION TECHNOLOGIES, INC.
-----------------------------
(Registrant)
Dated: September 13, 2002
By: /s/ SHAW HONG
-------------------------------
Shaw Hong
Chief Executive Officer, President and Director
(Principal Executive Officer)
Dated: September 13, 2002
By: /s/ H. GENE MCCOWN
-------------------------------
H. Gene McCown
Vice President of Finance and Chief Financial
Officer (Principal Financial
and Accounting Officer)
32
I, Shaw Hong, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OmniVision
Technologies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Dated: September 13, 2002
By: /s/ SHAW HONG
-------------------------------
Shaw Hong
Chief Executive Officer and President
I, H. Gene McCown, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OmniVision
Technologies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Dated: September 13, 2002
By: /s/ H. GENE MCCOWN
-------------------------------
H. Gene McCown
Vice President of Finance and Chief Financial
Officer (Principal Financial Officer)
34