===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from to
-------------- --------------
Commission file number: 0-29939
----------------------
OMNIVISION TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0401990
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1341 Orleans Drive, Sunnyvale, California 94089-1136
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 542-3000
----------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
At December 8, 2003, 27,138,362 shares of common stock of the Registrant
were outstanding.
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OMNIVISION TECHNOLOGIES, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets (unaudited) -
October 31, 2003 and April 30, 2003............................ 3
Condensed Consolidated Income Statements (unaudited) -
Three and Six Months Ended October 31, 2003 and 2002........... 4
Condensed Consolidated Statements of Cash Flows (unaudited) -
Six Months Ended October 31, 2003 and 2002..................... 5
Notes to Condensed Consolidated Financial Statements (unaudited). 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 40
Item 4. Controls and Procedures.......................................... 40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 41
Item 4. Submission of Matters to a Vote of Security Holders.............. 42
Item 5. Other Information................................................ 42
Item 6. Exhibits and Reports on Form 8-K................................. 43
Signatures................................................................ 44
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data and per share data)
(unaudited)
October 31, April 30,
2003 2003
---------- --------
ASSETS
Current assets:
Cash and cash equivalents............................. $ 173,796 $ 50,438
Restricted cash....................................... 1,068 --
Short-term investments................................ 11,548 10,224
Accounts receivable, net.............................. 39,649 19,133
Inventories........................................... 29,302 13,642
Refundable and deferred income taxes.................. 6,438 7,642
Prepaid expenses and other assets..................... 1,696 1,195
--------- ---------
Total current assets................................ 263,497 102,274
Property, plant and equipment, net...................... 18,370 12,456
Long-term investments................................... 4,828 2,845
Other non-current assets................................ 407 378
--------- ---------
Total assets........................................ $ 287,102 $ 117,953
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 38,031 $ 10,528
Accrued expenses and other liabilities................ 12,954 8,037
Deferred income....................................... 4,341 2,845
--------- ---------
Total current liabilities........................... 55,326 21,410
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock, $0.001 par value; 100,000,000 shares
authorized; 27,078,952 and 23,402,908 shares issued
and outstanding..................................... 27 23
Additional paid-in capital............................ 222,133 104,848
Deferred compensation related to stock options........ (71) (159)
Retained earnings (accumulated deficit)............... 9,687 (8,169)
--------- ---------
Total stockholders' equity.......................... 231,776 96,543
--------- ---------
Total liabilities and stockholders' equity.......... $ 287,102 $ 117,953
========= =========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
3
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues.............................. $ 68,540 $ 21,743 $115,032 $ 38,533
Cost of revenues(1)................... 42,476 13,063 71,604 23,337
-------- -------- -------- --------
Gross profit.......................... 26,064 8,680 43,428 15,196
-------- -------- -------- --------
Operating expenses:
Research and development............ 3,173 2,489 6,753 5,119
Selling, general and administrative. 5,705 2,710 10,195 4,790
Stock-based compensation charge(2).. 95 150 196 264
-------- -------- -------- --------
Total operating expenses.......... 8,973 5,349 17,144 10,173
-------- -------- -------- --------
Income from operations................ 17,091 3,331 26,284 5,023
Interest income, net.................. 548 216 770 432
-------- -------- -------- --------
Income before income taxes............ 17,639 3,547 27,054 5,455
Provision for income taxes............ 5,997 532 9,198 818
-------- -------- -------- --------
Net income............................ $ 11,642 $ 3,015 $ 17,856 $ 4,637
======== ======== ======== ========
Net income per share:
Basic............................... $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
Diluted............................. $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
Shares used in computing net income
per share:
Basic............................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
Diluted............................. 30,148 24,441 28,827 24,955
======== ======== ======== ========
(1) Stock-based compensation charges
included in Cost of revenues.... $ 1 $ 4 $ 3 $ 7
======== ======== ======== ========
(2) Stock-based compensation charges
by functional area:
Research and development........ $ 14 $ 36 $ 42 $ 82
Selling, general and
administrative................ 81 114 154 182
-------- -------- -------- --------
$ 95 $ 150 $ 196 $ 264
======== ======== ======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
4
OMNIVISION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
October 31,
------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income.............................................. $ 17,856 $ 4,637
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization......................... 716 432
Amortization of deferred stock-based compensation..... 198 271
Changes in assets and liabilities:
Accounts receivable, net............................ (20,516) (4,324)
Inventories......................................... (15,660) (8,661)
Refundable and deferred income taxes................ 1,204 82
Prepaid expenses and other assets................... (530) (1,492)
Accounts payable.................................... 27,503 5,896
Accrued expenses and other liabilities.............. 4,917 596
Deferred income..................................... 1,496 275
-------- --------
Net cash provided by (used in) operating
activities...................................... 17,184 (2,288)
-------- --------
Cash flows from investing activities:
Purchase of short-term marketable investments........... (1,324) (2,000)
Restricted cash......................................... (1,068) --
Proceeds from sale of short-term investments............ -- 2,002
Purchase of long-term non-marketable investment......... (1,983) --
Purchases of property, plant and equipment.............. (6,630) (2,797)
-------- --------
Net cash used in investing activities............. (11,005) (2,795)
-------- --------
Cash flows from financing activities:
Deposit refunded........................................ -- (600)
Proceeds from issuance of common stock, net............. 117,179 1,279
Payment for repurchase of common stock, net............. -- (1)
-------- --------
Net cash provided by financing activities......... 117,179 678
-------- --------
Net increase (decrease) in cash and cash equivalents...... 123,358 (4,405)
Cash and cash equivalents at beginning of period.......... 50,438 55,803
-------- --------
Cash and cash equivalents at end of period................ $173,796 $ 51,398
======== ========
Supplemental cash flow information:
Taxes paid.............................................. $ 7,210 $ 2,088
======== ========
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements (unaudited).
5
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Note 1 -- Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements as
of October 31, 2003 and April 30, 2003 and for the three and six months ended
October 31, 2003 and 2002 have been prepared by OmniVision Technologies, Inc.
and subsidiaries (the "Company" or "OmniVision") in accordance with the rules
and regulations of the Securities and Exchange Commission. The amounts as of
April 30, 2003 have been derived from the Company's annual audited financial
statements. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted in accordance with such rules and
regulations. In the opinion of management, the accompanying unaudited financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the Company
and its results of operations and cash flows as of and for the periods
presented. These financial statements should be read in conjunction with the
annual audited financial statements and notes thereto as of and for the year
ended April 30, 2003, included in the Company's Annual Report on Form 10-K.
The results of operations for the three and six months ended October 31,
2003 are not necessarily indicative of the results that may be expected for the
year ending April 30, 2004 or any other future interim period, and the Company
makes no representations related thereto.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Note 2 -- Summary of Significant Accounting Policies
------------------------------------------
Revenue Recognition
-------------------
The Company recognizes revenue from the sale of products to original
equipment manufacturers and value added resellers upon the shipment of its
products to the customer provided that the Company has received a signed
purchase order, the price is fixed or determinable, title and risk of loss has
transferred to the customer, collection of resulting receivables is considered
reasonably assured, product returns are reasonably estimable, there are no
customer acceptance requirements and there are no remaining significant
obligations. The Company provides for future returns based on historical
experiences at the time revenue is recognized. For certain shipments to
distributors under agreements allowing for return or credits, revenue is
deferred until the distributor resells the product to the end-user customer.
Deferred income on shipment to distributors represents the amount billed less
the cost of inventory shipped to but not yet sold by distributors.
Short-Term Investments
----------------------
The Company's short-term investments, which are classified as available-
for-sale, are invested in marketable high-grade corporate securities and
government bonds maturing twelve months or less from the date of purchase.
These investments are reported at fair value which approximates cost.
Unrealized gains or losses are recorded in stockholders' equity and included in
other comprehensive income (losses). Unrealized gains or losses were not
significant during any period presented in these financial statements.
Stock-Based Compensation
------------------------
The Company accounts for stock-based employee compensation arrangements
using the intrinsic value method in accordance with the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
------------------------------
Employees" ("APB 25"), and the Financial Accounting Standards Board ("FASB")
- ---------
FASB Interpretation 44, "Accounting for Certain Transactions Involving Stock
---------------------------------------------------
Compensation" ("FIN 44"), and complies with the disclosure provisions of
- ------------
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
---------------------
Based Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for
- ------------------ --------------
Stock-Based Compensation--Transition and Disclosure--An Amendment of FASB
- -------------------------------------------------------------------------
Statement No. 123" ("SFAS 148"). Under APB 25, compensation cost is recognized
- -----------------
6
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
based on the difference, if any, on the date of grant between the fair value of
the Company's stock and the amount an employee must pay to acquire the stock.
Deferred stock-based compensation is then amortized over the vesting period of
the option on an accelerated basis using the multiple option approach as
defined in paragraph 24 of FIN 28. SFAS 123 describes a "fair value" based
method of accounting for an employee stock option or similar equity instrument.
The following table illustrates the effect on net income and net income per
share as if the Company had applied the fair value recognition provisions of
SFAS 123 and SFAS 148 to stock-based employee grants compensation and is
referenced to in this Note as "as adjusted" (in thousands, except per share
amounts):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported................ $ 11,642 $ 3,015 $ 17,856 $ 4,637
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 20 59 58 138
Deduct: Total stock-based employee
compensation determined under
fair value based method for all
awards, net of related tax
effects........................ 4,591 1,983 7,696 3,377
-------- -------- -------- --------
As adjusted net income................. $ 7,072 $ 1,091 $ 10,218 $ 1,398
======== ======== ======== ========
Net income per share -- Basic:
As reported.......................... $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
As adjusted.......................... $ 0.26 $ 0.05 $ 0.40 $ 0.06
======== ======== ======== ========
Net income per share -- Diluted:
As reported.......................... $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
As adjusted.......................... $ 0.25 $ 0.05 $ 0.40 $ 0.06
======== ======== ======== ========
Shares used in computing net income per
share -- Basic:
As reported.......................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
As adjusted.......................... 26,973 22,438 25,406 22,348
======== ======== ======== ========
Shares used in computing net income per
share -- Diluted:
As reported.......................... 30,148 24,441 28,827 24,955
======== ======== ======== ========
As adjusted.......................... 28,719 22,552 25,587 22,487
======== ======== ======== ========
The Company accounts for stock issued to non-employees in accordance with
the provisions of SFAS 123 and Emerging Issues Task Force Consensus No. 96-18,
"Accounting for Equity Instruments that are Offered to Other than Employees for
------------------------------------------------------------------------------
Acquiring or in Conjunction with Selling Goods or Services" ("EITF 96-18").
- ----------------------------------------------------------
Under SFAS 123 and EITF 96-18, stock option awards issued to non-employees are
accounted for at their fair value, determined using the Black-Scholes option
pricing model.
Recent Accounting Pronouncements
- --------------------------------
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN 46"). FIN 46
requires certain variable interest entities to be consolidated by the primary
7
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The original effective date
of FIN 46 was delayed to the first reporting period after December 15, 2003 for
any variable interest entities or potential variable interest entities created
before February 1, 2003. The Company does not expect the adoption of FIN 46 to
have a material impact on its consolidated financial position, results of
operations and cash flows.
8
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Note 3 -- Balance Sheet Accounts (In Thousands)
------------------------------------
October 31, April 30,
2003 2003
---------- --------
Cash and cash equivalents:
Cash.................................................. $ 4,142 $ 941
Money market funds.................................... 91,748 25,363
Commercial paper...................................... 77,906 24,134
--------- ---------
$ 173,796 $ 50,438
========= =========
Accounts receivable:
Accounts receivable................................... $ 46,122 $ 21,188
Less: Allowance for doubtful accounts................. (2,315) (915)
Sales return reserve............................ (4,158) (1,140)
--------- ---------
$ 39,649 $ 19,133
========= =========
Inventories:
Work in progress...................................... $ 17,985 $ 8,942
Finished goods........................................ 11,317 4,700
--------- ---------
$ 29,302 $ 13,642
========= =========
Prepaid expenses and other assets:
Prepaid expenses...................................... $ 1,444 $ 1,187
Other receivables..................................... 252 8
--------- ---------
$ 1,696 $ 1,195
========= =========
Property, plant and equipment, net:
Building.............................................. $ 8,244 $ --
Building improvements................................. 3,310 --
Machinery and equipment............................... 6,728 3,607
Furniture and fixtures................................ 216 283
Software.............................................. 1,103 976
Construction in progress.............................. 2,881 10,986
--------- ---------
22,482 15,852
Less: Accumulated depreciation and amortization....... (4,112) (3,396)
--------- ---------
$ 18,370 $ 12,456
========= =========
Note 4 -- Net Income Per Share
--------------------
Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed using the weighted average number of common
and potentially dilutive common shares outstanding during the period using the
treasury stock method. Potentially dilutive common shares include the effect of
stock options. For the three and six months ended October 31, 2002, 2,372,300
and 1,552,050 shares of common stock subject to outstanding options were not
included in the calculation of diluted net income per share as they were
considered antidilutive (i.e., the per share exercise price for such options
exceeded the trading price of the Company's common stock as reported on The
Nasdaq Stock Market). For the six months ended October 31, 2003, 300,875 shares
of common stock subject to outstanding options were not included in the
calculation of diluted net income per share as they were considered
antidilutive. There were no antidilutive shares for the three months ended
October 31, 2003.
