-----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, LsJeyoZdntfcN5ck03jUjCSz0fx5MG6l44vWQbJbnZ+hSqemUYO4mOYDiOSyj/ne 6QaSBfryH1ZR8z2s0AWSJA== 0000891618-99-001309.txt : 19990402 0000891618-99-001309.hdr.sgml : 19990402 ACCESSION NUMBER: 0000891618-99-001309 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K SEC ACT: SEC FILE NUMBER: 000-26660 FILM NUMBER: 99581994 BUSINESS ADDRESS: STREET 1: 48401 FREMONT BLVD CITY: FREMONT STATE: CA ZIP: 94538 BUSINESS PHONE: 5104921088 MAIL ADDRESS: STREET 1: 48401 FREMONT BLVD CITY: FREMONT STATE: CA ZIP: 94538 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION 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 BLVD., FREMONT, CALIFORNIA 94538 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 492-1088 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, NO PAR VALUE (TITLE OF CLASS) 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 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on January 31, 1999 ($6.875) as reported on the Nasdaq National Market, was approximately $160,508,000. Shares of Common Stock held by each officer and director and by each person who owned 5% or more of the registrant's outstanding Common Stock on that date have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of January 31, 1999, registrant had outstanding 40,863,083 shares of Common Stock. ------------------------ DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Registrant's 1999 Annual Meeting of Shareholders are incorporated by reference in Part III. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 ESS TECHNOLOGY, INC. 1998 FORM 10-K TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business.................................................... 2 Item 2. Properties.................................................. 11 Item 3. Legal Proceedings........................................... 11 Item 4. Submission of Matters to a Vote of Security Holders......... 11 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters......................................... 12 Item 6. Selected Financial Data..................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 14 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................................ 24 Item 8. Financial Statements and Supplementary Data................. 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 43 PART III Item 10. Directors and Executive Officers of the Registrant.......... 44 Item 11. Executive Compensation...................................... 45 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 45 Item 13. Certain Relationships and Related Transactions.............. 45 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 46 Signatures............................................................. 48
1 3 Statements contained in this filing 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 Internet, PC audio, video and other multimedia capabilities for notebook and desktop computers, as well as consumer electronic and Internet 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. PART I ITEM 1. BUSINESS ESS Technology, Inc. and its subsidiaries ("ESS" or the "Company") designs, markets and supports highly integrated mixed signal semiconductor, hardware, software and system solutions for multimedia applications in the Internet, personal computer ("PC") and consumer marketplaces. The Company offers comprehensive solutions for audio, video and modem applications. ESS has established itself as a leading supplier in both mixed-signal PC audio solutions that integrate all essential audio components on a single chip and Video CD solutions ("VCD"). During 1998, ESS continued to strengthen its core family of ISA and PCI audio solutions as well as its video and modem solutions. The Company was incorporated in California in 1984. AudioDrive Products ESS' single chip AudioDrive products enable PC manufacturers to provide audio capabilities on add-in sound cards and directly on the motherboards of desktop and notebook computers. The Company has established itself as a leader in integrated audio solutions and counts many of the leading manufacturers of personal computers and sound cards among its customers. During 1998, the manufacturers in the PC market began to shift from ISA solutions to PCI solutions due to the higher performance which the PCI solutions provide to meet the demands for advanced PC audio applications. The Company's AudioDrive products are based on ESS' audio technologies, design methodologies, and software and firmware expertise. ESS has developed a proven set of ISA and PCI product solutions for the PC market. The AudioDrive ISA and PCI product families integrate ESFM(TM), a proprietary FM sound synthesis technology, that produces superior sound quality by enhancing traditional FM synthesis techniques, with hardware, software and music database technology. ESS also utilizes its proprietary advanced analog and mixed signal design methodologies, together with its library of audio semiconductor designs, to produce highly integrated mixed signal audio chips. ESS software technology is bundled as part of its comprehensive solution and consists of its AudioDrive device drivers for Microsoft(R) Windows(R)3.1, Windows NT(R), Windows 95(R), Windows 98(R), IBM OS/2(R)Warp(R), DirectX(TM)PC games, and audio applications, including ESS AudioRack(TM) controller, an integrated graphical controller for the entire PC audio system. ISA AudioDrive Products ES692: a wavetable music synthesizer chip. The ES692 includes reverb special effects without need for external RAM. With its embedded microcontroller, the ES692 supports General MIDI, providing for 128 melodic instruments with ability to play back 32 voices of 16-bit data at a sampling rate of 44.1kHz. Music is produced in high fidelity with the realism of a live symphony orchestra. The ES692 includes a 1MB wavetable ROM to provide a complete wavetable solution. This internal ROM provides digitally recorded sound samples of musical instruments. 2 4 ES1869: a single mixed signal 16-bit stereo audio chip with integrated ESFM synthesizer, plug-and-play, full-duplex operation, Zoom Video support, game support and three-dimensional sound effect. The ES1869 integrates digital logic and a microcontroller with audio CODEC and other analog functions onto one chip, and includes ESFM synthesis. The ES1869 is PC games compatible in SB and SB Pro modes and is compatible with Microsoft Windows and other operating systems. The ES1869 provides full ISA plug-and-play support and includes hardware volume control, 64 step volume control and dual game/joystick port for game support. The ES1869 supports full-duplex operation with simultaneous record and playback with two DMA channels and contains an I2S interface to support Zoom Video port for MPEG audio. It also integrates circuitry to produce a three-dimensional sound effect from two speakers. ES1879: a single mixed signal 16-bit stereo audio chip with integrated ESFM synthesizer, full-duplex operation, Zoom Video support, telegaming and game support and three-dimensional sound effect. The ES1879 combines the features of the ES1878 with I2S interface for Zoom Video support, as well as circuitry to produce three-dimensional sound effect from two speakers. The ES1879 provides full plug-and-play support and provides interface to a docking station unit. PCI AudioDrive Products ES1918: Maestro PCI audio CODEC. The ES1918 is a single mixed signal AC '97 CODEC and mixer for a digital audio controller. The ES1918 meets PC '98 and Audio CODEC '97 Rev. 1.03 specifications. ES1920: Maestro PCI audio CODEC. The ES1920 is a single mixed signal AC '97 CODEC and mixer for a digital audio controller. The ES1920 meets AC '98 and Audio CODEC '97 Rev. 2.0 specifications. ES1938: Solo-1: a PCI single mixed signal audio chip. The ES1938 provides a single chip PCI audio solution providing high-quality audio processing while maintaining full legacy DOS game compatibility. The ES1938 has 16-bit stereo with 7 channel record and playback mixers and an integrated 3-D sound effects processor. It supports ACPI, PPMI and PCI Mobile Design Guide specifications. ES1946: Solo-1E: a PCI single mixed signal audio chip with I(2)S interface. The ES1946 combines the features of the ES1938 with I(2)S interface for ZOOMED Video Port audio and 3.3 Volt digital supply operation. ES1948: Maestro-1: a PCI digital audio accelerator. The Maestro-1 provides enhanced audio, utilizing the additional bandwidth provided by the PCI bus and taking advantage of the Intel AC-97 architecture. The Maestro-1 implements positional 3D and 64 channel hardware wavetable using system memory to dramatically improve the multimedia gaming experience. The Maestro-1 uses ESS proprietary technology called TDMA to provide legacy compatibility for DOS games which is a requirement for multimedia PCs. ES1968: Maestro-2: a PCI digital audio accelerator. The Maestro-2 provides enhanced audio, utilizing the additional bandwidth provided by the PCI bus and taking advantage of the Intel AC-97 architecture. The Maestro-2 implements positional 3D using CRL's Digital Ear(TM) and Sensaura(TM) 3D audio technology to dramatically improve the multimedia gaming experience. The Maestro-2 implements 64 channel hardware wavetable using system memory to reduce size, cost and host utilization while increasing sound quality for MIDI. The Maestro-2 utilizes ACPI and small form factor to enable low power designs for notebooks and motherboards. The Maestro-2 also uses ESS proprietary technology, TDMA to provide legacy compatibility for DOS games, a requirement for multimedia PCs. ES1968M: Maestro-2M: a PCI audio/modem combo solution. The Maestro-2M provides the features of the Maestro-2 with a parallel modem interface to a modem DSP processor. ES1978: Maestro-2E: A PCI digital audio accelerator. The Maestro-2E provides the features of the Maestro-2 with an EEPROM interface for system configuration and S/PDIF output for interface to consumer stereo equipment. 3 5 ES1978M: Maestro-2EM: a PCI audio/modem combo solution. The Maestro-2EM provides the features of the Maestro-2E in a 144 pin TQFP package with a parallel modem interface to a modem DSP processor. TeleDrive Products Internet-related applications, such as voice e-mail, Internet radio, audio home pages, and news on demand, are increasing the demand for integrated audio and computer fax/modem functions on the personal computer. ESS TeleDrive products enable PC manufacturers to provide fax/modem capabilities to add-on cards and directly onto the motherboards of desktop and notebook PCs. ES336V: a V.34bis chipset data/fax/voice controller-less modem solution. The ES336V provides base data, full duplex speaker phone, telephone answer machine and V.80 support for H.324 video conferencing applications. ES56V: a V.90 chipset data/fax/voice controller-less modem solution. The ES56V is a superset of the ES336V and is compliant with the V.90 worldwide modem standard via proprietary software. ES56CVH: a ES56V modem solution with 16 or 32 bit full duplex stereo. The ES56CVH combines the ES56V modem solution with a single mixed signal 16 or 32 bit stereo audio chip with integrated ESFM synthesizer, plug-and-play full-duplex operation and game support. VideoDrive Products ESS VideoDrive products provide consumer original equipment manufacturers ("OEMs") of VCD, SuperVCD ("SVCD") and DVD players with total programmable system solutions. The VideoDrive products provide OEMs of VCD players with a programmable single-chip processor which includes MPEG-1 video, audio and system decoder. It delivers full-screen, full-motion video at 30 frames per second with selectable CD-quality audio and can be combined with memory and video/audio DACs. The products also provide OEMs of SVCD and DVD players with a programmable single chip processor which includes MPEG-2 audio/video/system and transport layer decoder and video post-processing. In addition, the MPEG-2 decoder also integrates Dolby AC-3 and Navigation Software for DVD players. These chips are designed for a variety of applications in consumer electronics such as Internet set-top boxes, SVCD and DVD players. VCD Player Products ES3207: Analog companion chip. The ES3207 provides echo, surround sound, 3D audio, TV encoder with clock generation and audio DAC functions. ES3209: Analog companion chip to VCD processor chip. The ES3209 incorporates the ES3207 features of echo, surround sound, 3D audio, TV encoder with clock generation, audio DAC functions with HTML, hyperlink and a graphic user interface. ES3210: Single chip programmable VCD processor which includes MPEG-1 audio/video/system decoder for use in standalone and portable VCD players. The ES3210 is a single chip that supports MPEG-1 video decoding and incorporates on-screen display, Karaoke functions, programmable playback control, trick play mode features, an integrated SRAM and remote control interface logic in a smaller form factor allowing a more compact design. ES3211: Arcade accelerator. The ES3211 enables direct interface with external games controllers to allow CD-ROM games to be played on a VCD player. ES3880: Single chip programmable VCD processor. The ES3880 incorporates the ES3210 features and functions with improved video quality. ES3883: Analog companion chip. The ES3883 replaces the ES3707 and ES3209 with the same features and functions. 4 6 ES4108: Single chip programmable SVCD processor which include MPEG-2 video and MPEG-1 audio. The ES4108 incorporates on-screen display, Karaoke functions, programmable playback control, trick play mode features, integrated remote control interface logic and a direct CD loader interface for small form factor and cost effective design. DVD Player Products ES3301: Audio/video Transport Demultiplexer and Descrambler. The ES3301 is a transport-layer demultiplexer, parser and descrambler designed for the set-top box, DVD and Broadcast PC applications. ES3308: Single chip programmable DVD processor that includes MPEG-2 audio/video/system decoder for use in DVD players and digital set-top boxes. The ES3308 is a single chip solution that supports MPEG-2 video decoding and provides on-screen display and transport layer compliance with DVD standard as well as Digital Broadcast Signal standards. ES4308: Single chip programmable DVD processor with integrated system navagation software and direct DVD loader interface. ES4308 supports two channels stereo down mix and incorporates the ES3308 features with the integrated system navagation software and a direct DVD loader interface for a smaller form factor and cost effective design. Currently sampling ES4408: Single chip programmable DVD processor with 5.1 channel Dolby AC-3. The ES4408 incorporates the features of the ES3308 with support of 5.1 channel Dolby AC-3. Currently sampling Internet Set-Top Box Products ES4228: Single chip programmable SVCD and Internet set-top box processor. ES4228 incorporates the ES4108 features with a graphic function and flicker filter algorithm to enhance viewing quality on the television. ES4227: Analog companion chip. The ES4227 incorporates the ES3209 features of echo, surround sound, 3D audio, TV encoder with clock generation, audio DAC functions with HTML, hyperlink and a graphic user interface with a programmable I/O interface to communicate with ES56V modem chip set. Software and Support ESS provides comprehensive support for its products including software that can be bundled with its products. This software includes device drivers for Microsoft(R) Windows(R) 3.1, Windows NT(R), Windows 95(R) and Windows 98(R), IBM OS/2(R) Warp(R), Intel NSP and PC games, for PC products and systems support for the Company's VCD and DVD products. Other support software that is available to customers includes localization software and installation software that allows customers to tailor their products for specific applications and needs. Customer development support includes an Evaluation Kit that contains a reference add-in card design with all the necessary information to incorporate an ESS chip in the customer's product. To assist customers in further reducing their time to market, ESS also provides a Manufacturing Kit that contains manufacturing information, including a bill-of-materials, printed circuit board layout and production test software. 5 7 CUSTOMERS ESS sells its products principally to OEMs of PCs, PC-related add-in boards and consumer electronics systems. The Company sells its product through a direct sales force, distributors and manufacturer representatives. The following table shows representative customers worldwide:
HONG KONG UNITED STATES TAIWAN JAPAN(1) REST OF THE WORLD - --------- ------------- ------ -------- ----------------- Dynax(2) Compaq Acer Fujitsu Hyundai Weikeng(2) Dell BTC Hitachi Multiwave Shinco Hewlett Packard FIC Matsushita Philips IBM GVC NEC Pineview Micron Inventec Sanyo Samsung Labway Sony Trigem Mitac Wearnes Quanta
- --------------- (1) Sales in Japan are made through a distributor. (2) Distributors of the Company. A limited number of customers have historically accounted for a substantial portion of the Company's net revenues. In 1996, 1997 and 1998, sales to the Company's top five customers, including sales to its international distributors, accounted for approximately 40%, 49% and 54%, respectively, of the Company's net revenues. In 1996, Compaq and Universe Electron Corporation each accounted for approximately 12% and 13%, respectively, of the Company's net revenues. In 1997, Eastbase and Dynax, a Hong Kong distributor, each accounted for approximately 13% of the Company's net revenues. In 1998, Dynax and Shinco accounted for approximately 16% and 15%, respectively, of the Company's net revenues. The Company expects that a limited number of customers may continue to account for a substantial portion of its net revenues for the foreseeable future. The Company has experienced changes from year to year in the composition of its major customer base and believes this will continue in the future. SALES AND MARKETING The Company sells and markets to leading PC and consumer OEM's worldwide. The Company markets its products through its direct sales force, distributors and manufacturer representatives. In 1996, 1997 and 1998, international sales comprised approximately 92%, 89% and 92% of the Company's net revenues, respectively. The Company's international revenues in 1996, 1997 and 1998 have been derived primarily from Asian customers who manufacture PCs, PC-related add-in boards and consumer OEM's of VCD players. A large percentage of the worldwide supply of these products is manufactured by suppliers in Asia. ESS has direct sales personnel and technical staff located in Taiwan. A significant portion of the Company's Asian sales have been to customers located in Taiwan. See "Factors That May Affect Future Results -- International Operations." The Company's products are also sold internationally through distributors and manufacturer representatives located in Hong Kong, Taiwan, Japan, India, Singapore, Korea and Germany. The Company's manufacturer representatives and distributors are not subject to minimum purchase requirements and can discontinue marketing any of the Company's products at any time. In addition, certain of the Company's manufacturer representatives, distributors and customers typically are authorized certain rights of return for unsold product or pricing allowances to compensate for rapid, unexpected prices changes. See "Factors That May Affect Future Results -- Customer Concentration." The Company believes that customer service and technical support are important competitive factors in selling to major customers. The Company provides technical support to its customers. Manufacturer representatives and distributors supplement the Company's efforts by providing additional customer service at the local level. The Company believes that close contact with its customers not only improves the customers' level of satisfaction, but also provides important insight into future market direction. Sales of the Company's products are generally made pursuant to standard purchase orders, which are frequently revised to reflect changes in the customer's requirements. Product deliveries are scheduled upon the 6 8 Company's receipt of purchase orders. Generally, these purchase orders allow customers to reschedule delivery dates and cancel purchase orders without significant penalties. For these reasons, the Company believes that its backlog, while useful for scheduling production, is not necessarily a reliable indicator of future revenues. See "Factors That May Affect Future Results -- Potential Fluctuations in Operating Results." RESEARCH AND DEVELOPMENT In order to compete successfully, the Company believes that it must continually design, develop and introduce new products that take advantage of market opportunities and address emerging technical standards. The Company's strategy is to leverage its base of design expertise, analog, digital and mixed signal design capabilities and process technologies, and software and systems expertise to develop audio, modem and video solutions for the Internet, PC and consumer marketplace. ESS has in the past acquired and in the future will consider acquiring technology and product lines to enhance its own product offerings and to accelerate its time-to-market. The Company intends to continue to provide comprehensive solutions for its customers by developing state of the art semiconductor chips, device drivers, firmware and application software in its chosen markets. ESS utilizes a design environment based on workstations, dedicated product simulators, system simulation with hardware and software modeling, and a high level design description language. The Company invests regularly in new advanced equipment and software tools and intends to maintain and enhance its library of core cells. At December 31, 1998, ESS had a staff of 185 research and development personnel, 67 of which were involved in semiconductor design and process development and 118 of which were involved in software development. In addition, ESS has engaged outside developers to develop certain technologies to the Company's specifications and intends to continue to utilize outside developers in the future. During 1996, 1997 and 1998 the Company spent approximately $20.3 million, $29.5 million and $30.5 million, respectively, on research and development activities, excluding a one-time pre and post-tax charge of $30.4 million related to acquired research and development in-process from the acquisitions of VideoCore Technology, Inc. ("VideoCore") and OSEE Technology, Inc. ("OSEE") in the first quarter of 1996 and a one-time pre and post-tax charge of $22.2 million related to acquired research and development in-process from the acquisition of Platform Technologies, Inc. ("Platform") in the second quarter of 1997. In June 1997, the Company completed its acquisition of Platform pursuant to which the Company acquired all the outstanding capital stock of Platform in exchange for approximately 2.54 million shares of the Company's Common Stock including approximately 954,000 options with a value of $32.7 million. Platform is a wholly-owned subsidiary of the Company. The acquisition of Platform provided the Company with certain PCI audio expertise and designs in process, along with significant engineering talent. In January 1996, the Company completed its acquisition of VideoCore pursuant to which the Company acquired all of the outstanding capital stock of VideoCore in exchange for approximately 525,000 shares of the Company's Common Stock and $5.7 million in cash. VideoCore, a wholly owned subsidiary of the Company, is developing integrated circuits which incorporates advanced compression technology for digital video products. In March 1996, the Company completed its acquisition of OSEE pursuant to which the Company acquired all of the outstanding capital stock of OSEE in exchange for approximately 217,000 shares of the Company's Common Stock and $3.6 million in cash. Also outstanding stock options of OSEE were exchanged for 85,000 stock options of the Company. OSEE, a wholly owned subsidiary of the Company, is developing algorithm technology which enables the Company to offer modem applications to its customers. The Company may continue to utilize cash and equity 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 investments in such businesses, products or technologies owned by third parties. 7 9 MANUFACTURING The Company contracts with independent foundries and assembly and test service providers to manufacture all of its products. This manufacturing strategy enables the Company to focus on its design strengths, minimize fixed costs and capital expenditures and gain access to advanced manufacturing capabilities. Semiconductor manufacturing consists of foundry activity where wafer fabrication takes place, and assembly and test activities. Wafer fabrication is performed by two independent foundries, which utilize advanced manufacturing technologies. A substantial majority of the Company's products are manufactured by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC"), which has manufactured certain of the Company's products since 1989. The Company also has a foundry arrangement with United Microelectronics Corporation ("UMC") in Taiwan. Most of the Company's devices are currently fabricated using a mixed signal CMOS 0.35 micron process technology. The Company is dependent on its foundries to allocate to the Company a portion of their foundry capacity sufficient to meet the Company's needs and to produce products of acceptable quality and with acceptable manufacturing yields in a timely manner. These foundries fabricate products for other companies and manufacture products of their own design. In November 1995, the Company entered into long-term agreements with TSMC and UMC. Under the Company's long-term agreement with TSMC, in exchange for TSMC's wafer capacity commitments for the years 1996 through 1999, the Company made payments of approximately $32 million in two installments in 1996 and 1997. Under the Company's agreement with UMC, the Company entered into a joint venture arrangement with UMC and other U.S. semiconductor companies to build a separate semiconductor manufacturing facility to be located in Taiwan at an estimated cost of $1 billion. The Company has invested approximately $24.6 million in this joint venture. Under the terms of the agreement, the Company received approximately a 5% equity ownership in the joint venture company and capacity rights. The facility was scheduled to open during 1998, but fires during construction impeded progress. UMC has stated that it expects insurance will cover its recent fire losses at the joint venture foundry. On October 17, 1998, the Company entered into an agreement with UMC to sell UMC approximately 63.8 million shares of the joint venture for a purchase price of $22.4 million dollars. Following the sale, the Company continues to hold 6 million shares of stock. All of the Company's semiconductor products are assembled and tested by third-party vendors, primarily OSE and Advanced Semiconductor Engineering in Taiwan, ASAT in Hong Kong, and Astra Microtronics in Indonesia. The Company has internally designed and developed its own test software and certain test equipment, which are provided to the Company's test vendors. Shortages of raw materials or disruptions in the provision of services by the Company's assembly vendors could lead to supply constraints or delays in the delivery of the Company's products. Such constraints or delays might result in the loss of customers, limitations or reductions in the Company's revenues or other material adverse effects on the Company's business, financial condition and results of operations. The Company's reliance on third-party assembly and testing vendors involves a number of other risks, including reduced control over delivery schedules, quality assurance and costs. The inability of such third parties to deliver products of acceptable quality and in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. See "Factors That May Affect Future Results -- Dependence on TSMC and Other Third Parties" and " -- International Operations." 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 other 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 at lower costs 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 8 10 adversely affect the average selling prices ("ASPs") 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 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. See "Factors That May Affect Future Results -- Potential Fluctuations in Operating Results." 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 and Yamaha. The Company's principal video competitors include C-Cube, Windbond, LSI Logic and SGS Thompson. The Company's principal modem competitors include Cirrus Logic, Lucent, PC-TEL, Rockwell, 3Com and Texas Instruments. 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 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 multimedia 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. See "Factors That May Affect Future Results -- Importance of New Products and Technological Changes." PATENTS AND PROPRIETARY RIGHTS The Company relies on a combination of patents, trademarks, copyrights, trade secret laws and confidentiality procedures to protect its intellectual property rights. As of December 31, 1998, the Company had 9 patents granted in the United States, which expire over time, commencing in 1999 and ending in 2015, and 12 corresponding foreign patents. In addition, the Company intends to seek further United States and international patents on its technology. There can be no assurance that patents will be issued from any of the Company's pending applications or applications in preparation or that any claims allowed from pending applications or applications in preparation will be of sufficient scope or strength, or be issued in all countries where the Company's products can be sold, to provide meaningful protection or any commercial advantage to the Company. Also, competitors of the Company may be able to design around the Company's patents. The laws of certain foreign countries in which the Company's products are or may be designed, 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 9 11 Company's technology and products more likely. Although the Company is not aware of the development, distribution or sales of any illegal copies of the Company's hardware or software, any infringements of its patents, copyrights or trademarks, or any violation of its trade secrets, confidentiality procedures or licensing agreements to date, there can be no assurance that the steps taken by the Company to protect its proprietary information will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which have resulted in significant and often protracted and expensive litigation. Except for the Lemelson Foundation complaint (See "Item 3. Legal Proceedings"), there was no pending intellectual property litigation against the Company. However, the Company or its foundries may from time to time receive notice of claims that the Company has infringed patents or other intellectual property rights owned by others. The Company may seek licenses under such patents or other intellectual property rights. However, there can be no assurance that licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a license from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of products or the use by the Company's foundries of processes requiring the technology. