-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TDqUmVSWr6tGjOZchyES3hFhpxZRqWZwWS2sSfZavE5ybi+vm7qWEDNOC7s7u2N1 heij9RGeBrtmj+je/m99uw== 0000891618-96-002803.txt : 19961118 0000891618-96-002803.hdr.sgml : 19961118 ACCESSION NUMBER: 0000891618-96-002803 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ESS TECHNOLOGY INC CENTRAL INDEX KEY: 0000907410 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 942928582 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26660 FILM NUMBER: 96666548 BUSINESS ADDRESS: STREET 1: 46107 LANDING PKWY CITY: FREMONT STATE: CA ZIP: 94538 BUSINESS PHONE: 5102261088 MAIL ADDRESS: STREET 1: 46107 LANDINE PARKWAY CITY: FREMONT STATE: CA ZIP: 94538 10-Q 1 FORM 10-Q 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996. OR [ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM: TO: . COMMISSION FILE NUMBER 0-26660 ESS TECHNOLOGY, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 94-2928582 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
48401 FREMONT BOULEVARD FREMONT, CALIFORNIA 94538 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (510) 492-1088 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of September 30, 1996, the registrant had 37,569,103 shares of common stock outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 ESS TECHNOLOGY, INC. TABLE OF CONTENTS
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets -- September 30, 1996 and December 31, 1995, unaudited..................................................... 3 Condensed Consolidated Statements of Operations -- three months and nine months ended September 30, 1996 and 1995, unaudited..................... 4 Condensed Consolidated Statements of Cash Flows -- nine months ended September 30, 1996 and 1995, unaudited.................................. 5 Notes to Condensed Consolidated Financial Statements.................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................................... 16 Item 5. Other Information....................................................... 16 Item 6. Exhibits and Reports on Form 8-K........................................ 16 SIGNATURES ........................................................................ 17
3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ESS TECHNOLOGY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 1996 1995 ------------- ------------ ASSETS Current assets: Cash and cash equivalents........................................ $ 3,451 $ 51,881 Short-term investments........................................... 29,259 26,243 Accounts receivable, net......................................... 24,393 10,236 Inventories...................................................... 31,440 19,169 Deferred income taxes............................................ 2,337 2,337 Prepaid expenses and other assets................................ 4,646 2,271 -------- -------- Total current assets.......................................... 95,526 112,137 Property and equipment, net........................................ 20,274 10,371 Other assets....................................................... 44,133 40,195 -------- -------- $159,933 $162,703 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses............................ $ 36,158 $ 33,744 Income taxes payable............................................. 1,925 3,722 Deferred income taxes............................................ 5,909 4,069 -------- -------- Total current liabilities..................................... 43,990 41,535 -------- -------- Long-term advances payable to vendors.............................. -- 15,960 -------- -------- Total liabilities............................................. 43,990 57,495 -------- -------- Commitments and contingencies (See Note 4) Shareholders' equity: Preferred stock, no par value, 10,000 shares authorized; none issued and outstanding........................................... -- -- Common stock, no par value, 100,000 shares authorized; 37,569 and 36,794 shares issued and outstanding............................. 72,807 66,891 Deferred compensation related to stock options..................... (15) (60) Retained earnings.................................................. 43,151 38,377 -------- -------- Total shareholders' equity.................................... 115,943 105,208 -------- -------- Total liabilities and shareholders' equity............... $159,933 $162,703 ======== ========
See notes to condensed consolidated financial statements. 3 4 ESS TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------- ------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1996 1995 1996 1995 ------------- ------------- ------------- ------------- Net revenues........................... $60,138 $31,389 $149,776 $68,893 Cost of revenues....................... 29,540 11,431 69,066 24,714 ------- ------- -------- ------- Gross profit......................... 30,598 19,958 80,710 44,179 Operating expenses: Research and development............. 5,577 2,666 13,760 6,005 Research and development in-process........................ -- -- 30,355 -- Selling, general and administrative.................... 4,352 1,920 10,540 6,909 ------- ------- -------- ------- Operating income....................... 20,669 15,372 26,055 31,265 Nonoperating income, net............... 418 602 1,757 1,400 ------- ------- -------- ------- Income before provision for income taxes................................ 21,087 15,974 27,812 32,665 Provision for income taxes............. 8,224 6,530 23,038 13,378 ------- ------- -------- ------- Net income............................. $12,863 $ 9,444 $ 4,774 $19,287 ======= ======= ======== ======= Net income per share................... $ 0.31 $ 0.26 $ 0.11 $ 0.52 ======= ======= ======== ======= Weighted average common and common equivalent shares.................... 41,128 36,940 41,805 37,012 ======= ======= ======== =======
See notes to condensed consolidated financial statements 4 5 ESS TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED ------------------------------- SEPTEMBER 30, SEPTEMBER 30, 1996 1995 ------------- ------------- Cash flows from operating activities: Net income...................................................... $ 4,774 $19,287 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................................ 2,267 640 Charges for research and development in-process.............. 30,355 -- Loss (gain) on sales of marketable equity securities, net.... -- (854) Deemed compensation expense and compensation related to stock options..................................................... 45 45 Other non cash activity...................................... -- (84) Change in assets and liabilities (net of effects of VideoCore and OSEE acquisitions): Accounts receivable........................................ (14,157) (11,013) Inventories................................................ (12,259) (10,736) Deferred income taxes...................................... -- (902) Prepaid expenses and other assets.......................... (2,521) (873) Accounts payable and accrued expenses...................... 1,805 7,593 Income taxes payable....................................... (1,797) 875 ------- ------- Net cash provided by operating activities............... 8,512 3,978 ------- ------- Cash flows from investing activities: Acquisition of property and equipment........................... (11,258) (3,309) Sale of marketable equity securities and short-term investments.................................................. 7,360 938 Purchase of marketable equity securities and short-term investments.................................................. (10,376) -- Cash paid for VideoCore and OSEE acquisitions................... (9,288) -- ------- ------- Net cash used in investing activities................... (23,562) (2,371) ------- ------- Cash flows from financing activities: Repayment of long-term advances payable to vendors.............. (15,960) -- Issuance (repurchase) of common stock, net...................... (17,420) 100 ------- ------- Net cash provided by (used in) financing activities..... (33,380) 100 ------- ------- Net increase (decrease) in cash and cash equivalents.............. (48,430) 1,707 Cash and cash equivalents at beginning of period.................. 51,881 10,860 ------- ------- Cash and cash equivalents at end of period........................ $ 3,451 $12,567 ======= ======= Supplemental disclosures of cash flow information: Common stock issued for VideoCore and OSEE acquisitions......... $23,352 $ -- ======= ======= Income taxes.................................................... $24,835 $13,406 ======= =======
See notes to condensed consolidated financial statements. 5 6 ESS TECHNOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The unaudited Consolidated Financial Statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial position, operating results and cash flows for those periods presented. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto for the years ended December 31, 1995 and 1994, included in the Company's Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for any other period or for the fiscal year which ends December 31, 1996. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS. The Company considers all highly liquid investments with an initial maturity of 90 days or less to be cash equivalents and investments with original maturity dates of greater than 90 days to be short-term investments. The Company accounts for its short-term investments under Financial Accounting Standard No. 115 "Accounting for Certain Investments in Debt or Equity Securities" (SFAS 115), which requires investment securities to be classified as either held to maturity, trading or available for sale. All of the Company's short-term investments, comprising primarily debt instruments with contractual maturities of less than two years and marketable equity securities have been classified as available for sale and therefore are reported at fair value with unrealized gains and losses presented as a separate component of shareholders' equity. Management determines the appropriate classification of securities at the time of purchase and reevaluates the classification at each reporting date. NOTE 2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 1996 1995 ------------- ------------ Inventories: Raw materials............................................ $ 2,484 $ 2,773 Work-in-process.......................................... 16,733 9,224 Finished goods........................................... 12,223 7,172 ------- ------- $31,440 $ 19,169 ======= =======
NOTE 3. NET INCOME PER SHARE Net income per share is computed using the weighted average number of common and common equivalent shares ("weighted average share") outstanding during the period. Common equivalent shares consist of the Company's common stock issuable upon exercise of stock options during the period (using the treasury stock method) except when anti-dilutive. Common stock issued and stock options granted subsequent to July 31, 1994 through October 5, 1995 (the date of the initial public offering) have been included in the calculation of weighted average shares outstanding as if they were outstanding for reporting periods occurring between these dates. The Company used the treasury stock method and the initial public offering price of $15.00 per share for these calculations. 6 7 ESS TECHNOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4. WAFER CAPACITY COMMITMENTS In November 1995, the Company entered into agreements with two wafer foundries, Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC") and United Microelectronics Corporation ("UMC"), in which the Company secured access to additional manufacturing capacity and to certain technology. Under the TSMC agreement, in exchange for TSMC's increased wafer capacity commitments, the Company committed to pay approximately $32 million over the next two years as deposits for wafers through 1999. The cash requirements associated with this agreement are two $16 million payments due on June 30, 1996 and 1997. The Company issued two promissory notes totaling $32 million securing these payments. The Company made the first $16 million installment by making payments of $12.6 million and $3.4 million on June 28th and July 1, respectively. The Company also obtained an option to expand the TSMC wafer capacity commitments further for years 1997 through 2000. If the Company exercises its option to commit TSMC to additional wafer capacity, the Company would be committed to an additional $30.8 million in deposits to be paid in two $15.4 million payments due on June 30, 1997 and 1998. If the Company is not able to use, assign, or sell the additional wafer quantities, a portion of the deposits may be forfeited. Under the UMC agreement, the Company entered into a joint venture arrangement with UMC, together with other US semiconductor companies, to build a separate semiconductor manufacturing facility located in Taiwan at an estimated cost of $1 billion. The Company will invest approximately $30 million in three installments over the projected eighteen-month period required to build the facility. The Company made the first installment payment of $6.9 million in the first quarter of 1996. The Company will invest the remaining $23.1 in two installments over the next 12 months. Under the terms of the agreement, the Company will receive a 5% equity ownership in the joint venture company and certain capacity rights. The new fabrication facility is currently projected to commence production in 1997. NOTE 5. ACQUISITIONS AND RELATED CHARGES On January 3, 1996, the Company completed the acquisition of VideoCore Technology, Inc. ("VideoCore"), a California based company, by purchasing all outstanding shares of VideoCore in exchange for $5.4 million in cash, approximately 525,000 shares of ESS' common stock and acquisition costs for an aggregate purchase price of $23.6 million. VideoCore, now a wholly owned subsidiary of the Company, is developing integrated circuits which once completed, will incorporate advanced compression technology for digital video products. On March 29, 1996, the Company completed its acquisition of OSEE Corporation ("OSEE"), a California based Company, by purchasing all outstanding shares of OSEE in exchange for $3.6 million in cash, approximately 217,000 shares of ESS' common stock and acquisition costs for an aggregate purchase price of $9.0 million. OSEE, now a wholly owned subsidiary of the Company, is a developer of advanced fax/modem V.34 and V.34bis algorithm technology which will enable the Company to provide modem and computer telephony applications on the Company's multimedia processor. 