9
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The following table sets forth the computation of basic and diluted income
per share attributable to common stockholders for the periods indicated (in
thousands, except per share data):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net income........................... $ 11,642 $ 3,015 $ 17,856 $ 4,637
======== ======== ======== ========
Denominator:
Weighted average shares.............. 26,997 22,552 25,442 22,487
Weighted average unvested common
shares subject to repurchase....... (24) (114) (36) (139)
-------- -------- -------- --------
Denominator for basic net income
per share.......................... 26,973 22,438 25,406 22,348
Effect of dilutive securities:
Common stock options................. 3,151 1,889 3,385 2,468
Unvested common stock subject to
repurchase......................... 24 114 36 139
-------- -------- -------- --------
Denominator for dilutive net income
per share......................... 30,148 24,441 28,827 24,955
======== ======== ======== ========
Basic net income per share............. $ 0.43 $ 0.13 $ 0.70 $ 0.21
======== ======== ======== ========
Diluted net income per share........... $ 0.39 $ 0.12 $ 0.62 $ 0.19
======== ======== ======== ========
In July 2003, the Company sold 3,093,226 shares of common stock in a
follow-on public offering at a price of $38.75 per share, resulting in net
proceeds of approximately $113.2 million. The incremental shares are reflected
in the weighted average shares outstanding during the three- and six-month
periods ended October 31, 2003.
Note 5 -- Segment, Product Line and Geographic Information
------------------------------------------------
The Company identifies its operating segments based on business
activities, management responsibility and geographic location. For all periods
presented, the Company operated in a single business segment.
Revenues from the Company's two product lines, digital and analog image
sensors, were as follows (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Digital image sensors.................. $ 61,174 $ 16,121 $ 99,721 $ 24,615
Analog image sensors................... 7,366 5,622 15,311 13,918
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
10
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The Company sells its products primarily to customers in the Asia Pacific
region and in the United States of America. Revenues by geographic locations
are not necessarily representative of the geographic distribution of sales into
end-user markets, as the Company's customers sell their products globally. The
revenues by geographic locations in the following table are based on the
country or region in which the customer is located (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Hong Kong.............................. $ 21,828 $ 13,232 $ 40,506 $ 20,878
Taiwan................................. 22,937 5,642 38,541 9,785
China.................................. 15,599 1,134 21,495 1,561
Japan.................................. 865 243 1,191 1,139
United States.......................... 349 388 974 3,166
All other.............................. 6,962 1,104 12,325 2,004
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
In December 2000, the Company formed a subsidiary to conduct testing
operations and other processes associated with the manufacturing of its
products in China. The registered capital of this subsidiary was initially
$12.0 million, of which $3.8 million was funded by the Company in the fiscal
year ended April 30, 2001, as required by Chinese law. The Company funded an
additional $3.7 million during fiscal 2002. In August 2002, the Company
increased the registered capital to $30.0 million and funded an additional $4.0
million during fiscal 2003. A total of $14.0 million of the $30.0 million of
registered capital of the subsidiary had been funded as of October 31, 2003
from the Company's available working capital. The remaining $16.0 million of
registered capital must be funded as follows: $0.7 million by January 2004 and
$15.3 million by January 2005. The $14.0 million invested through October 31,
2003 was used primarily to pay for the construction of a building and
associated building improvements and purchase of machinery and equipment.
The Company's long-lived assets are located in the following countries (in
thousands):
October 31, April 30,
2003 2003
---------- --------
China................................................... $ 12,354 $ 8,968
United States........................................... 5,722 3,588
Taiwan.................................................. 5,234 2,845
All other............................................... 295 278
--------- ---------
Total................................................. $ 23,605 $ 15,679
========= =========
Note 6 -- Employee Stock Option and Stock Purchase Plans
----------------------------------------------
Employee Stock Option Grants
----------------------------
Options to purchase 300,875 and 1,722,300 shares of common stock were
granted to employees during the three and six months ended October 31, 2003,
respectively. As of October 31, 2003, options to purchase 4,888,847 shares of
common stock were outstanding.
2000 Employee Stock Purchase Plan
---------------------------------
As of October 31, 2003, 675,980 shares had been purchased under the 2000
Employee Stock Purchase Plan (the "2000 Purchase Plan").
11
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
Fair Value Disclosures
----------------------
Information regarding net income and net income per share, as adjusted, is
required by SFAS 123, which also requires that the information be determined as
if the Company had accounted for its employee stock options granted under the
fair value method. The fair value for these options was estimated using the
Black-Scholes option pricing model. The per share weighted average estimated
fair value for employee options granted was $42.93 and $10.52 during the three
months ended October 31, 2003 and 2002, respectively. The per share weighted
average estimated fair value for employee options granted was $34.57 and $11.92
during the six months ended October 31, 2003 and 2002, respectively. The Black-
Scholes model was developed for use in estimating the fair value of traded
options that have no restrictions and are fully transferable and negotiable in
a free trading market. Black-Scholes does not consider the employment, transfer
or vesting restrictions that are inherent in the Company's employee options.
Use of an option valuation model, as required by SFAS 123, includes highly
subjective assumptions based on long-term predictions, including the expected
stock price volatility and average life of each option grant. Because the
Company's employee options have characteristics significantly different from
those of freely traded options, and because changes in the subjective input
assumptions can materially affect the Company's estimate of the fair value of
those options, in the Company's opinion, the existing valuation models,
including Black-Scholes, are not reliable single measures and may misstate the
fair value of the Company's employee options.
The following weighted average assumptions are included in the estimated
fair value calculations for stock option grants in the three and six months
ended October 31, 2003 and 2002:
Employee Stock Option
---------------------------------------
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Risk-free interest rate................ 2.31% 2.10% 1.74% 2.10%
Expected term of options (in years).... 3.5 3.5 3.5 3.5
Expected volatility.................... 126.6% 134.6% 128.5% 134.6%
Expected dividend yield................ 0% 0% 0% 0%
Using Black-Scholes, the per share weighted average estimated fair value
of rights issued pursuant to the Company's 2000 Purchase Plan during the three
and six months ended October 31, 2003 was $30.92 and $26.23, respectively.
Using Black-Scholes, the per share weighted average estimated fair value of
rights issued pursuant to the Company's 2000 Purchase Plan during the three and
six months ended October 31, 2002 was $8.18 and $9.29, respectively.
12
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
The following weighted average assumptions are included in the estimated
grant date fair value calculations for rights to purchase stock under the 2000
Purchase Plan:
Employee Stock Purchase
---------------------------------------
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Risk-free interest rate................ 1.19% 1.80% 1.18% 1.80%
Expected term of options (in years).... 0.25 0.25 0.25 0.25
Expected volatility.................... 126.6% 134.6% 128.5% 134.6%
Expected dividend yield................ 0% 0% 0% 0%
Note 7 -- Commitments and Contingencies
-----------------------------
From time to time, the Company has been subject to legal proceedings and
claims with respect to such matters as patents, product liabilities and other
actions arising out of the normal course of business.
On November 29, 2001, a complaint captioned McKee v. OmniVision
Technologies, Inc., et. al., Civil Action No. 01 CV 10775, was filed in the
United States District Court for the Southern District of New York against
OmniVision, some of the Company's directors and officers, and various
underwriters for the Company's initial public offering. Plaintiffs generally
allege that the named defendants violated federal securities laws because the
prospectus related to the Company's offering failed to disclose, and contained
false and misleading statements regarding, certain commissions purported to
have been received by the underwriters, and other purported underwriter
practices in connection with their allocation of shares in the Company's
offering. The complaint seeks unspecified damages on behalf of a purported
class of purchasers of the Company's common stock between July 14, 2000 and
December 6, 2000. Substantially similar actions have been filed concerning the
initial public offerings for more than 300 different issuers, and the cases
have been coordinated as In re Initial Public Offering Securities Litigation,
21 MC 92. The Company's directors and officers have been dismissed without
prejudice pursuant to a stipulation. On February 19, 2003, the Court granted in
part and denied in part a motion to dismiss brought by defendants including
OmniVision. The order dismisses all claims against the Company except for a
claim brought under Section 11 of the Securities Act of 1933. A proposal has
been made for the settlement and release of claims against the issuer
defendants, including OmniVision. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the Court.
If the settlement does not occur, and litigation against the Company continues,
the Company believes that it has meritorious defenses and intends to defend the
case vigorously.
On August 21, 2002 the Company initiated a patent infringement action in
Taiwan, R.O.C. against IC Media Corporation of San Jose, CA for infringement of
Taiwan patent NI-139439 owned by OmniVision. The action was brought in the
Civil Tribunal of the Shih Lin District Court and assigned Civil Action Number
91 Su-Zi 1074. The patent infringement action seeks damages and injunctive
relief against IC Media Corporation. In response to the Company's patent
infringement action, on October 2, 2002, IC Media Corporation initiated a
cancellation proceeding (Cancellation No. 089123560N01) in the Taiwan
Intellectual Property Office with respect to its Taiwan patent NI139439. On
July 23, 2003, the Taiwan Intellectual Property Office made an initial
determination to grant the cancellation of Taiwan patent NI-139439. The
decision of the Taiwan Intellectual Property Office was upheld by the Taiwan
Ministry of Economic Affairs in November 2003. The Company intends to file an
action with the High Administrative Court of Taiwan to reverse the grant of
cancellation.
On October 11, 2002, the Company filed a complaint against IC Media
Corporation in Superior Court of California, Santa Clara County (Case No. CV
811866). In its complaint, the Company alleges misappropriation of trade
secrets, unfair competition and other business torts, and seek damages and
injunctive relief. IC Media Corporation has answered the complaint by denying
the allegations and raising various defenses; no counterclaims have been
13
OMNIVISION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Three and Six Months Ended October 31, 2003 and 2002
(unaudited)
asserted against the Company by IC Media. In accordance with the Alternative
Dispute Resolution practices of the Superior Court of California, Santa Clara
County, this matter has been submitted for non-binding arbitration.
On June 30, 2003, Mr. Chia-Chin Ku filed a complaint in Santa Clara County
Superior Court against the Company and its president and chief executive
officer, Mr. Shaw Hong. The complaint alleges that, by forming OmniVision in
1995, Mr. Hong breached a fiduciary duty owed to HK Technology, Inc., a
privately-held corporation Mr. Hong and others founded in 1988. The complaint
further alleges that the Company "misappropriated and converted" assets and
technology belonging to HK Technology, Inc. The complaint seeks damages in an
unspecified amount. The Company believes that it has meritorious defenses to
the allegations and claims and intends to defend itself vigorously. The Company
understands that HK Technology, Inc. has not engaged in significant substantive
operations since the early 1990s. The Company also understands that HK
Technology Inc.'s primary line of business was the design of chipsets for
personal computers, and that it did not engage in any business concerning image
sensors, which is OmniVision's primary line of business. The Company does not
believe that OmniVision's technology or products incorporate or use any
proprietary technology of HK Technology, Inc.
On July 14, 2003, Sunex, Inc. filed a complaint against OmniVision in San
Diego County Superior Court. Sunex was a supplier of optical lenses and lens
holders for one of the Company's cell phone products. Under its complaint,
Sunex is seeking to recover approximately $1.8 million plus interest and
attorney's fees. Sunex's complaint relates to parts delivered by Sunex to
OmniVision in the quarters ended January 31, 2003 and April 30, 2003 and the
Company's cancellation in that quarter of additional purchase orders it had
previously placed with Sunex. In October 2003, the Superior Court granted
Sunex's request for a prejudgment writ of attachment. The parties stipulated to
the filing of a bond in lieu of an attachment which OmniVision posted with the
Superior Court in the approximate amount of $1.1 million. The attachment order
and subsequent filing of the bond are not reflective of the merits of the case
and are expressly prohibited from being referred to at the time of trial. The
Company intends to defend itself vigorously and has filed a counterclaim
against Sunex in which the Company alleges breach of contract and breach of
warranties, and seeks damages in an amount yet to be determined. The Company
believes that any amount it may ultimately owe Sunex in excess of the amount it
had accrued as of April 30, 2003 will not have a material adverse affect on its
financial condition, results of operations or cash flows.
In October 2003, the Company entered into a Shareholders' Agreement with
Taiwan Semiconductor Manufacturing Company, or TSMC, pursuant to which the
Company agreed with TSMC to form VisEra Technology Company, or VisEra, a joint
venture in Taiwan, for the purposes of providing manufacturing services and
automated final testing services. The Company has committed with TSMC and
certain employees and affiliates of VisEra to provide an aggregate of $50.0
million in total capital to VisEra, which commitments may be made in the form
of cash or asset contributions. The Company and TSMC will have equal interests
in VisEra. The Company's share of this capital commitment to VisEra is $23.5
million and becomes due in stages as VisEra's business and service capabilities
develop over a number of years. The Company's net cash commitment to VisEra is
approximately $4.5 million. OmniVision will also contribute approximately $19.0
million of assets to the joint venture, including technology, plant and
equipment currently owned by the Company or to be purchased with funds for
existing commercial commitments. (See Note 5.)
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors that include, but are not
limited to, the risks discussed in "Factors Affecting Future Results." These
forward-looking statements include, but are not limited to: the statements
relating to the transition of our testing operations to China and the expansion
of our testing capabilities in the seventh paragraph under "Overview;" the
statements relating to the our commitments and TSMC's commitments to VisEra in
the eighth, ninth and tenth paragraphs under "Overview;" the statements
relating to the future revenues from sales of CameraChips for digital
applications in the third paragraph under "Revenues;" the statements relating
to research and development expenses during the remainder of fiscal 2004 in the
second paragraph under "Research and Development;" the statements relating to
future selling, general and administrative expenses in the second paragraph
under "Selling, General and Administrative;" the statements relating to the
expected effective tax rate for fiscal 2004 under "Provision for Income Taxes;"
the statements relating to increased future revenues made in the second
paragraph under "Liquidity and Capital Resources;" the statements relating to
research and development expenses during the remainder of fiscal 2004 and to
selling, general and administrative expenses during the remainder of fiscal
2004 in the third paragraph under "Liquidity and Capital Resources;" the
statements relating to our capital commitments to VisEra in the footnote to the
table in "Contractual Obligations and Commercial Commitments;" the statements
relating to our efforts to increase capacity and reduce cost through the
establishment of a Chinese subsidiary in the second paragraph under
"Contractual Obligations and Commercial Commitments;" the statements relating
to the our commitments and TSMC's commitments to VisEra in the second paragraph
in "Contractual Obligations and Commercial Commitments;" the statements
relating to third party financing, the issuance of equity securities and the
issuance of debt securities in the fourth paragraph under "Contractual
Obligations and Commercial Commitments;" the statements relating to the
expected effect of our contractual obligations and commercial commitments on
our liquidity and cash flows in future periods in the fifth paragraph under
"Contractual Obligations and Commercial Commitments;" the statements relating
to the effect of and exposure to foreign currency exchange rate risk under
"Foreign Currency Exchange Risk;" the statements relating to the effect of and
exposure to market interest rate risk under "Quantitative and Qualitative
Discussion of Market Interest Rate Risk;" and the statements relating to the
effect that the implementation of a new enterprise resource planning system
will have on our internal controls in the third paragraph under "Controls and
Procedures;" among others. These forward-looking statements are based on
current expectations and entail various risks and uncertainties that could
cause actual results to differ materially from those projected in the forward-
looking statements. Such risks and uncertainties are set forth below under
"Factors Affecting Future Results." All subsequent written and oral forward-
looking statements by or attributable to us or persons acting on our behalf are
expressly qualified in their entirety by such factors.
Overview
- --------
We design, develop and market high performance, highly integrated and cost
efficient semiconductor image sensor devices. Our main product, an image
sensing device called the CameraChip(tm), is used to capture an image in a
number of consumer and commercial mass market applications. Our CameraChips are
designed to use the complementary metal oxide semiconductor, or CMOS,
fabrication process. We have designed our CameraChip as a single chip solution
that integrates several distinct functions including image capture, image
processing, color processing and the conversion and output of a fully processed
image or video stream. Our highly integrated CMOS CameraChips help enable mass
market camera device manufacturers to build camera applications that generally
have high image quality and resolution, are low cost and small in size and
consume low amounts of power.
Our CameraChips are currently used in a number of consumer applications
including digital still and video cameras, cell phones, personal computers and
toys and games such as interactive video games.
Our CameraChips are sold to customers who incorporate them in either
digital or analog mass market applications. Some examples of digital mass
market applications that currently incorporate our CameraChips are digital
still cameras, cell phone cameras and personal computer camera applications.
Some examples of analog applications that currently incorporate our CameraChips
are security and surveillance cameras and toy cameras.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
We sell our products worldwide directly to original equipment
manufacturers, or OEMs, which include branded customers and contract
manufacturers, and value added resellers, or VARs, and indirectly through
distributors.
We currently outsource the wafer fabrication, color filter application and
packaging of our CameraChip products. This approach allows us to focus our
resources on the design, development and marketing of our products and
significantly reduces our capital requirements.
We have designed and developed a complete PC-based system for the testing
of our CameraChips. This system has automatic handling capability, an image
source, a lighting and lens system and automatic output sorting capability. We
believe that this proprietary testing process helps us to reduce our testing
costs, maintain consistent product quality, and identify areas for continued
improvement in product quality.
We have initiated the process of relocating some of our automated image
testing equipment from the United States to China. We anticipate that we will
substantially complete this transition prior to the end of fiscal 2004. In
addition, we also expect to expand testing capabilities with additional
automated testing equipment, which will also be located in China.
In October 2003, we entered into a Shareholders' Agreement with Taiwan
Semiconductor Manufacturing Company, or TSMC, pursuant to which we agreed with
TSMC to form VisEra Technology Company, or VisEra, a joint venture in Taiwan,
for the purposes of providing manufacturing services and automated final
testing services. In connection with the formation of VisEra, OmniVision and
TSMC have separately agreed to enter into nonexclusive license agreements with
VisEra pursuant to which OmniVision and TSMC shall license certain intellectual
property to VisEra relating to manufacturing services and automated final
testing services. Once VisEra has the capability to deliver high quality
manufacturing services and automated final testing services, we have committed
to direct a substantial portion of our requirements in these areas to VisEra,
subject to pricing and technology requirements. Our company and TSMC have also
committed not to compete directly or indirectly in the future with VisEra in
the fields of certain manufacturing services and automated final testing
services.
We have committed with TSMC and certain employees and affiliates of VisEra
to provide an aggregate of $50.0 million in total capital to VisEra, which
commitments may be made in the form of cash or asset contributions. Our company
and TSMC will have equal interests in VisEra. Our share of this capital
commitment to VisEra is $23.5 million and becomes due in stages as VisEra's
business and service capabilities develop over a number of years. Our net cash
commitment to VisEra is approximately $4.5 million. We will also contribute
approximately $19.0 million of assets to the joint venture, including
technology, plant and equipment currently owned by us or to be purchased with
funds for existing commercial commitments.
Historically, we have relied upon TSMC to provide us with a substantial
proportion of our wafers, but we have never before entered into a long-term
supply agreement with TSMC and instead have traditionally secured manufacturing
availability on a purchase order basis. As a part of the Shareholders'
Agreement, TSMC has agreed to commit substantial wafer manufacturing capacity
to us for a period of time in exchange for our commitment over this time period
to purchase a substantial portion of our wafers from TSMC, subject to pricing
and technology requirements.
As of October 31, 2003, we had approximately $173.8 million in cash and
cash equivalents and approximately $11.5 million in short-term investments. To
mitigate credit risk related to short-term investments, we have an investment
policy designed to preserve the value of capital and to generate interest
income from these investments without undue exposure to market fluctuations.
Market risk is the potential loss due to the change in value of a financial
instrument due to changes in interest rates or bond prices. Our policy is to
invest in financial instruments with short durations, limiting interest rate
exposure, and to measure performance against comparable benchmarks. We maintain
our portfolio of cash equivalents and short-term investments in a variety of
securities, including both government and corporate obligations with ratings of
A or better and money market funds.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Recent Events
-------------
In June 2003, we purchased approximately 27% of the equity of a privately
held company based in Taiwan for a total of $2.0 million in cash. The Taiwan
company provides plastic packaging services, and we will be a major customer.
We have accounted for this investment using the equity method. In November
2003, we increased our investment in this privately held company by an
additional $0.8 million to maintain our equity ownership percentage in this
company.
Critical Accounting Policies
----------------------------
For a discussion of the critical accounting policies, please see the
discussion in our Annual Report on Form 10-K for the fiscal year ended April
30, 2003.
Results of Operations
- ---------------------
The following table sets forth the results of our operations as a
percentage of revenues. Our historical operating results are not necessarily
indicative of the results for any future period.
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues............................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues....................... 62.0 60.1 62.3 60.6
------ ------ ------ ------
Gross profit......................... 38.0 39.9 37.7 39.4
------ ------ ------ ------
Operating expenses:
Research and development............. 4.6 11.4 5.9 13.3
Selling, general and administrative.. 8.3 12.5 8.8 12.4
Stock compensation charge............ 0.2 0.7 0.2 0.7
------ ------ ------ ------
Total operating expenses........... 13.1 24.6 14.9 26.4
------ ------ ------ ------
Income from operations................. 24.9 15.3 22.8 13.0
Interest income, net................... 0.8 1.0 0.7 1.1
------ ------ ------ ------
Income before income taxes............. 25.7 16.3 23.5 14.1
Provision for income taxes............. 8.7 2.4 8.0 2.1
------ ------ ------ ------
Net income............................. 17.0% 13.9% 15.5% 12.0%
====== ====== ====== ======
Three and Six Months Ended October 31, 2003 as Compared to Three and Six Months
- -------------------------------------------------------------------------------
Ended October 31, 2002
- ----------------------
Revenues
- --------
We derive revenues from the sale of our CameraChip products for use in a
wide variety of consumer and commercial mass market applications including
digital still cameras, cell phones, video game consoles and security and
surveillance cameras. Revenues for the three months ended October 31, 2003 and
2002 were approximately $68.5 million and $21.7 million, respectively. Revenues
for the six months ended October 31, 2003 and 2002 were approximately $115.0
million and $38.5 million, respectively.
Revenues from Sales of CameraChips for Digital as Compared to Analog
--------------------------------------------------------------------
Applications.
------------
Our CameraChips are sold to customers who incorporate them into either
digital or analog applications. Examples of digital applications that
incorporate our CameraChips are digital still cameras, cellular phone cameras,
personal computer camera applications and digital toy cameras. Examples of
analog applications that incorporate our CameraChips are security and
surveillance cameras and toy cameras. We sell a large portion of our products
through VARs and distributors, and often we do not know the identity of the
manufacturer who is embedding our CameraChips into their products. As a result
of our sales to VARs and distributors and because our CameraChips can be used
in a wide variety of digital or analog products, we cannot accurately confirm
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
the distribution of our revenues across specific product categories. However,
we are able to confirm the distribution of our revenues by digital and analog
product categories and they are as follows (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Digital image sensors.................. $ 61,174 $ 16,121 $ 99,721 $ 24,615
Analog image sensors................... 7,366 5,622 15,311 13,918
-------- -------- -------- --------
Total................................ $ 68,540 $ 21,743 $115,032 $ 38,533
======== ======== ======== ========
Digital Revenues. For the three months ended October 31, 2003, revenues
----------------
from sales of CameraChips for digital applications increased 279.5% to
approximately $61.2 million from $16.1 million for the three months ended
October 31, 2002. Revenues from sales of CameraChips for digital applications
represented 89.3% and 74.1% of revenues for the three months ended October 31,
2003 and 2002, respectively. For the six months ended October 31, 2003,
revenues from sales of CameraChips for digital applications increased 305.1% to
approximately $99.7 million from $24.6 million for the six months ended October
31, 2002. Revenues from sales of CameraChips for digital applications
represented 86.7% and 63.9% of revenues for the six months ended October 31,
2003 and 2002, respectively. The increase in revenues from sales of CameraChips
for digital applications for the three and six months ended October 31, 2003
was due to increased unit sales and to a shift in product mix toward higher
resolution products, which, in general, carry higher average sales prices than
lower resolution products. The increased unit sales resulted from heightened
demand for CameraChips for digital still cameras, cell phones, and interactive
video games. We expect revenues from sales of CameraChips for digital
applications to increase in the third quarter of fiscal 2004 primarily as a
result of increased sales to the digital still camera and cell phone markets.
Analog Revenues. For the three months ended October 31, 2003, revenues
---------------
from sales of CameraChips for analog applications increased 31.0% to
approximately $7.4 million from $5.6 million for the three months ended October
31, 2002. Revenues from sales of CameraChips for analog applications
represented 10.7% and 25.9% of revenues for the three months ended October 31,
2003 and 2002, respectively. For the six months ended October 31, 2003,
revenues from sales of CameraChips for analog applications increased 10.0% to
approximately $15.3 million from $13.9 million for the six months ended October
31, 2002. Revenues from sales of CameraChips for analog applications
represented 13.3% and 36.1% of revenues for the six months ended October 31,
2003 and 2002, respectively. The increase in revenues from sales of CameraChips
for analog applications for the three and six months ended October 31, 2003 was
due primarily to increased demand for CameraChips for use in cameras for toys
and games.
Revenues from Sales to OEMs and VARs as Compared to Distributors
----------------------------------------------------------------
We sell our CameraChips either directly to OEMs and VARs or through
distributors. The following table illustrates the percentage of revenues from
sales to OEMs and VARs as compared to distributors in the three and six months
ended October 31, 2003 and 2002:
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
OEMs and VARs.......................... 70.8% 68.9% 66.7% 64.9%
Distributors........................... 29.2 31.1 33.3 35.1
------ ------ ------ ------
Total................................ 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
OEMs and VARs. In the three months ended October 31, 2003, Aiptek
International, Inc., or Aiptek, headquartered in Taiwan, accounted for 11.5% of
revenues, and Nam Tai Electronics, Inc., or Nam Tai, headquartered in Hong
King, accounted for 10.4% of revenues. In the three months ended October 31,
2002, Concord Camera HK Limited, or Concord, headquartered in Hong Kong,
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
accounted for 19.5% of revenues, and Aiptek accounted for 12.7% of revenues. In
the six months ended October 31, 2003, Aiptek accounted for 10.5% of revenues.
In the six months ended October 31, 2002, Concord accounted for 12.2% of
revenues. No other OEM or VAR customer accounted for 10% or more of revenues
during any of these periods.
Distributors. In the three months ended October 31, 2003, World Peace
------------
Industrial Co. Ltd., or World Peace, headquartered in Taiwan, accounted for
18.9% of revenues. In the three months ended October 31, 2002, World Peace
accounted for 20.5% of revenues, including sales to World Peace's subsidiary,
GainTune, based in Hong Kong. In the six months ended October 31, 2003, World
Peace accounted for 22.9% of revenues, including sales to GainTune. In the six
months ended October 31, 2002, World Peace accounted for 22.2% of revenues,
including sales to GainTune. No other distributor accounted for 10% or more of
revenues during any of these periods.
Revenues from Domestic Sales as Compared to Foreign Sales
---------------------------------------------------------
The following table illustrates the percentage of revenues from sales of
our CameraChip products to domestic customers as compared to foreign customers
for the three and six months ended October 31, 2003 and 2002:
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Domestic sales......................... 0.5% 1.8% 0.9% 8.2%
Foreign sales.......................... 99.5 98.2 99.1 91.8
------ ------ ------ ------
Total................................ 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
The majority of our foreign sales are attributable to sales made to
customers in Asia and, to a lesser extent, in Europe. Over time, our sales to
Asia-Pacific customers have increased primarily as a result of the continuing
trend of outsourcing production to Asian manufacturers and facilities. Because
of the preponderance of Asia-Pacific manufacturers and the fact that virtually
all products incorporating our CameraChips are sold globally, we believe that
such figures do not accurately reflect geographic distribution of sales of our
products into end-user markets.
Gross Profit
- ------------
Gross margins for the three months ended October 31, 2003 and 2002 were
38.0% and 39.9% of revenues, respectively. Gross margins for the six months
ended October 31, 2003 and 2002 were 37.7% and 39.4% of revenues, respectively.
The decrease in gross margins for the three and six months ended October 31,
2003, as compared to the corresponding periods in the prior year, was primarily
due to a reduction in sales of previously written off inventory. For the three
months ended October 31, 2003, approximately $0.4 million of gross profit was
attributable to the sale of previously written off inventory. For the six
months ended October 31, 2003, approximately $0.8 million of gross profit was
attributable to the sale of previously written off inventory. Excluding the
revenues and gross profit from the sale of previously written off inventory,
the gross margin for the three months ended October 31, 2003 would have been
approximately 37.6% of revenues, as compared to 37.2% of revenues during the
comparable period in the prior year. Excluding the revenues and gross profit
from the sale of previously written off inventory, the gross margin for the six
months ended October 31, 2003 would have been approximately 37.3% of revenues,
as compared to 36.6% of revenues during the comparable period in the prior
year.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
The following table summarizes the effect of sales of previously written-
off inventory on gross profits for the three and six months ended October 31,
2003 and 2002 (in thousands):
Three Months Ended Six Months Ended
October 31, October 31,
------------------ --------------------
2003 2002 2003 2002
---- ---- ---- ----
Sales of all products.................. $ 68,540 $ 21,743 $115,032 $ 38,533
Gross profit........................... $ 26,064 $ 8,680 $ 43,428 $ 15,196
Gross margin........................... 38.0% 39.9% 37.7% 39.4%
Sales excluding products for which the
costs were previously written off.... $ 68,099 $ 20,786 $114,248 $ 36,781
Gross profit excluding the effect of
sales of products for which the costs
were previously written off.......... $ 25,623 $ 7,723 $ 42,644 $ 13,444
Gross margin excluding the effect of
sales of products for which the costs
were previously written off.......... 37.6% 37.2% 37.3% 36.6%
Research and Development
- ------------------------
Research and development expenses consist primarily of compensation and
personnel related expenses and costs for purchased materials, designs and
tooling, depreciation of computers and workstations, and amortization of
computer aided design software, some of which may fluctuate significantly from
period to period as a result of our product development cycles. Research and
development expenses for the three months ended October 31, 2003 and 2002 were
approximately $3.2 million and $2.5 million, respectively. As a percentage of
revenues, research and development expenses for the three months ended October
31, 2003 and 2002 represented 4.6% and 11.4%, respectively. Research and
development expenses for the six months ended October 31, 2003 and 2002 were
approximately $6.8 million and $5.1 million, respectively. As a percentage of
revenues, research and development expenses for the six months ended October
31, 2003 and 2002 represented 5.9% and 13.3%, respectively.
The increase in research and development expenses of approximately $0.7
million, or 27.5%, for the three months ended October 31, 2003 from the similar
period in the prior year resulted primarily from a $0.4 million increase in
expenses related to new product development required to improve our current
product line and support new product introductions and a $0.3 million increase
in salary and payroll-related expenses associated with additional personnel.
Examples of new product development expenses include tape-out and prototype
runs with our wafer manufacturers. The decline in research and development as a
percentage of revenues for the three months ended October 31, 2003 was due to
the proportionately greater increase in revenues from levels in the prior year.
The increase in research and development expenses of approximately $1.7
million, or 31.9%, for the six months ended October 31, 2003 from the similar
period in the prior year resulted primarily from an $0.8 million increase in
salary and payroll-related expenses associated with additional personnel, $0.5
million in expenses related to new product development required to improve our
current product line and support new product introductions and $0.1 million
each in expenses for patent prosecution, engineering supplies and software,
respectively. The decline in research and development as a percentage of
revenues was due to the proportionately greater increase in revenues for the
six months ended October 31, 2003 from levels in the prior year. We anticipate
that our research and development expenses will increase in the remainder of
fiscal 2004 as we develop our next generation of CameraChip products and as we
continue to grow our business, including our research and development team.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses consist primarily of
compensation and personnel related expenses, commissions paid to distributors
and manufacturers' representatives, and insurance and legal expenses. Selling,
general and administrative expenses include some of the expenses associated
with the startup of our Chinese subsidiary. Selling, general and administrative
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
expenses for the three months ended October 31, 2003 and 2002 were
approximately $5.7 million and $2.7 million, respectively. As a percentage of
revenues, selling, general and administrative expenses for the three months
ended October 31, 2003 and 2002 represented 8.3% and 12.5%, respectively.
Selling, general and administrative expenses for the six months ended October
31, 2003 and 2002 were approximately $10.2 million and $4.8 million,
respectively. As a percentage of revenues, selling, general and administrative
expenses for the six months ended October 31, 2003 and 2002 represented 8.8%
and 12.4%, respectively.
The increase in selling, general and administrative expenses of
approximately $3.0 million for the three months ended October 31, 2003 from the
similar period in the prior year resulted primarily from a $1.0 million
increase in commissions associated with increased revenues, a $0.9 million
increase in provisions for bad debts related to the increase in accounts
receivable, a $0.6 million increase in employment expenses and a $0.5 million
increase in legal and accounting expenses. Selling, general and administrative
expenses decreased as a percentage of revenues in the three months ended
October 31, 2003 as compared to the similar period in the prior year as a
result of the proportionately greater increase in revenues. The increase in
selling, general and administrative expenses of approximately $5.4 million for
the six months ended October 31, 2003 from the similar period in the prior year
resulted primarily from a $1.8 million increase in commissions associated with
increased revenues, a $1.4 million increase in salary and payroll-related
expenses, a $1.3 million increase in provisions for bad debts related to the
increase in accounts receivable and a $1.0 million increase in legal and
accounting expenses. Selling, general and administrative expenses decreased as
a percentage of revenues for the six months ended October 31, 2003, as compared
to the similar period in the prior year, as a result of the proportionately
greater increase in revenues. We anticipate that our future selling, general
and administrative expenses will increase in absolute dollars as we continue to
grow our business.
Interest Income, Net
- --------------------
Our cash, cash equivalents and short-term and long-term investments are
invested in interest-bearing accounts consisting primarily of money market
accounts and high-grade corporate securities and government bonds maturing
approximately twelve months or less from the date of purchase. Interest income,
net, increased for the three months ended October 31, 2003 from the similar
period in the prior year to approximately $0.5 million. Interest income, net,
increased for the six months ended October 31, 2003 from the similar period in
the prior year to approximately $0.8 million. Increased interest income, net,
resulted from increased investments in interest-bearing accounts resulting from
approximately $113.2 million in net proceeds from the issuance of common stock
in our follow-on public offering in July 2003 and cash provided by operating
activities.
Provision for Income Taxes
- --------------------------
We generated approximately $17.6 million and $3.5 million in income before
income taxes for the three months ended October 31, 2003 and 2002,
respectively. We recorded provisions for income taxes for the three months
ended October 31, 2003 and 2002 of approximately $6.0 million and $0.5 million,
respectively. We generated approximately $27.1 million and $5.5 million in
income before income taxes for the six months ended October 31, 2003 and 2002,
respectively. We recorded provisions for income taxes for the six months ended
October 31, 2003 and 2002 of approximately $9.2 million and $0.8 million,
respectively. We anticipate the effective tax rate for fiscal 2004 will
increase as compared to fiscal 2003 but will be less than the combined federal
and state statutory rate for fiscal 2004. The increase in tax rate is due to
the anticipated mix of income between domestic and foreign entities for the
fiscal year. Achieving an effective tax rate in fiscal 2004 that is less than
the combined federal and state statutory rates is principally contingent upon
our foreign affiliates generating income.
Liquidity and Capital Resources
- -------------------------------
Principal sources of liquidity at October 31, 2003 consisted of cash, cash
equivalents and short-term investments of $185.3 million.
Our working capital increased by approximately $127.3 million to $208.2
million as of October 31, 2003 from $80.9 million as of April 30, 2003. The
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
increase was primarily attributable to a $123.3 million increase in cash and
cash equivalents principally resulting from our follow-on public offering of
common stock in July 2003, a $20.5 million increase in accounts receivable,
net, consistent with the increase in revenues from prior year levels during the
six months ended October 31, 2003, a $15.7 million increase in inventories to
support future sales, a $1.3 million increase in short-term investments, a $1.1
million increase in restricted cash and a $0.5 million increase in prepaid
expenses and other assets, partially offset by a $27.5 million increase in
accounts payable, a $4.9 million increase in accrued liabilities to support
increased levels of operations and a $1.5 million increase in deferred income.
The $20.5 million increase in accounts receivable, net, reflects the sharply
higher level of sales during the six months ended October 31, 2003 and an
increase in days of sales outstanding to 53 days as of October 31, 2003 from 43
days as of April 30, 2003. The increase in accounts receivable, net, was
partially offset by a $3.0 million increase in the reserve for sales returns,
which rose as a result of the sharp increase in revenues for the six months
ended October 31, 2003, and by a $1.4 million increase in the allowance for
doubtful accounts, which rose as a result of the sharp increase in accounts
receivable balances. The $15.7 million increase in inventories is attributable
to higher inventory levels to support future sales. Inventory turns, calculated
based on the fiscal quarters ended October 31, 2003 and April 30, 2003,
decreased to 5.8 as of October 31, 2003 as compared to 7.2 as of April 30,
2003, in anticipation of increased future revenues.
For the six months ended October 31, 2003, net cash provided by operating
activities totaled approximately $17.2 million as compared to our use of cash
for operating activities of $2.3 million for the similar period in the prior
year, primarily due to net income of approximately $17.9 million for the six
months ended October 31, 2003 as compared to $4.6 million for the similar
period in the prior year, a $27.5 million increase in accounts payable, a $4.9
million increase in accrued expenses and other liabilities, a $1.5 million
increase in deferred income, and a $1.2 million decrease in refundable and
deferred income taxes, which were partially offset by a $20.5 million increase
in accounts receivable, net, a $15.7 million increase in inventories to support
future sales and a $0.5 million increase in prepaid expenses and other assets.
For the remainder of fiscal 2004, we anticipate that our research and
development expenses will increase as we develop our next generation of
CameraChip products and as we continue to grow our business. We also anticipate
that our selling, general and administrative expenses will increase for the
remainder of fiscal 2004 as we continue to grow our business.
For the six months ended October 31, 2003, our cash used in investing
activities increased to approximately $11.0 million from $2.8 million for the
similar prior year period, due to $6.6 million in purchases of property, plant
and equipment, $3.3 million in purchases of short-term and long-term marketable
investments and a $1.1 million increase in restricted cash. Net cash used in
investing activities of $2.8 million for the six months ended October 31, 2002,
resulted from purchases of property, plant and equipment. The $6.6 million
increase in property, plant and equipment was due to the additional investment
in buildings, building improvements and machinery and equipment to support the
expanding operations of our Chinese subsidiary.
For the six months ended October 31, 2003, net cash provided by financing
activities increased to approximately $117.2 million from $0.7 million for the
similar period in the prior year. The increase was primarily due to
approximately $113.2 million in net proceeds resulting from our follow-on
public offering of common stock in July 2003 and $4.0 million in proceeds from
the issuance and sale of common stock pursuant to the exercise of stock options
and from employee purchases through the employee stock purchase plan during the
six months ended October 31, 2003 as compared to $1.3 million for the similar
period in the prior year. Proceeds from the issuance and sale of common stock
for the six months ended October 31, 2002 were partially offset by $0.6 million
in refunded deposits related to investments from third parties in our Chinese
subsidiary, HuaWei Semiconductor.
In June 2003, we purchased approximately 27% of the equity of a privately
held company based in Taiwan for a total of $2.0 million in cash. The Taiwan
company provides plastic packaging services, and we will be a major customer.
We have accounted for this investment using the equity method. In November
2003, we increased our investment in this privately held company by an
additional $0.8 million to maintain our equity ownership percentage in this
company.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Contractual Obligations and Commercial Commitments
- --------------------------------------------------
The following summarizes our contractual obligations and commercial
commitments as of October 31, 2003 and the effect such obligations and
commitments are expected to have on our liquidity and cash flows in future
periods (in thousands):
Less than 1-3 4-5 After
Total 1 Year Years Years 5 Years
----- ------ ------ ------ -------
Contractual Obligations
- -----------------------
Operating leases................ $ 4,640 $ 1,275 $ 2,281 $ 839 $ 245
Noncancelable orders............ 40,900 40,900 -- -- --
------- ------- ------- ------- -------
Total contractual obligations. 45,540 42,175 2,281 839 245
------- ------- ------- ------- -------
Other Commercial Commitments
- ----------------------------
Investment in China............. 16,000 700 15,300 -- --
Joint Venture with TSMC......... 4,500 1 1,000 3,500 -- --
------- ------- ------- ------- -------
Total commercial commitments.. 20,500 1,700 18,800 -- --
------- ------- ------- ------- -------
Total contractual obligations
and commercial commitments.. $66,040 $43,875 $21,081 $ 839 $ 245
======= ======= ======= ======= =======
- -------------------------
1 Pursuant to the Shareholders' Agreement with TSMC, our share of the
capital commitment to VisEra is $23.5 million, which becomes due in
stages as VisEra's business and service capabilities develop over a
number of years. Our net cash investment to the joint venture will
approximate $4.5 million. We will also contribute approximately $19.0
million of assets to the joint venture, including technology, plant
and equipment currently owned by us or to be purchased with funds for
existing commercial commitments. Our cash and asset contributions
will be made in three phases. In the first phase, we shall contribute
$1.5 million in cash to VisEra and a non-exclusive license to certain
of our manufacturing and automated final testing technologies and
patents. In the second phase, we shall contribute $9.5 million in cash
to VisEra and a non-exclusive license to certain of our manufacturing
and automated final testing technologies and patents.
In the third phase, we shall contribute $12.5 million in cash and
assets to VisEra and receive back from VisEra an aggregate cash payment
of $17.5 million.
The $16.0 million cash payment referenced in the table above relates to
the remaining $16.0 million of registered capital for our Chinese subsidiary.
We established this subsidiary as part of our efforts to increase capacity and
reduce costs for testing our CameraChips.
In October 2003, we entered into a Shareholders' Agreement with TSMC
pursuant to which we agreed with TSMC to form VisEra, a joint venture in
Taiwan, for the purposes of providing manufacturing services and automated
final testing services. We have committed with TSMC and certain employees and
affiliates of VisEra to provide an aggregate of $50.0 million in total capital
to VisEra, which commitments may be made in the form of cash or asset
contributions. Our company and TSMC will have equal interests in VisEra. Our
share of this capital commitment to VisEra is $23.5 million and becomes due in
stages as VisEra's business and service capabilities develop over a number of
years. Our net cash commitment to VisEra is approximately $4.5 million. We will
also contribute approximately $19.0 million of assets to the joint venture,
including technology, plant and equipment currently owned by us or to be
purchased with funds for existing commercial commitments. The $4.5 million
commercial commitment referenced in the table above refers to the remaining
$4.5 million of net cash capital contributions to VisEra.
We expect to fund the capital commitment to our Chinese subsidiary and to
our joint venture with TSMC through a combination of funds from our available
working capital, investments from third parties, or equity or debt financing.
Third party financing may not be available to us when and as required or on
terms that are favorable to our stockholders and us. In addition, Chinese law
may limit the sources that may be eligible to invest in our Chinese subsidiary.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
In the event we are unable to obtain financing from third parties, the issuance
of our equity securities, including securities convertible into our equity
securities, would dilute the ownership interests of our existing stockholders,
and the issuance of debt securities could increase the risk or the perceived
risk of our business. Issuance of debt securities could also impair our
financial condition, and interest payments could have an adverse effect on our
results of operation.
We currently expect our available cash, cash equivalents, and short-term
investments, together with cash that we anticipate to be generated from
business operations, to be sufficient to satisfy our working capital
requirements for the next twelve months. Our ability to generate cash from
operations is subject to substantial risks described below under the caption
"Factors Affecting Future Results." We encourage you to review these risks
carefully. If we are unable to generate sufficient cash from our operations, it
would have a material adverse effect on our business and financial condition.
Factors Affecting Future Results
- --------------------------------
This Quarterly Report on Form 10-Q, including this Management's Discussion
and Analysis, contains forward-looking statements. These forward-looking
statements are subject to substantial risks and uncertainties that could cause
our future business, financial condition or results of operations to differ
materially from our historical results or currently anticipated results,
including those set forth below.
Risks Related to Our Business
-----------------------------
We face intense competition in our markets from more established CCD and
------------------------------------------------------------------------
CMOS image sensor manufacturers, and if we are unable to compete
----------------------------------------------------------------
successfully we may not be able to maintain or grow our business.
----------------------------------------------------------------
The image sensor market is intensely competitive and we expect
competition in this industry to continue to increase. This competition has
resulted in rapid technological change, evolving standards, reductions in
product sales prices and rapid product obsolescence. If we are unable to
successfully meet these competitive challenges, we may be unable to maintain
and grow our business. Any failure to compete successfully would also adversely
affect our results of operation and impair our financial condition.
Our CameraChips face competition from a number of sources, including
companies that sell CCD image sensors, as well as other companies that sell
CMOS image sensors. Many of our competitors have longer operating histories,
greater presence in key markets, greater name recognition, larger customer
bases, more established strategic and financial relationships and significantly
greater financial, sales and marketing, manufacturing, distribution, technical
and other resources than we do. As a result, they may be able to adapt more
quickly to new or emerging technologies and customer requirements or devote
greater resources to the promotion and sale of their products. Our competitors
include CCD image sensor manufacturers such as Fuji, Matsushita, NEC, Sharp,
Sony, Sanyo and Toshiba, as well as established CMOS image sensor manufacturers
such as Agilent, ESS, Fujitsu, Hynix, Micron, Mitsubishi Electronic, Motorola,
National Semiconductor, Samsung, Sharp, Sony, STMicroelectronics and Toshiba.
In addition, we compete with a large number of smaller CMOS manufacturers
including Foveon, IC Media Corporation, PixArt and Zoran.
Our competitors may acquire or enter into strategic or commercial
agreements or arrangements with foundries or providers of color filter
processing, assembly or packaging services. These strategic arrangements
between our competitors and third party service providers could involve
preferential or exclusive arrangements for our competitors. As a result, these
strategic alliances could impair our ability to secure sufficient capacity from
foundries and service providers to meet our demand for wafer manufacturing,
color filter processing, assembly or packaging services, adversely affecting
our ability to meet customer demand for our products. In addition, competitors
may enter into exclusive relationships with distributors, which could reduce
available distribution channels for our products and impair our ability to sell
our products and grow our business.
In addition, some of our customers may also be developers of image
sensors, and this could potentially adversely affect our results of operations,
business and prospects. Samsung, for example, is a current customer that uses
our CMOS products in certain of its products, but also independently
manufactures CMOS image sensors. A customer such as Samsung that develops its
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
own image sensors may reduce or cease purchases from us, and this could
materially and adversely affect our ability to sustain and grow our business
and could impair our financial results. Samsung is also a third party service
provider that has fabricated, and may in the future fabricate, our interface
chips or other products. If Samsung were to decide not to fabricate our
interface chips for competitive or other reasons, that could impair our ability
to meet customer demand for our products.
Problems with wafer manufacturing yields could result in higher operating
-------------------------------------------------------------------------
costs and could impair our ability to meet customer demand for our products.
---------------------------------------------------------------------------
If the foundries manufacturing the wafers used in our products cannot
achieve expected yields, we may incur higher per unit costs and reduced product
availability. Any reduction in our ability to timely deliver products to
customers could adversely affect our customer relations and make it more
difficult to sustain and grow our business. Foundries that supply our wafers
have experienced problems in the past achieving acceptable wafer manufacturing
yields. Wafer yields are a function of both our design technology and the
particular foundry's manufacturing process technology. Low yields may result
from design errors or manufacturing failures in new or existing products. We
perform a final test of our products after they are assembled, as their optical
nature makes earlier testing difficult and expensive. As a result, yield
problems may not be identified until our products are well into the production
process. The risks associated with low yields are exacerbated because we rely
on third party offshore foundries for our wafers, which increases the effort
and time required to identify, communicate and resolve manufacturing yield
problems.
We depend on the increased acceptance of CMOS technology for mass market
------------------------------------------------------------------------
image sensor applications, and any delay in the acceptance of this
------------------------------------------------------------------
technology could adversely affect our ability to grow our business and
----------------------------------------------------------------------
increase our revenues.
---------------------
Our business strategy depends in large part on the continued growth of
various markets into which we sell our CameraChips, including the markets for
digital still and video cameras, cell phones, personal computers, toys and
games, including interactive video games, and commercial and home security and
surveillance applications. Our ability to sustain and grow our business also
depends on the emergence of new markets for our products such as cameras for
automotive applications, personal identification systems and medical imaging
devices. If these current and new markets do not grow and develop as
anticipated, we may be unable to sustain or grow the sales of our products.
Although CMOS technology has been available for over 20 years, CMOS
technology has been used in image sensors only relatively recently. Along with
the other risk factors described in this section, the following are examples of
factors that may delay the increasing adoption of the CMOS fabrication process
and our single chip technology for mass market image sensor applications:
o the failure of the emergence of a universal platform for imaging solutions
for computers and the Internet;
o improvements in or price reductions for CCD image sensors, which could
slow the adoption of CMOS image sensors in markets already dominated by
CCD image sensors or prevent or delay the adoption of CMOS image sensors
in emerging markets; and
o the failure to develop easy to use and affordable products using CMOS
image sensors.
The occurrence of any of these factors could adversely affect our ability
to sustain and grow our business and increase our revenues and earnings.
In addition, the market price of our common stock may be adversely
affected if certain of these new markets do not emerge or develop as expected,
such as the markets for image sensor products in automobiles and personal
identification systems. Securities analysts may have already factored revenue
from such new markets into their future estimates of our financial performance
and any failure for such markets to develop as expected by such security
analysts may adversely affect the trading price of our common stock.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
If we do not forecast customer demand correctly, our business could be
----------------------------------------------------------------------
impaired as a result of excess inventory or the loss of existing or
-------------------------------------------------------------------
potential customers.
-------------------
Our sales are generally made on the basis of purchase orders rather than
long-term purchase commitments, and we manufacture products and build inventory
based on our estimates of customer demand. Accordingly, we must rely on
multiple assumptions concerning forecasted customer demand. In addition, our
customers may cancel or defer orders at any time. If we overestimate customer
demand, we may manufacture products that we may be unable to sell, or we may
have to sell our products to other customers at lower prices. This could
materially and adversely affect our results of operation and financial
condition. We have experienced problems with accurately forecasting customer
demand in the past. For example, beginning in the third quarter of fiscal 2001,
the demand for our CameraChips for use in PC cameras decreased significantly
and one of our significant OEM customers unexpectedly cancelled its purchase
orders. If we underestimate customer demand, we may be unable to manufacture
sufficient product quickly enough to meet actual demand, causing us to lose
customers and impairing our ability to grow our business. In recent periods,
due to customer demand we have had relatively low levels of inventory, and we
have turned over our inventory several times per year. Low levels of inventory
could materially impair our ability to meet customer demand for our CameraChip
products. As we build our inventory levels, this subjects us to the product
obsolescence risks described above.
Sales of our CameraChips for digital still cameras have accounted for a
-----------------------------------------------------------------------
significant portion of our revenues on both a quarterly and annual basis,
-------------------------------------------------------------------------
and any decline in sales to the digital still market or failure for this
------------------------------------------------------------------------
market to continue to grow as we expect could adversely affect our results
--------------------------------------------------------------------------
of operations.
-------------
We derive a substantial portion of our revenues from sales to the digital
still camera market. Although we can only estimate the percentages of our
products that are used in the digital still camera market due to the
significant amount of our CameraChips that are sold through distributors and
value added resellers, we believe that the digital still camera market
accounted for approximately 42% of our revenue in fiscal 2003 and 44% of our
revenue in the three months ended October 31, 2003. We expect that revenues
from sales of our CameraChips to the digital still camera market will continue
to account for a substantial portion of our revenues during fiscal 2004 and for
each of our fiscal quarters during such year. Sales of our CameraChips for the
digital still camera market are subject to seasonal fluctuations. Any factors
adversely affecting the demand for our CameraChips in the digital still camera
market could cause our business to suffer and adversely affect our results of
operations. The digital image sensor market for digital still cameras is
extremely competitive, and we expect to face increased competition in this
market in the future. If we fail to continue to receive design wins with key
digital still camera manufacturers, our market share or revenues could
decrease. In addition, digital still camera manufacturers typically purchase
digital image sensors through distributors, and we do not have contracts with
any distributor that obligate them to sell our products. Such distributors may
also sell products of our competitors. We may not be able to successfully
increase or maintain the rate of sales of our CameraChip products for digital
still cameras through distributors in the future. The image sensor market for
digital still cameras is also subject to frequent technology change. In order
to compete successfully in such market, we will have to correctly forecast
customer demand for technological improvements and be able to deliver such
products on a timely basis at competitive costs. If we fail to do this, our
results of operation, business and prospects would be materially adversely
affected. In the past, we have experienced problems accurately forecasting
customer demand in other markets. For example, beginning in the third quarter
of fiscal 2001, the demand for our CameraChips for use in PC cameras decreased
significantly and one of our significant OEM customers unexpectedly cancelled
its purchase orders. If customer demand in the digital still camera market were
to fall suddenly due to oversupply of product or for any other reason, we will
be subject to excess inventory risks.
We depend on a limited number of third party wafer foundries, which reduces
---------------------------------------------------------------------------
our ability to control our manufacturing process.
------------------------------------------------
We do not own or operate a semiconductor fabrication facility. Instead, we
primarily rely on TSMC, Powerchip Semiconductor Company, or PSC, and other
subcontract foundries to produce substantially all of our wafers. Samsung has
fabricated and may in the future fabricate one of our interface chips on its
standard fabrication line. Historically, we have relied upon TSMC to provide us
with a substantial majority of our wafers, but we have never entered into a
long-term supply agreement with TSMC and instead have traditionally secured
manufacturing availability on a purchase order basis. As a part of the
Shareholders' Agreement for the formation of the TSMC and OmniVision joint
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
venture, VisEra, TSMC has agreed to commit substantial wafer manufacturing
capacity to us for a period of time in exchange for our commitment over this
time period to purchase a substantial portion of our wafers from TSMC, subject
to pricing and technology requirements. We do not have long-term supply
agreements with any other foundries and instead secure manufacturing
availability on a purchase order basis. These other foundries have no
obligation to supply products to us for any specific period, in any specific
quantity or at any specific price, except as set forth in a particular purchase
order. In general, our reliance on third party foundries involves a number of
significant risks, including:
o reduced control over delivery schedules, quality assurance, manufacturing
yields and production costs;
o lack of guaranteed production capacity or product supply;
o unavailability of, or delayed access to, next generation or key process
technologies; and
o financial difficulties or disruptions in the operations of third party
foundries due to causes beyond our control.
If TSMC or any of our other foundries were to become unable to continue
manufacturing our wafers in the required volumes, at acceptable quality, yields
and costs, and in a timely manner, we would have to identify and qualify
substitute foundries, which would be time consuming and difficult, and could
increase our costs or result in unforeseen manufacturing and operations
problems. In addition, if competition for foundry capacity increases we may be
required to pay increased amounts for manufacturing services. We are also
exposed to additional risks if we transfer our production of semiconductors
from one foundry to another as such transfer could interrupt our manufacturing
process. Further, some of our foundries, such as Samsung, are also developers
of image sensor products. If Samsung or one of our other foundries were to
decide not to fabricate our interface chips for competitive or other reasons,
we would have to identify and qualify additional foundries.
We rely on third party service providers for color filter application and
-------------------------------------------------------------------------
packaging services, which reduces our control over delivery schedules,
----------------------------------------------------------------------
product quality and cost, and could adversely affect our ability to deliver
---------------------------------------------------------------------------
products to customers.
---------------------
We rely on TSMC and Toppan for the color filter processing of our
completed wafers. In addition, we rely on Kyocera and Sun Yang Digital Image,
or SYDI, for substantially all of our ceramic chip packages, which are
generally used in our higher-priced products, another service provider for our
plastic chip packages, which are generally used in our lower-priced products,
and yet another service provider for chip scale packages, which are generally
used in our products designed for the smallest form factor applications. We do
not have long-term agreements with any of these service providers and typically
obtain services on a purchase order basis. If for any reason one or more of
these service providers becomes unable or unwilling to continue to provide
color filter processing or packaging services of acceptable quality, at
acceptable costs and in a timely manner, our ability to deliver our products to
our customers could be severely impaired. We would quickly have to identify and
qualify substitute service providers, which could be time consuming and
difficult and could result in unforeseen operational problems. Substitute
service providers might not be available or, if available, might be unwilling
or unable to offer services on acceptable terms.
In addition, if competition for color filter processing or packaging
capacity increases, we may be required to pay or invest significant amounts to
secure access to these services, which could adversely impact our operating
results. There are a limited number of companies that provide these services,
some of which have limited operating histories and financial resources. In the
event our current providers refuse or are unable to continue to provide these
services to us, we may be unable to procure services from alternate service
providers. Furthermore, if customer demand for our products increases, we may
be unable to secure sufficient additional capacity from our current service
providers on commercially reasonable terms, if at all. Moreover, our reliance
on a limited number of third party service providers to provide color filter
processing services subjects us to reduced control over delivery schedules,
quality assurance and costs. This lack of control may cause us to incur
unforeseen product shortages or may increase our costs of manufacturing,
assembling or testing our products, which would adversely affect our operating
results.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Historically, our revenues have been dependent upon a few key customers, the
----------------------------------------------------------------------------
loss of one or more of which could significantly reduce our revenues.
--------------------------------------------------------------------
Historically, a relatively small number of original equipment
manufacturers, or OEMs, value added resellers, or VARs, and distributors have
accounted for a significant portion of our revenues. Any material delay,
cancellation or reduction of purchase orders from one of our major customers or
distributors could result in our failure to achieve anticipated revenue for the
period. If we are unable to retain one or more of our largest OEM, distributor
or VAR customers, or if we are unable to maintain our current level of revenues
from one or more of these significant customers, our business and results of
operation would be impaired and our stock price could decrease, potentially
significantly. In fiscal 2003, our only OEM or VAR customer that accounted for
more than 10% of our revenues was Primax Electronics Products Huizhou based in
China, which accounted for approximately 14% of our revenues in such fiscal
year. In the six months ended October 31, 2003, Aiptek International, Inc., or
Aiptek, headquartered in Taiwan, accounted for 10.5% of revenues. In fiscal
2003, our only distributor customer that accounted for more than 10% of our
revenues was World Peace Industrial Co., or World Peace, headquartered in
Taiwan which accounted for approximately 21% of our revenues in such fiscal
year. In the six months ended October 31, 2003, World Peace Industrial Co.
Ltd., or World Peace, headquartered in Taiwan, accounted for 22.9% of revenues,
was our only distributor customer that accounted for more than 10% of revenues.
Our business, financial condition and results of operations will continue to
depend significantly on our ability to retain our current key customers and
attract new customers, as well as on the financial condition and success of our
OEMs, VARs and distributors.
Our ability to deliver products that meet customer demand is dependent upon
---------------------------------------------------------------------------
our ability to meet new and changing requirements for color filter
------------------------------------------------------------------
application and sensor packaging.
--------------------------------
We expect that as we develop new products to meet technological advances
and new and changing industry and customer demands, our color filter
application and ceramic, plastic and chip-scale packaging requirements will
also evolve. Our ability to continue to profitably deliver products that meet
customer demand is dependent upon our ability to procure third party services
that meet these new requirements on a cost-effective basis. We have
historically relied exclusively on third parties to provide these services.
There can be no assurances that any of these parties will be able to develop
enhancements to the services they provide to us to meet these new and changing
industry and customer requirements. Furthermore, even if these service
providers are able to develop their services to meet new and evolving
requirements, these services may not be available at a cost that enables us to
sustain profitability.
The assembly and packaging of our image sensors into camera modules further
---------------------------------------------------------------------------
complicates and reduces our ability to control the manufacturing process,
-------------------------------------------------------------------------
and may decrease our gross margins.
----------------------------------
Recently, some of our camera manufacturer customers have requested that we
deliver our CameraChips in the more finished form of camera modules. This
increases the complexity of the overall manufacturing process and, as a result,
may result in decreased yields. We have engaged third party contract
manufacturers to assemble and package our image sensors into camera modules,
requiring us to manage service provider relationships that have not
historically been a part of our business. If these third party contract
manufacturers are unable to provide timely, reliable and high quality assembly
and packaging services, we could experience product shortages and be unable to
fill customer orders, resulting in loss of revenues, damage to our reputation
and an adverse effect on our ability to retain existing customers and attract
new customers. In addition, several of these third party contract manufacturers
also sell camera modules directly to third parties. Due to the competition with
our camera module products, any of these third party contract manufacturers may
decide to reduce or terminate their relationship with us, which could create
product shortages for us and result in a loss of revenues and damage to our
customer relationships. Moreover, we must purchase and hold in our inventory
products that are not related to our business in order to deliver our image
sensors in a more finished form, which adds complexity to the overall
manufacturing process and increases inventory risks. The gross margin
percentage we realize on modules has been lower than the gross margin
percentage we have achieved historically on our CameraChips, and we expect this
to continue. In addition, if we are unable to realize a premium in selling
price for camera modules compared to our CameraChips that is greater than the
cost of assembling and packaging camera modules, our profitability would also
be adversely affected.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Declines in our average sales prices may result in a decline in our revenues
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and gross margin.
----------------
We have experienced and expect to continue to experience pressure to
reduce the sales prices of our products and have experienced declines in our
average sales prices as a result. We expect that the average sales prices for
many of our products will continue to decline over time. Declines in our
average sales prices could result in reduced revenues and a decline in our
gross margin, and could materially and adversely affect our operating results
and impair our financial condition. For the remainder of fiscal 2004, we intend
to increase our research and development expenses in an attempt to accelerate
the development of our next generation of CameraChip products. However, if we
are unable to timely introduce new products that incorporate more advanced
technology and include more advanced features that can be sold at higher
average sales prices, our financial results will be adversely affected.
We may never achieve the anticipated benefits from our operations in China.
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Currently, wafer production, color filter application, and sensor
packaging is performed primarily in Asia and, to a limited extent, in Israel by
third party manufacturers and service providers. Historically, our CameraChips
have been shipped to our facility in the United States to undergo sensor
testing before being shipped to customers. This process is time-consuming and
relatively expensive and can result in damaged products. In December 2000, we
established a Chinese subsidiary as part of our efforts to streamline our
manufacturing process and reduce the costs and working capital associated with
the testing of our CameraChips. We have initiated the process of moving final
testing operations to our Chinese subsidiary and have begun to relocate some of
our automated image testing equipment from the United States to China. We
anticipate that we will substantially complete this transition prior to the end
of fiscal 2004. In addition, we also expect to expand testing capabilities with
additional automated testing equipment, which will also be located in China.
However, there are significant administrative, legal and governmental risks to
operating in China that could result in increased operating expenses or that
could prevent us from achieving our objectives in operations. Consequently, we
may never be able to achieve the anticipated cost savings from the transition
of testing operations to China, resulting in failure to improve our gross
margins. If our operations in China do not result in offsetting gains in the
form of operating cost reductions, whether because of risks and difficulties
entailed by foreign operations or for other reasons, our business and financial
condition could be adversely affected. The substantial risks from operating in
China that could increase our operating expenses and adversely affect our
operating results, financial condition and ability to deliver our products and
grow our business include, without limitation:
o difficulties in staffing and managing foreign operations, in particular
attracting and retaining personnel qualified to design, sell and support
CMOS image sensors;
o difficulties in coordinating our operations in China with those in
California;
o diversion of management attention;
o difficulties in maintaining uniform standards, controls, procedures and
policies across our global operations, including inventory management and
financial consolidation;
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 China; and
o inadequacy of the local infrastructure to support our needs.
We may never achieve the anticipated benefits from our joint venture with
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TSMC.
----
In October 2003, we entered into an agreement with TSMC pursuant to which
we agreed with TSMC to form VisEra, a joint venture in Taiwan, for the purposes
of providing manufacturing services and automated final testing services. We
expect that VisEra will eventually be able to provide us with a committed
supply of high quality manufacturing services and automated final testing
services at competitive prices. However, there are significant legal,
governmental and relationship risks to forming and developing VisEra, and we
cannot ensure that we will be able to receive the expected benefits from this
joint venture. For example, VisEra may not be able to provide manufacturing
services or automated testing services that have competitive technology or
prices, which would adversely affect our product offerings and our ability to
meet customer requirements for our products. In addition, the formation of
VisEra provides us with an additional source for certain manufacturing services
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
but, in the future, may also make it more difficult for us to secure dependable
services from other merchant vendors who provide similar manufacturing
services. We also will be required to account for our investment in VisEra
under the equity method, and any loss that VisEra incurs will negatively impact
our reported earnings.
We maintain a backlog of customer orders which is subject to cancellation or
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delay in delivery schedules, and any cancellation or delay may result in
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lower than anticipated revenues.
------------------------------
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. Any cancellation or delay in orders which constitute our current or
future backlog may result in lower than expected revenues.
Our operations in China and our joint venture with TSMC will require
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substantial capital expenditures.
--------------------------------
We must meet certain minimal capital requirements applicable to our
Chinese subsidiary and our joint venture with TSMC. Our Chinese subsidiary has
$30.0 million in registered capital, $14.0 million of which had been funded as
of October 31, 2003. Of the remaining $16.0 million, $0.7 million must be
funded by January 2004 and $15.3 million must be funded by January 2005. In
addition, we must meet certain financial requirements with regard to VisEra,
our joint venture with TSMC. We have committed with TSMC and certain employees
and affiliates of VisEra to provide an aggregate of $50.0 million in total
capital to VisEra, which commitments may be made in the form of cash or asset
contributions. Our share of this capital commitment to VisEra is $23.5 million
and becomes due in stages as VisEra's business and service capabilities develop
over a number of years. Our net cash investment in the joint venture will
approximate $4.5 million. We will also contribute approximately $19.0 million
of assets to the joint venture, including technology, plant and equipment
currently owned by us or to be purchased with funds for existing commercial
commitments. Our cash and net asset contributions to VisEra will be made in
three phases. In the first phase, we shall contribute $1.5 million in cash to
VisEra and a non-exclusive license to certain of our manufacturing and
automated final testing technologies and patents. In the second phase, we shall
contribute $9.5 million in cash to VisEra and a non-exclusive license to
certain of our manufacturing and automated final testing technologies and
patents. In the third phase, we shall contribute $12.5 million in cash and
assets to VisEra and receive back from VisEra an aggregate cash payment of
$17.5 million.
We expect to fund the capital commitment to our Chinese subsidiary and to
our joint venture with TSMC through a combination of funds from our available
working capital, investments from third parties, or equity or debt financing.
Third party financing may not be available to us when and as required or on
terms that are favorable to our stockholders and us. In addition, Chinese law
may limit the sources that may be eligible to invest in our Chinese subsidiary.
In the event we are unable to obtain financing from third parties, the issuance
of our equity securities, including securities convertible into our equity
securities, would dilute the ownership interests of our existing stockholders,
and the issuance of debt securities could increase the risk or the perceived
risk of our business. Issuance of debt securities could also impair our
financial condition, and interest payments could have an adverse effect on our
results of operation.
We have a limited history of profitability and may be unable to maintain our
----------------------------------------------------------------------------
recent levels of profitability.
------------------------------
We have a limited history of profitability and may be unable to sustain
our recent levels of profitability. If we fail to sustain or increase our
levels of profitability, our financial condition may be materially and
adversely affected, and the trading price of our common stock may decline.
Since our inception in 1995, we have achieved profitability on an annual basis
only on two occasions, in fiscal 2000 and fiscal 2003. In fiscal 2001 we
incurred net losses of $11.6 million, and in fiscal 2002 we incurred net losses
of $1.3 million. In fiscal 2000, the only year in which we were profitable on a
fiscal year basis prior to fiscal 2003, our net income was $3.4 million. In
fiscal 2003 our net income was $15.3 million. In the future, we expect to incur
significant expenses, including expenses related to our research and
development efforts, our operations in China and capital commitments to our
Chinese subsidiary and our joint venture with TSMC, which could impair our
ability to sustain profitability. In addition, as we hire additional personnel,
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
we expect selling, general and administrative and other expenses to increase.
Other risks associated with our business described elsewhere in this section
could also affect our ability to sustain profitability. If our revenues do not
increase or if we cannot effectively control our expenses, we may be unable to
sustain profitability at levels consistent with our financial performance in
fiscal 2003, or at all.
We may be unable to adequately protect our intellectual property and
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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
provide assurance that any patent will issue as a result of any applications
or, if issued, that any claims allowed will be sufficiently broad to protect
our technology. It is possible that existing or future patents may be
challenged, invalidated or circumvented. For example, on August 21, 2002 we
initiated a patent infringement action in Taiwan, R.O.C. against IC Media
Corporation of San Jose, CA for infringement of Taiwan patent NI-139439 owned
by us. The action was brought in the Civil Tribunal of the Shih Lin District
Court and assigned Civil Action Number 91 Su-Zi 1074. The patent infringement
action seeks damages and injunctive relief against IC Media Corporation. In
response to our patent infringement action, on October 2, 2002, IC Media
Corporation initiated a cancellation proceeding (Cancellation No. 089123560N01)
in the Taiwan Intellectual Property Office with respect to its Taiwan patent
NI139439. On July 23, 2003, the Taiwan Intellectual Property Office made an
initial determination to grant the cancellation of Taiwan patent NI-139439. The
decision of the Taiwan Intellectual Property Office was upheld by the Taiwan
Ministry of Economic Affairs in November 2003. We intend to file an action with
the High Administrative Court of Taiwan to reverse the grant of cancellation.
If IC Media is ultimately successful, we may lose or suffer diminished rights
in the challenged patent. In addition, if we are not successful in suits in
which we claim that third parties infringe our patents or other intellectual
property, our competitive position may be adversely affected.
Furthermore, 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
patent, copyright, trademark and trade secret protection may be unavailable or
limited in foreign countries. Any disputes over our intellectual property
rights may result in costly and time-consuming litigation or the license of
additional elements of our intellectual property for little or no compensation.
Litigation regarding intellectual property could divert management
------------------------------------------------------------------
attention, be costly to defend and prevent us from using or selling the
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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. We have in the past, are currently, and may in the
future be subject to legal proceedings and claims with respect to our
intellectual property, including such matters as trade secrets, patents,
product liabilities and other actions arising out of the normal course of
business. See "Legal Proceedings." These claims may increase as our
-----------------
intellectual property portfolio becomes larger or more valuable. Intellectual
property claims against us, and any resulting lawsuit, may cause us to incur
significant expenses, subject us to liability for damages and invalidate our
proprietary rights. In one case we paid $3.5 million to settle a litigation
matter. 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 take actions such as:
o ceasing the sale or use of products or services that incorporate the
infringed intellectual property;
o obtaining 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 redesigning those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses and prevent us from selling the products until the
redesign is completed, if at all.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
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, we may be
unable to sell some or all of our products, and our operating results could be
adversely affected. 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.
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, including other CMOS image sensor manufacturers.
We may also make acquisitions of or investments in businesses that we believe
could expand our distribution channels. Even if we were to announce an
acquisition, we may not be able to complete it. Additionally, any future
acquisition or substantial investment would present numerous risks, including:
o difficulty in integrating the technology, operations or work force of the
acquired business with our existing business;
o disruption of our ongoing 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, customers, suppliers
and strategic partners 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 any 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 consideration for a transaction is paid in common stock, this
would further dilute our existing stockholders.
If we do not effectively manage our growth, our ability to increase our
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revenues and improve our earnings could be adversely affected.
-------------------------------------------------------------
Our growth has placed, and will continue to place, a significant strain on
our management and other resources. In particular, we expect that we will
continue to face challenges in managing the expansion of our operations in
China. To manage our growth effectively, we must, among other things:
o implement and improve operational, financial and accounting systems;
o train and manage our employee base; and
o attract and retain qualified personnel with relevant experience.
In addition, in recent fiscal quarters we have also seen significant
growth in the level of our inventory and accounts receivables, net, and an
increase in our days of sales outstanding, primarily as a result of our revenue
growth in fiscal 2003 and the first half of fiscal 2004. Our failure to
effectively manage our inventory levels could either result in excess
inventories, which could adversely affect our gross margins and operating
results, or lead to an inability to fill customer orders, which would result in
lower sales and could harm our relationships with existing and potential
customers. As part of the increase in our sales, during the first six months of
fiscal 2004 our accounts receivables and days sales outstanding increased. If
we do not manage effectively our accounts receivable, our cash balance and
operating results will be adversely affected.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
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 may not make 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
potential market opportunities. Our future operating results will also depend
on our ability to expand sales and marketing, research and development,
accounting, finance and administrative support.
Our future tax rates could be higher than expected if the proportion of
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future operating income generated outside the U.S. by our foreign
-----------------------------------------------------------------
subsidiaries is less than we expect.
-----------------------------------
A number of factors will affect our tax rate in the future, and the
combined effect of these factors could result in an increase in our effective
rate as compared to our effective tax rate in fiscal 2003. This will adversely
affect our operating results. A key factor that will cause the rate to increase
is that the financial statement benefit of reversing the valuation allowance
offsetting net deferred tax assets has already been fully recognized as of the
end of fiscal 2003. If our foreign subsidiaries are unable to achieve operating
income in fiscal 2004, our effective tax rate in fiscal 2004 may be higher than
the combined federal and state statutory rates. We expect that our tax rate for
fiscal 2004 will be higher than our effective tax rate in fiscal 2003.
Our sales through distributors increase the complexity of our business,
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which may increase our operating costs and may reduce our ability to
--------------------------------------------------------------------
forecast revenues.
-----------------
During fiscal 2003 and the six months ended October 31, 2003,
approximately 32% and 33%, respectively, of our sales were made through
distributors. Selling through distributors reduces our ability to accurately
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 creditworthiness of our distributors.
Any failure to manage these challenges could cause us to inaccurately
forecast sales and carry excess or insufficient inventory, thereby adversely
affecting our operating results.
Failure to obtain design wins could cause our market share and revenues to
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decline and could impair our ability to grow our business in the future.
-----------------------------------------------------------------------
Our future success is dependent upon manufacturers, designing our
CameraChips into their products. To achieve design wins, which are decisions by
those manufacturers to design our products into their systems, we must define
and deliver cost effective and innovative semiconductor solutions. Our ability
to achieve design wins is subject to numerous risks including competitive
pressures as well as technological risks. If we do not achieve a design win
with a prospective customer, it may be difficult to sell our CameraChips to
such prospective customer in the future because, 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,
time, effort and risk associated with qualifying a new supplier. In addition, a
decision by manufacturers to offer our products in attachments or add-ons to,
rather than embedded in, their products could limit our market share or
revenues because the manufacturer may more easily switch to a competitive
product. Accordingly, if we fail to achieve design wins with key camera device
manufacturers that embed image sensors in their products, our market share or
revenues could decrease. Furthermore, to the extent that our competitors secure
design wins, our ability to expand our business in the future will be impaired.
33
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
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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 fourteen to sixteen weeks or
more. Additional time may pass 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. This delay makes it more difficult to forecast
customer demand, which adds uncertainty to the manufacturing planning process
and could adversely affect our operating results.
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 and
other industry risks, many of which are more fully discussed in our other risk
factors, include:
o our ability to accurately forecast demand for our products;
o our ability to achieve acceptable wafer manufacturing yields;
o the gain or loss by us of a large customer;
o our ability to manage our product transitions;
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. For example, our gross margins on revenues from sales of
our line of camera module products are lower than sales of our more established
image sensor products. We typically experience lower yields when manufacturing
new products through the initial production phase, and consequently our gross
margins on new products have historically been lower than our gross margins on
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 to our Chinese subsidiary
and our joint venture with TSMC, and our inventory levels are based on our
expectations of future revenues and are relatively fixed. Consequently, if we
do not achieve revenues in any quarter as 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 are factors
over which we have little or no control, including:
o the growth of the market for products and applications using CMOS image
sensors;
o the timing and size of orders from our customers;
o the volume of our product returns;
o the seasonal nature of customer demand for our products;
o the deferral of customer orders in anticipation of new products, product
designs or enhancements by us; and
o the announcement and introduction of products and technologies by our
competitors.
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Any one or more of these factors is difficult to forecast and could result
in fluctuations in our quarterly operating results. Our operating results in a
given quarter could be substantially less than anticipated, and if we fail to
meet market analyst expectations, a substantial decline in our stock price
could result. 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.
Our success depends on the timely development and introduction of new
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products, which we might not be able to achieve.
-----------------------------------------------
The development of new products is highly complex, and we have in the past
experienced delays in completing the development and introduction of new
products. 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, timely completion and introduction of new products that
satisfy customer requirements;
o development of products that maintain a technological advantage over the
products of our competitors, including our advantages with respect to the
functionality and pixel capability of our CameraChips and our proprietary
testing processes; and
o market acceptance of the new products.
Accomplishing all of this is time consuming and expensive. We may be
unable to develop new products or product enhancements in time to capture
market opportunities or achieve a significant or sustainable acceptance in new
and existing markets. In addition, our products could become obsolete sooner
than anticipated because of a faster than anticipated change in one or more of
the technologies related to our products. The failure to successfully develop
new products that achieve market acceptance in a timely fashion would adversely
affect our ability to grow our business and our operating results.
We face foreign business, political and economic risks, because a majority
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of our products and those of our customers are manufactured and sold outside
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of the United States.
--------------------
We face difficulties in managing our third party foundries, color filter
application service providers, ceramic and plastic packaging service providers
and our foreign distributors, most of whom are located in Asia. Potential
political and economic instability in Asia may have an adverse impact on
foreign exchange rates and could cause service disruptions for our vendors and
distributors.
Sales outside of the United States accounted for approximately 94% and 74%
of our revenues for fiscal 2003 and fiscal 2002, respectively, for
approximately 99.5% and 98.2% of our revenues for the three months ended
October 31, 2003 and 2002, respectively and for approximately 99.1% and 91.8%
of our revenues for the six months ended October 31, 2003 and 2002,
respectively. We anticipate that sales outside of the United States will
continue to account for a substantial portion of our revenues 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;
o decreased visibility as to future demand;
o difficulties in accounts receivable collections; and
o burdens of complying with a wide variety of foreign laws and labor
practices.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Sales of our products have been denominated to date exclusively in U.S.
dollars. Therefore, increases in the value of the U.S. dollar will increase the
price of our products in the currency of the countries in which our customers
are located. This may result in our customers seeking lower-priced suppliers,
which could adversely impact our operating results. A portion of our
international revenues may be denominated in foreign currencies in the future,
which would subject us to risks associated with fluctuations in those foreign
currencies.
We may not achieve the anticipated benefits of our alliances with, and
----------------------------------------------------------------------
strategic investments in, third parties.
---------------------------------------
We expect to develop our business through forming alliances or joint
ventures with, and making strategic investments in, other companies, some of
which may be companies at a relatively early stage of development. For example,
in April 2003 we completed an investment in a chip scale packaging service
company, and in June 2003 we completed an investment in a packaging service
company. In addition, we entered into an agreement with TSMC in October 2003 to
form a joint venture in Taiwan which shall provide manufacturing services and
automated final testing services. Certain risks associated with this joint
venture are discussed above in "Factors Affecting Future Results." We expect to
increase our reliance on partnerships, strategic alliances and investments,
particularly those that enhance our manufacturing capacity and those that
provide manufacturing services and testing capability. These investments and
partnering arrangements are crucial to our ability to grow our business and
meet the increasing demands of our customers. However, we cannot ensure that we
will achieve the benefits expected as a result of these alliances. For
instance, we may not be able to receive acceptable wafer manufacturing yields
from these companies, which could result in higher operating costs and could
impair our ability to meet customer demand for our products. In addition,
certain of these investments or partnering relationships may place restrictions
on the scope of our business, the geographic areas in which we can sell our
products and the types of products that we can manufacture and sell. For
example, our agreement with TSMC provides that we may not engage in any
business that will directly compete with the business of VisEra. This type of
non-competition provision may impact our ability to grow our business and to
meet the demands of our customers. We also may be required to account for some
of these investments under the equity method or to consolidate them into our
operating results. Under such circumstances, losses that such companies incur
could also adversely affect our operating results. As several of these
companies are at a relatively early stage of development, we expect each of
them to incur losses on a quarterly and annual basis.
The implementation of a new enterprise resource planning system presents
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certain risks and financial requirements.
----------------------------------------
We are currently implementing a new enterprise resource planning, or ERP,
system which is critical to the accounting and financial functions of our
company. In addition, the new ERP system imposes certain financial and various
other demands due to the cost of implementation. The ERP system also imposes
certain risks inherent in the conversion to a new computer system, including
disruption to our accounting controls and problems achieving accuracy in the
conversion of electronic data. Failure to properly or adequately address these
issues could result in the diversion of management's attention and resources,
and could materially adversely affect our operating results and impact our
ability to manage our business.
The high level of complexity and integration of our products increases the
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risk of latent defects, which could damage customer relationships and
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increase our costs.
------------------
Because we integrate many functions on a single chip, our products are
complex and are based upon evolving technology. The integration of additional
functions on and complex operations of our products could result in a greater
risk that customers or end users could discover latent defects or subtle faults
after volumes of product have already been shipped. Although we test our
products, we have in the past and may in the future encounter defects or
errors. Delivery of products with defects or reliability, quality or
compatibility problems may damage our reputation and 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.
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
Our customers experience fluctuating product cycles and seasonality, which
--------------------------------------------------------------------------
cause our results of operations to fluctuate from period to period.
------------------------------------------------------------------
Some of the products using our CameraChips, such as digital still cameras,
cell phone cameras, personal computer cameras and cameras for toys and games,
are consumer electronics goods. These mass market camera devices generally have
particular seasonal cycles. For example, sales of our CameraChips for use in
digital still cameras tend to increase in the second quarter of our fiscal year
in anticipation of the holiday sales cycle and in the third quarter of our
fiscal year in anticipation of the Chinese New Year. If we fail to predict
accurately and respond appropriately to this consumer demand on a timely basis
to meet seasonal fluctuations, or if there is any disruption of consumer buying
habits during these key periods, our business and operating results would be
harmed.
Our business could be harmed if we lose the services of one or more members
---------------------------------------------------------------------------
of our senior management team, or if we are unable to attract and retain
------------------------------------------------------------------------
qualified personnel.
-------------------
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, in particular, Shaw Hong, our
President and Chief Executive Officer, Raymond Wu, our Executive Vice
President, John T. Rossi, our new Vice President of Finance and Chief Financial
Officer and certain 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.
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. 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.
Our operations may be impaired as a result of disasters, business
-----------------------------------------------------------------
interruptions or similar events, including the outbreak of the Severe Acute
---------------------------------------------------------------------------
Respiratory Syndrome.
--------------------
Disasters such as earthquakes, water, fire, electrical failure, accidents
and epidemics affecting our operating activities, major facilities, and
employees' and customers' health could materially and adversely affect our
operating results and financial condition. In particular, our operations in
China and most of our third party manufacturers and service providers involved
in the manufacturing of our products are located within relative close
proximity in China. Therefore, any disaster that strikes within close proximity
of that geographic area could be tremendously disruptive to our business and
could materially and adversely affect our operating results and financial
condition. We do not currently have a disaster recovery plan.
As a result of the relatively recent outbreak of severe acute respiratory
syndrome, or SARS, which has impacted a number of countries in Asia,
particularly China and Singapore, our facilities and/or the facilities of our
third party manufacturers and service providers located in China could be
quarantined or temporarily closed. If this occurs, it could delay or prevent us
from developing new products or manufacturing, testing or shipping our current
products, and may require us to find other providers of such services, which
may be unavailable or more expensive than our current providers of such
services. Further, if the outbreak of SARS has an adverse impact on the
businesses of our customers, it could reduce the size and/or frequency of our
customers' purchases, which could adversely impact our operating results and
our ability to sustain and expand our business.
Acts of war and terrorist acts may seriously harm our business and revenue,
--------------------------------------------------------------------------
costs and expenses and financial condition.
------------------------------------------
Acts of war or terrorist acts, wherever located around the world, may
cause damage or disruption to our business, employees, facilities, suppliers,
distributors or customers, which could significantly impact our revenue, costs,
expenses and financial condition. In addition, as a company with significant
operations and major distributors and customers located in Asia, we may be
adversely impacted by heightened tensions and acts of war that occur in
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
locations such as the Korean Peninsula, Taiwan and China. The potential for
future terrorist attacks, the national and international responses to terrorist
attacks or perceived threats to national security, and other acts of war or
hostility have created many economic and political uncertainties that could
adversely affect our business and results of operations in ways that cannot
presently be predicted. We are uninsured for losses and interruptions caused by
terrorist acts and acts of war.
Risks related to our stock
- --------------------------
Provisions in our charter documents and Delaware law, as well as our
--------------------------------------------------------------------
stockholders rights plan, could prevent or delay a change in control of our
---------------------------------------------------------------------------
company 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. Pursuant to the rights
agreement, our board of directors declared a dividend of one 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. 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 our company, 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 selling 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. Since the
beginning of fiscal 2002, the trading price of our common stock has ranged from
a high of $67.66 per share to a low of $2.35 per share. The closing sales price
of our common stock on December 10, 2003 was $57.54. 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 other transfer restrictions on our outstanding
shares of common stock or sales of additional shares of common stock;
o sales or the perception in the market of possible sales of shares of our
common stock by our directors, officers, employees or principal
stockholders;
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (Continued)
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.
39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Foreign Currency Exchange Risk
------------------------------
We are an international company, selling our products globally, in
particular, to branded customers, contract manufacturers, VARs and distributors
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 China, Japan, Korea, Taiwan,
Thailand, the United Kingdom 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
of 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.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
(a) Disclosure Controls and Procedures.
----------------------------------
We maintain disclosure controls and procedures that are designed to
provide us with a reasonable level of assurance that the information required
to be disclosed in our Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms,
and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure based
closely on the definition of "disclosure controls and procedures" in Rule 13a-
15e promulgated under the Exchange Act. We carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on the
foregoing, the Chief Executive Officer and Chief Financial Officer concluded
that as of the end of the period covered by this Quarterly Report on Form 10-Q,
our disclosure controls and procedures were effective in providing us with a
reasonable level of assurance that our control objectives, as discussed above
in the first sentence of this paragraph, were met.
(b) Changes in Internal Controls.
----------------------------
There was no change in our internal controls over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting, or in other factors that could
significantly affect these controls subsequent to the date of their last
evaluation.
We are in the process of implementing a new enterprise resource planning
system. We believe that we have adequate backup procedures and systems in place
such that the process of implementing this new enterprise resource planning
system will not materially adversely affect our internal controls.
40
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
OmniVision, some of our directors and officers, and various underwriters for
our initial public offering. Plaintiffs generally allege that the named
defendants violated federal securities laws because the prospectus related to
our 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 our offering. The complaint seeks unspecified
damages on behalf of a purported class of purchasers of our 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. Our directors and officers have been dismissed
without prejudice pursuant to a stipulation. On February 19, 2003, the Court
granted in part and denied in part a motion to dismiss brought by defendants
including OmniVision. The order dismisses all claims against us except for a
claim brought under Section 11 of the Securities Act of 1933. A proposal has
been made for the settlement and release of claims against the issuer
defendants, including OmniVision. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the Court.
If the settlement does not occur, and litigation against us continues, we
believe we have meritorious defenses and intend to defend the case vigorously.
On August 21, 2002 we initiated a patent infringement action in Taiwan,
R.O.C. against IC Media Corporation of San Jose, CA for infringement of Taiwan
patent NI-139439 owned by OmniVision. The action was brought in the Civil
Tribunal of the Shih Lin District Court and assigned Civil Action Number 91 Su-
Zi 1074. The patent infringement action seeks damages and injunctive relief
against IC Media Corporation. In response to our patent infringement action, on
October 2, 2002, IC Media Corporation initiated a cancellation proceeding
(Cancellation No. 089123560N01) in the Taiwan Intellectual Property Office with
respect to our Taiwan patent NI-139439. On July 23, 2003, the Taiwan
Intellectual Property Office made an initial determination to grant the
cancellation of Taiwan patent NI-139439. The decision of the Taiwan
Intellectual Property Office was upheld by the Taiwan Ministry of Economic
Affairs in November 2003. We intend to file an action with the High
Administrative Court of Taiwan to reverse the grant of cancellation.
On October 11, 2002, we filed a complaint against IC Media Corporation in
Superior Court of California, Santa Clara County (Case No. CV 811866). In our
complaint, we allege misappropriation of trade secrets, unfair competition and
other business torts, and seek damages and injunctive relief. IC Media
Corporation has answered the complaint by denying the allegations and raising
various defenses; no counterclaims have been asserted against us by IC Media.
In accordance with the Alternative Dispute Resolution practices of the Superior
Court of California, Santa Clara County, this matter has been submitted for
non-binding arbitration.
On June 30, 2003, Mr. Chia-Chin Ku filed a complaint in Santa Clara County
Superior Court against us and our president and chief executive officer, Mr.
Shaw Hong. The complaint alleges that, by forming OmniVision in 1995, Mr. Hong
breached a fiduciary duty owed to HK Technology, Inc., a privately-held
corporation Mr. Hong and others founded in 1988. The complaint further alleges
that we "misappropriated and converted" assets and technology belonging to HK
Technology, Inc. The complaint seeks damages in an unspecified amount. We
believe that we have meritorious defenses to the allegations and claims and
intend to defend ourselves vigorously. We understand that HK Technology, Inc.
has not engaged in significant substantive operations since the early 1990s. We
also understand that HK Technology Inc.'s primary line of business was the
design of chipsets for personal computers, and that it did not engage in any
business concerning image sensors, which is OmniVision's primary line of
business. We do not believe that OmniVision's technology or products
incorporate or use any proprietary technology of HK Technology, Inc.
On July 14, 2003, Sunex, Inc. filed a complaint against OmniVision in San
Diego County Superior Court. Sunex was a supplier of optical lenses and lens
41
holders for one of our cell phone products. Under its complaint, Sunex is
seeking to recover approximately $1.8 million plus interest and attorney's
fees. Sunex's complaint relates to parts delivered by Sunex to OmniVision in
the quarters ended January 31, 2003 and April 30, 2003 and our cancellation in
that quarter of additional purchase orders we had previously placed with Sunex.
In October 2003, the Superior Court granted Sunex's request for a prejudgment
writ of attachment. The parties stipulated to the filing of a bond in lieu of
an attachment which OmniVision posted with the Superior Court in the
approximate amount of $1.1 million. The attachment order and subsequent filing
of the bond are not reflective of the merits of the case and are expressly
prohibited from being referred to at the time of trial. We intend to defend
ourselves vigorously and have filed a counterclaim against Sunex in which we
allege breach of contract and breach of warranties, and seek damages in an
amount yet to be determined. We believe that any amount we may ultimately owe
Sunex in excess of the amount we had accrued as of April 30, 2003 will not have
a material adverse affect on our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Our annual meeting of stockholders was held at our corporate headquarters
at 1341 Orleans Drive, Sunnyvale, California on October 1, 2003 at 10:00 a.m.
local time. The results of the matters voted upon were as follows:
1. To elect one Class III director to serve until the expiration of his three-
year term or until his successor is duly elected or appointed and qualified.
Vote
-------------------------------
For Withheld
--- --------
Joseph Jeng.................................... 24,036,414 323,050
The term of office of directors Shaw Hong, Edward C.V. Winn, Raymond Wu
and John T. Rossi continued after the Annual Meeting.
2. To ratify the appointment of PricewaterhouseCoopers LLP as our independent
auditors for the fiscal year ending April 30, 2004.
For Against Abstained
---------------- ---------------- ----------------
24,282,744 72,260 4,460
3. To amend and restate our 2000 Stock Plan to increase the number of shares
reserved for issuance thereunder by 500,000 shares.
For Against Abstained Broker Non-Votes
---------------- ---------------- ---------------- ----------------
4,338,567 11,896,630 12,511 8,111,756
4. To ratify the option grant limitations contained in our amended and restated
2000 Stock Plan for purposes of Section 162(m) of the Internal Revenue Code
of 1986, as amended.
For Against Abstained Broker Non-Votes
---------------- ---------------- ---------------- ----------------
15,230,123 1,006,076 11,509 8,111,756
ITEM 5. OTHER INFORMATION
Non-Audit Services.
------------------
In accordance with Section 10A(i)(2) of the Securities Exchange Act of
1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002 (Act), we are
required to disclose the non-audit services approved by our Audit Committee to
42
be performed by PricewaterhouseCoopers LLP (PWC), our external auditor. Non-
audit services are defined in the Act as services other than those provided in
connection with an audit or a review of the financial statements of a company.
The Audit Committee has approved the engagement of PWC for non-audit services
consisting of tax planning services.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
------ -----------------------------------------------------------------
10.17(a)* Shareholders' Agreement, dated October 29, 2003, by and between
the Registrant and Taiwan Semiconductor Manufacturing Company.
10.17(b)* Letter of Comfort, dated October 29, 2003, by and between the
Registrant and Taiwan Semiconductor Manufacturing Company.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of Sarbanes-Oxley Act of 2002.
- --------------------
* Portions of this agreement have been omitted pursuant to a request for
confidential treatment and the omitted portions have been filed separately
with the Securities and Exchange Commission.
(b) Reports on Form 8-K.
-------------------
We furnished a Current Report on Form 8-K on August 20, 2003 announcing
our fiscal results for our first quarter ended July 31, 2003. Such report was
"furnished," but not "filed."
We filed a Current Report on Form 8-K on September 17, 2003 relating to
our announcement of our appointment of John T. Rossi as our new Vice President
of Finance and Chief Financial Officer.
43
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: December 11, 2003
By: /s/ SHAW HONG
----------------------------------
Shaw Hong
Chief Executive Officer, President
and Director
(Principal Executive Officer)
Dated: December 11, 2003
By: /s/ JOHN T. ROSSI
----------------------------------
John T. Rossi
Vice President of Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
44