7 8 ESS TECHNOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) These acquisitions have been recorded using the purchase method of accounting and accordingly, the results of operations and cash flows of such acquisitions have been included from the applicable dates of acquisition. The acquired research and development in-process aggregating $30.4 million was charged to expense in the first quarter of 1996. Additionally, the pro forma effect of these acquisitions was not significant on the Company's reported operating results for the first quarter or first nine months of 1996 or 1995. NOTE 6. STOCK REPURCHASE PROGRAM On July 15, 1996, the Company's board of directors authorized repurchase of up to 2.0 million of the Company's shares of common stock over the subsequent 12 months at market prices and as market and business conditions warrant. Such repurchases will be made at management's discretion. At September 30, 1996, the Company had repurchased 1,802,500 shares at market prices ranging from $9.41 to $16.75 per share. 8 9 r ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements contained in this discussion that are not statements of historical fact may be deemed to be forward-looking statements. A number of important factors could cause actual events or the Company's actual results to differ materially from those indicated by such forward-looking statements, including dependence on continued growth in demand for PC multimedia capabilities for notebook and desktop computers, as well as consumer electronic products; the Company's ability to take advantage of new markets; increased competition and pricing pressures, general economic conditions and conditions specific to the semiconductor industry; the timing and market acceptance of new product introductions; the timely development of new products; continued availability of quality foundry capacity; and other risks set forth in this filing and in the Company's filings from time to time with the Securities and Exchange Commission. This information should be read along with the unaudited condensed consolidated financial statements and notes thereto included in Item I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the fiscal years ended December 31, 1995 and 1994, contained in the Company's Annual Report filed on Form 10-K. RESULTS OF OPERATIONS The following table discloses key elements of the statements of operation, expressed as a percentage of revenues.
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------- ------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30 1996 1995 1996 1995 ------------- ------------- ------------- ------------- Net revenues......................... 100.0% 100.0% 100.0% 100.0% Cost of revenues..................... 49.1 36.4 46.1 35.9 ----- ----- ----- ----- Gross margin........................... 50.9 63.6 53.9 64.1 Operating expenses: Research and development.......... 9.3 8.5 9.2 8.7 Research and development in-process...................... -- -- 20.3 -- Selling, general and administrative.................. 7.2 6.1 7.0 10.0 ----- ----- ----- ----- Operating income....................... 34.4 49.0 17.4 45.4 Nonoperating income, net............. 0.7 1.9 1.2 2.0 ----- ----- ----- ----- Income before provision for income taxes................................ 35.1 50.9 18.6 47.4 Provision for income taxes........... 13.7 20.8 15.4 19.4 ----- ----- ----- ----- Net income............................. 21.4% 30.1% 3.2% 28.0% ===== ===== ===== =====
Net Revenues. The Company's net revenues, which have primarily been derived from PC audio semiconductor product sales, increased from $31.4 million in the third quarter of 1995 to $60.1 million reported in the third quarter of 1996. Net revenues increased primarily due to increased unit shipments of the Company's PC audio and video semiconductor products. The Company's overall average selling price for its products was higher in the third quarter of 1996 as compared to the same quarter of 1995, primarily due to a change in sales mix to higher priced integrated PC audio and video semiconductor products and lower unit shipments of consumer speech/sound semiconductors. This mix shift was partially offset by average selling price declines of certain individual products during the past year. Declining product prices over the life of such products are common in the semiconductor industry. As competition increases and product prices decline, the Company expects prices on existing products will decline further. International revenues accounted for approximately 89% and 70% of the Company's net revenues in the third quarter of 1996 and 1995, respectively, reflecting continued 9 10 growth in the Company's international sales including shipments to foreign locations of multinational U.S. based companies. The Company's net revenues increased from $68.9 million in the first nine months of 1995 to $149.8 million reported in the first nine months 1996. Net revenues increased primarily due to increased unit shipments of the Company's PC audio semiconductor products. In addition, the Company commenced shipments of video semiconductors in the second quarter of 1996. International revenues accounted for approximately 90% and 69% of the Company's net revenues in the first nine months of 1996 and 1995, respectively, reflecting continued growth in the Company's international sales. Gross Profit. The Company's gross profit increased from $20.0 million and $44.2 million in the third quarter and first nine months of 1995, respectively, to $30.6 million and $80.7 million in the third quarter and first nine months of 1996, respectively. The increase in gross profit in both the third quarter and first nine months of 1996 as compared to the same periods in 1995 was primarily the result of the increase in unit shipments of the Company's PC audio and video semiconductor products. Gross profit margin decreased in both the third quarter and first nine months of 1996 reflecting lower selling prices arising from highly competitive market conditions. The Company's overall gross profit and margin are subject to change due to various factors, including among others, competitive product pricing, unit volumes shipped, new product introductions, yields, wafer costs, assembly costs and product mix. The Company has encountered increased competition from other suppliers who are offering competitive single chip products. In addition, the Company expects that overall average selling prices for its existing products will continue to decline over time and that selling prices for each product will decline significantly over the life of the product. The Company believes that in order to maintain or increase gross profit, it must achieve higher unit volume shipments, cost reductions, new features and product introductions. No assurances can be given that the Company will be able to ship higher volumes, reduce costs, add new features or introduce new products that gain market acceptance. Research and Development. Research and development expenses were $5.6 million and $13.8 million in the third quarter and first nine months of 1996, excluding a one-time pre-tax charge of $30.4 million related to acquired research and development in-process from the acquisition of VideoCore and OSEE in the first quarter of 1996, respectively, an increase of $2.9 million and $7.8 million from the third quarter and first nine months of 1995, respectively. The increase in absolute dollars was primarily due to one-time charges for technology licensing fees as well as the increase in the Company's engineering staff, engineering test runs, masks and internal and external consulting expenses associated with research and development efforts to support the introduction of new multimedia products. Selling, General and Administrative. Selling, general and administrative expenses were $4.4 million and $10.5 million in the third quarter and first nine months of 1996, respectively, an increase of $2.4 million and $3.6 million from the third quarter and first nine months of 1995, respectively. In the first quarter of 1995, the Company recorded legal expenses of $1.8 million for the ongoing litigation with Yamaha Corporation. Excluding this legal expense, selling, general and administrative expense increased by $5.4 million from the first nine months of 1995. The increase in absolute dollars was primarily due to the increase in commissions and bonuses on higher sales volumes, increased personnel and related expenses resulting from the Company's status as a public company. Interest Income. Interest income consists of income on cash available for investment. Interest income, was $372,000 and $1.7 million in the third quarter and first nine months of 1996, respectively, compared to $195,000 and $505,000 in the third quarter and first nine months of 1995, respectively. The increase in interest income for the third quarter of 1996 was primarily due to the increased cash available from the proceeds of the Company's initial public offering in October of 1995 partially offset by cash used by the Company in the repurchase of its common stock, acquisitions of VideoCore and OSEE and payments under the TSMC wafer capacity and UMC joint venture agreements. 10 11 Provision for Income Taxes. The Company's effective tax rate was 39% and 40% for the third quarter and first nine months of 1996, respectively, compared to 41% in the third quarter and first nine months of 1995. The effective tax rate for the first nine months of 1996 was approximately equal to the combined federal and state statutory rates. During the third quarter of 1996, the Internal Revenue Service completed their examination of the Company's federal income tax returns for 1991 to 1993. The Company had previously provided sufficient reserves such that the results of these examinations did not have a material adverse impact on the Company's financial position or results of operations. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its cash requirements from cash generated from operations, the sale of equity securities, bank lines of credit and long-term and short-term debt. At September 30, 1996, ESS had cash and cash equivalents and short-term investments of $32.7 million and working capital of $51.5 million. As of September 30, 1996, the Company had two $10.0 million bank lines of credit expiring on March 31, 1997 and May 1, 1997. These lines of credit requires the Company to achieve certain financial ratios and operating results. There were no borrowing under these lines of credit as of September 30, 1996. In the first nine months of 1996, the Company generated approximately $8.5 million from its operating activities. Approximately $28.9 million was used to finance working capital, primarily due to increases in accounts receivable and inventories reflecting a growth in sales and a higher percentage of revenue to customers having credit terms offset in part by an increase in accounts payable and accrued expenses net of the effect of VideoCore and OSEE acquisitions. $19.5 million was used to repurchase 1.8 million shares of common stock; $16.0 million and $6.9 million were used to pay the first installment under the TSMC wafer capacity and UMC joint venture agreements, respectively, $10.4 million was used to purchase short-term investments; $9.3 million was used to acquire VideoCore and OSEE and $11.3 million was used to purchase property, plant and equipment primarily to fund the construction of a new headquarters facility. The Company believes that its existing cash and cash equivalents as of September 30, 1996, together with the cash generated from operations and available borrowings under its line of credit, will be sufficient to fund acquisitions of property and equipment and provide adequate working capital through at least the next twelve months. Capital expenditures for the next twelve months are anticipated to be approximately $14 million of which approximately $6 million will be used to fund construction of additional facilities and approximately $8 million will be used to acquire capital equipment. In addition, the Company is obligated to pay approximately $16 million over the next 9 months to TSMC in exchange for certain wafer capacity commitments and will invest approximately $23 million in 2 installments over the next 12 months in exchange for an equity ownership in a joint venture with UMC to build a new foundry and for certain wafer capacity commitments. The Company may also utilize cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, the Company may evaluate potential acquisitions of or investment in such businesses, products or technologies owned by third parties. The Company also has bank lines of credit which may be utilized to provide additional working capital. 11 12 FACTORS THAT MAY AFFECT FUTURE RESULTS Potential Fluctuations in Operating Results. The Company's operating results are subject to quarterly and other fluctuations due to a variety of factors, including the gain or loss of significant customers, increased competitive pressures, changes in pricing policies by the Company, its competitors or its suppliers, including decreases in unit average selling prices ("ASPs") of the Company's products, the timing of new product announcements and introductions by the Company or its competitors and market acceptance of new or enhanced versions of the Company's and its customers' products. Other factors include the availability of foundry capacity, fluctuations in manufacturing yields, availability and cost of raw materials, changes in the mix of products sold, the cyclical nature of both the semiconductor industry and the market for PCs, seasonal customer demand, the timing of significant orders and significant increases in expenses associated with the expansion of operations. The Company's operating results could also be adversely affected by economic conditions generally in various geographic areas where the Company or its customers do business, or order cancellations or rescheduling. Because the Company must order products in advance of product shipments and because the markets for the Company's products are volatile and its products are subject to rapid technological and price changes, there is a risk that the Company will produce excess or insufficient inventories of particular products. These factors are difficult to forecast, and these or other factors could materially affect the Company's quarterly or annual operating results. There can be no assurance as to the level of sales or earnings that may be attained by the Company in any given period in the future. Competition. The markets in which the Company competes are intensely competitive and are characterized by rapid technological change, price declines and rapid product obsolescence. The Company currently competes with add-in card suppliers and semiconductor manufacturers. The Company expects competition to increase in the future from existing competitors and from other companies that may enter the Company's existing or future markets with products that may be less costly or provide higher levels of integration, higher performance or additional features. The Company is unable to predict the timing and nature of any such competitive product offerings. The announcement and commercial shipment of competitive products could adversely affect sales of the Company's products and may result in increased price competition that would adversely affect the ASP's and margins of the Company's products. In general, product prices in the semiconductor industry have decreased over the life of a particular product. The markets for most of the applications for the Company's products, particularly the PC market, are characterized by intense price competition. The willingness of prospective customers to design the Company's products into their products depends to a significant extent upon the ability of the Company to sell its products at a price that is cost-effective for such customers. As the markets for the Company's products mature and competition increases, the Company anticipates that prices for its products will continue to decline. If the Company is unable to reduce its costs sufficiently to offset declines in product prices or is unable to introduce more advanced products with higher product prices, the Company's business, financial condition and results of operations would be materially adversely affected. The Company's existing and potential competitors consist principally of large domestic and international companies that have substantially greater financial, manufacturing, technical, marketing, distribution and other resources, greater intellectual property rights, broader product lines and longer-standing relationships with customers than the Company. The Company's competitors also include a number of smaller and emerging companies. The Company's principal audio competitors include Cirrus Logic, Creative Technology, OPTi and Yamaha. The Company's principal video competitors include C-Cube, Hyundai, LSI Logic and SGS Thompson. Certain of the Company's current and potential competitors maintain their own semiconductor foundries and may therefore benefit from certain capacity, cost and technical advantages. The Company believes that its ability to compete successfully depends on a number of factors, both within and outside of its control, including the price, quality and performance of the Company's and its competitors' products, the timing and success of new product introductions by the Company, its customers and its 12 13 competitors, the emergence of new multimedia standards, the development of technical innovations, the ability to obtain adequate foundry capacity and sources of raw materials, the efficiency of production, the rate at which the Company's customers design the Company's products into their products, the number and nature of the Company's competitors in a given market, the assertion of intellectual property rights and general market and economic conditions. There can be no assurance that the Company will be able to compete successfully in the future. Each successive generation of microprocessors has provided increased performance, which could in the future result in a microprocessor capable of performing audio functions. In this regard, Intel Corporation has developed Native Signal Processing ("NSP") capability and an extended multimedia system architecture ("MMX") for use in conjunction with its Pentium microprocessor, and is promoting the processing power of the Pentium for data and signal intensive functions such as graphics acceleration and other multimedia functions. There can be no assurance that the increased capabilities of microprocessors will not adversely affect demand for the Company's products. Dependence on Single Product Line and PC Industry. In the first nine months of 1996, sales of PC audio semiconductors accounted for substantially all of the Company's net revenues, and the Company expects that sales of audio semiconductors will continue to account for a significant majority of its net revenues for the foreseeable future. Any reduction in demand for the Company's audio semiconductors, whether because of a reduction in demand for PCs in general or PC audio, increased competition or otherwise, would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is currently engaged in the development and introduction of new PC audio products as well as new multimedia products for the PC and consumer markets that provide capabilities such as video and fax/modem/voice applications. There can be no assurance that the Company will be able to identify market trends or new product opportunities, develop and market new products, achieve design wins or respond effectively to new technological changes or product announcements by others. A failure in any of these areas would have a material adverse effect on the Company's business, financial condition and results of operations. Most of the Company's products are sold for incorporation into multimedia desktop and notebook computers. ESS semiconductor products are incorporated into motherboards by multimedia PC original equipment manufacturers ("OEMs") or in add-in cards. Therefore, the Company is heavily dependent on the continued growth of the markets for multimedia desktop and notebook computers and multimedia applications. A decline in demand in the PC industry could result in a corresponding decline in demand for the Company's products, which would have a material adverse effect on the Company's business, financial condition and results of operations. Importance of New Products and Technological Change. The markets for the Company's products are characterized by evolving industry standards, rapid technological change and product obsolescence. The Company's success is highly dependent upon the successful development and timely introduction of new products at competitive price and performance levels. The success of new products depends on a number of factors, including timely completion of product development, market acceptance of the Company's and its customers' new products, securing sufficient foundry capacity for volume manufacturing of wafers, achievement of acceptable wafer fabrication yields by the Company's independent foundries and the Company's ability to offer new products at competitive prices. In order to succeed in having the Company's products incorporated into new products being designed by desktop and notebook computer manufacturers, the Company must anticipate market trends and performance and functionality requirements of such manufacturers and must successfully develop and manufacture products that meet these requirements. In addition, the Company must meet the timing and price requirements of such manufacturers and must make such products available in sufficient quantities. Accordingly, in selling to OEMs, the Company can often incur significant expenditures prior to volume sales of new products, if any. In order to help accomplish these goals, the Company has in the past and will continue to consider in the future the acquisition of other companies or the products and technologies of other companies. Such acquisitions carry additional risks such as a lack of integration with existing products and corporate culture, the potential for large write-offs and the diversion of management attention. 13 14 Dependence on TSMC and Other Third Parties. The Company relies on independent foundries to manufacture all of its products. A substantial majority of the Company's products are currently manufactured by TSMC, which has manufactured certain of the Company's products since 1989. The Company also has foundry arrangements with Sharp Corporation, IC Works, and UMC, which have been manufacturing certain of the Company's products since 1986, 1991 and 1995, respectively. TSMC, in particular, provides the Company with access to advanced process technology necessary for the manufacture of the Company's products. These foundries fabricate products for other companies and, with the exception of TSMC, manufacture products of their own design. In November 1995, the Company entered into long-term agreements with TSMC and UMC in which the Company has secured access to additional capacity and to leading edge technology. In addition, the Company is obligated to pay approximately $16 million over the next nine months to TSMC in exchange for certain wafer capacity commitments and will invest approximately $23 million in 2 installments over the next year in exchange for an equity ownership in a joint venture with UMC to build a new foundry and for certain wafer capacity commitments. If the Company is not able to use, assign, or sell the additional wafer quantities, a portion of the deposits may be forfeited. While the Company has entered into long-term agreements with two of its foundries, the Company's reliance on these and other independent foundries involves a number of risks, including the absence of adequate capacity, the unavailability of, or interruption in access to, certain process technologies and reduced control over delivery schedules, manufacturing yields and costs, and the international risks more fully described below. The Company expects to rely upon TSMC and UMC to manufacture a substantial majority of the Company's products for the foreseeable future. In the event that TSMC and UMC are unable to continue to manufacture the Company's key products in required volumes, the Company will have to identify and secure additional foundry capacity. In such an event, the Company may be unable to identify or secure additional foundry capacity from another manufacturer, particularly at the levels that the Company currently expects TSMC and UMC to provide. Even if such capacity is available from another manufacturer, the qualification process could take six months or longer. The loss of any of its foundries as a supplier, the inability of the Company to acquire additional capacity at its current suppliers or qualify other wafer manufacturers for additional foundry capacity should additional capacity be necessary, or any other circumstances causing a significant interruption in the supply of semiconductors to the Company would have a material adverse effect on the Company's business, financial condition and results of operations. To address potential foundry capacity constraints in the future, ESS will continue to consider and may be required to enter into additional arrangements, including equity investments in or loans to independent wafer manufacturers in exchange for guaranteed production capacity, joint ventures to own and operate foundries, or "take or pay" contracts that commit the Company to purchase specified quantities of wafers over extended periods. Any such arrangements could require the Company to commit substantial capital and grant licenses to its technology. The need to commit substantial capital may require the Company to obtain additional debt or equity financing, which could result in dilution to the Company's shareholders. There can be no assurance that such additional financing, if required, will be available when needed or, if available, will be obtained on terms acceptable to the Company. International Operations. In the first nine months of 1996, international sales, accounted for 90% of the Company's net revenues. Substantially all of the Company's international sales were to customers in Taiwan, Japan, Singapore and Hong Kong and includes shipments to foreign locations of multinational U.S. based companies. The Company expects that international sales will continue to represent a significant portion of its net revenues for the foreseeable future. In addition, substantially all of the Company's products are manufactured, assembled and tested by independent third parties in Asia. Due to its reliance on international sales and foreign third-party manufacturing, assembly and testing operations, the Company is subject to the risks of conducting business outside of the United States. These risks include unexpected changes in, or impositions of legislative or regulatory requirements, delays resulting from difficulty in obtaining export licenses for certain technology, tariffs, quotas and other trade barriers and restrictions, longer payment cycles, greater difficulty in accounts receivable collection, potentially adverse taxes, the burdens of complying with a variety of foreign laws and other factors beyond the Company's control. The Company is also subject to 14 15 general geopolitical risks in connection with its international trade relationships. Although the Company has not to date experienced any material adverse effect on its business, financial condition or results of operations as a result of such regulatory, geopolitical and other factors, there can be no assurance that such factors will not have a material adverse effect on the Company's business, financial condition and results of operations in the future or require the Company to modify its current business practices. In addition, the laws of certain foreign countries in which the Company's products are or may be manufactured or sold, including various countries in Asia, may not protect the Company's products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of piracy of the Company's technology and products more likely. Currently, all of the Company's product sales and all of its arrangements with foundries and assembly and test vendors, other than its foundry arrangement with Sharp Corporation, provide for pricing and payment in U.S. dollars. To date, although the effect of currency fluctuations have been insignificant, there can be no assurance that fluctuations in currency exchange rates will not have a material adverse effect on the Company's business, financial condition and results of operations. In addition, to date the Company has not engaged in any currency hedging activities, although the Company may do so in the future. Further, there can be no assurance that one or more of the foregoing factors will not have a material adverse effect on the Company's business, financial condition and results of operations or require the Company to modify its current business practices. Semiconductor Industry. The semiconductor industry has historically been characterized by rapid technological change, cyclical market patterns, significant price erosion, periods of over-capacity and production shortages, variations in manufacturing costs and yields and significant expenditures for capital equipment and product development. In addition, the industry has experienced significant economic downturns at various times, characterized by diminished product demand and accelerated erosion of product prices. The Company may experience substantial period-to-period fluctuations in operating results due to general semiconductor industry conditions. Dependence on Key Personnel. The Company's success depends to a significant degree upon the continued contributions of Fred S.L. Chan, the Company's Chief Executive Officer and Chairman of the Board of Directors. Mr. Chan, together with his spouse, Annie M.H. Chan, a director of the Company and certain trusts for the benefit of the Chan's children and certain charities beneficially own, in the aggregate, approximately 43% of the Company's Common Stock. The future success of the Company depends on its ability to continue to attract, retain and motivate qualified senior management, sales and technical personnel, particularly highly skilled semiconductor design personnel and software engineers, for whom competition is intense. Recently, the Company has hired a number of key executives and management personnel (See Item 5). The loss of Mr. Chan, other key executive officers, key design personnel or software engineers or the inability to hire and retain sufficient qualified personnel could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to retain these employees. The Company currently does not maintain any key man life insurance on the life of any of its key employees. 15 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On May 17, 1996, the Company and Yamaha Corporation settled all patent infringement litigation between the two companies. See also the Company's Form 10-Q's for the quarters ended March 31, and June 30, 1996. ITEM 5. OTHER INFORMATION On September 16, October 14 and November 4, 1996, the Company appointed Mr. John H. Barnet as Vice President, Finance and Chief Financial Officer, Mr. Herbert J. Martin as President and Chief Operating Officer and Mr. Bo E. Ericsson as Vice President, Marketing, respectively. Due to the recent management changes and other recent changes to the internal executive officers reporting structures within the Company, the executive officers of the Company now consist of the following individuals: Fred S.L. Chan Chief Executive Officer and Chairman of the Board Herbert J. Martin President and Chief Operating Officer John H. Barnet Vice President, Finance and Chief Financial Officer Chi-Shin Wang Chief Technical Officer Bo E. Ericsson Vice President, Marketing Nicholas Aretakis Vice President, Sales Robert L. Blair Vice President, Operation ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 10.27 -- Form of Employment Agreement and Promissory Note among the Registrant and John H. Barnet dated August 22 and September 16, 1996, respectively. 27.01 -- Financial Data schedule (b) Reports on Form 8-K. No reports were filed on Form 8-K for the quarter ended September 30, 1996. 16 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. ESS TECHNOLOGY, INC. (Registrant) Date: November 14, 1996 By: /s/ FRED S.L. CHAN ------------------------------------------ Fred S.L. Chan Chief Executive Officer and Chairman of the Board Date: November 14, 1996 By: /s/ JOHN H. BARNET ------------------------------------------ John H. Barnet Vice President, Chief Financial Officer and Secretary
17 18 EXHIBIT INDEX Exhibit Description ------- ------------- 10.27 Form of Employment Agreement and Promissory Note among the Registrant and John H. Barnet dated August 22 and September 16, 1996, respectively. 27.01 Financial Data Schedule EX-10.27 2 FORM OF EMPLOYMENT AGREEMENT & PROMISSORY NOTE 1 Exhibit 10.27 [ESS TECHNOLOGY, INC. LOGO] August 22, 1996 MR. JOHN H. BARNET 2 Robert S. Drive Menlo Park, CA 94025 Dear John, I am delighted to welcome you to the ESS team as Vice President, Finance and Chief Financial Officer. I understand you will assume your new duties no later than September 23, 1996. Congratulations and welcome aboard! As Vice President, Finance and Chief Financial Officer, you will report directly to me, President and Chief Executive Officer. Your duties will include all financial and administrative functions of the Company as outlined in the position brief given to you by Frank Bacci. Your initial salary will be $185,000 per annum. You will also have the opportunity to earn 25% of your current annual salary under ESS's executive achievement bonus pool, provided that the plan's bonus objectives are achieved. The annual objectives shall be on the same basis as other executives. This bonus will be paid at the end of February following each calendar year of employment. The bonus for 1996 will be pro-rated and guaranteed. You will also receive the Company's standard employee benefits package, and will be subject to the Company's vacation policy. You will receive a sign-up bonus of $400,000 to be paid to you in your first week of employment. Such bonus must be repaid in proration to the Company if you voluntarily, other than by death or disability, terminate your employment less than one full year from your start date. Both you and the Company will provide each other a three month advance notice for termination of employment. You will also be granted an option under the Company's 1995 Equity Incentive Plan for 200,000 shares of the Company's stock (the "Option") to vest as follows: 40,000 shares will vest on your start date, and the remaining 160,000 shares will vest (40,000 shares per year each) on the next four anniversaries of your start date. The terms of the Option will be consistent with the ESS 1995 Equity Incentive Plan except as specifically provided to the contrary herein. To the extent possible under the Internal Revenue Code of 1986, as amended (the "Code"), the Option will constitute an "incentive stock option." The Option will be priced at 100% of fair market value as of your start date. Shares underlying the Option may not be sold for one full year following your start date. You will have the right to receive at least $5.00 per share for the first 80,000 of your Option shares which are vested. This right may be exercised at any time between the first and third anniversaries of your start date, provided you do so while employed by the Company and within 90 days after termination of such employment. The mechanics for you to exercise this right will depend upon the fair market value of ESS shares as quoted on Nasdaq, as follows: Initials ( /s/ ) 2 [ESS Technology, Inc. LETTERHEAD] (i) If such value exceeds your exercise price by an amount less than $5.00 per share, then you may exercise the Option and the Company will pay you the difference between $5.00 and such amount; or (ii) If such value is less than your exercise price, then the Company will purchase the Option for $5.00 per share. In the event that you are terminated without cause in the first year of your employment, the 40,000 shares underlying the Option that vest on the first anniversary date shall become vested immediately. In addition, should there be a change in control of the Company such that the stockholders of the Company no longer hold a majority of the capital stock of the new entity, the shares underlying the Option will accelerate and become vested immediately unless you are hired by such a new entity with similar compensation package. You will receive a loan from the Company for $400,000 commencing on your start date at the current statutory minimum interest rate necessary to avoid imputed income under the Code, which shall be evidenced by a recourse promissory note. The loan will be due and payable one year from your start date or 90 days after your earlier termination of employment. All proceeds from any sale of the Option or of shares underlying the Option, net of taxes, shall be applied to reduction of such loan. The Option and any shares exercised thereunder will be held by the Company as collateral for the loan. Tax consequences, if any, of this transaction will be your responsibility. As an employee of the Company, you will have access to Company confidential information and you may, during the course of your employment, develop certain information or inventions which will be the property of the Company. To protect the interests of the Company, you will need to sign the Company's standard "Employee Inventions and Confidentiality Agreement" as a condition of your employment. We wish to impress upon you that we do not wish you to bring with you any confidential or proprietary material of any former employer or violate any other obligation to your former employers. Should you decide to accept our offer, you will be an at-will employee of the Company, which means the employment relationship can be terminated by either of us for any reason at any time. Further, your participation in any stock award or benefit program is not to be regarded as assuring you of continuing employment for any particular period of time. Initials ( ) ( ) 3 [LETTERHEAD] ESS Technology, Inc. Please signify your acceptance of this offer and these conditions by signing and returning a copy of this letter. I look forward to having you join our outstanding team, and I know this will be a mutually beneficial relationship for many years to come. Again, my personal thanks and congratulations! ESS TECHNOLOGY, INC. By: /s/ FRED S.L. CHAN /s/ JOHN H. BARNET ----------------------------- ----------------------------- Fred S.L. Chan John H. Barnet Chairman of the Board, President and Chief Executive Officer Date: August 25, 1996 ----------------------- 4 [LETTERHEAD] ESS Technology, Inc. PROMISSORY NOTE $400,000 Fremont, California - -------- September 16, 1996 At the time hereinafter stated and as stated in the offer letter dated August 22, 1996, for value received, the undersigned, an employee of ESS Technology, Inc. ("the Company"), promises to pay the Company the principal sum of $400,000 with interest from the date hereof at a rate of six point zero two percent (6.02%) per annum (September 1996 statutory minimum interest rate), compounded annually, on the unpaid balance of said principal sum. Said principal and interest shall be due and payable one year from the date or 90 days after the undersigned earlier termination of employment. Principal and interest are payable in lawful money of United States of America. Should suit be commenced to collect this Note or any portion thereof, such sum as the Court may deem reasonable shall be added hereto as attorneys' fees. The maker and endorsers have severally waived presentment for payment, protest, notice of protest, and notice of non-payment of this Note. This Note, which is full recourse, is secured by a pledge of certain Options and any shares exercised thereunder which will be held by the Company as collateral for the note. All proceeds from any sale of the Options or of shares underlying the Options, net of taxes, shall be applied to reduction of such note. /s/ JOHN BARNET /s/ FRED S.L. CHAN - --------------------------- --------------------------- John Barnet Fred S.L. Chan EX-27.01 3 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 9-MOS DEC-31-1996 JAN-01-1996 SEP-30-1996 1 3,451 29,259 24,879 486 31,440 95,526 24,384 4,110 159,933 43,990 0 0 0 72,807 (15) 159,933 60,138 60,138 29,540 29,540 9,929 0 (418) 21,087 8,224 12,863 0 0 0 12,863 0.31 0.31
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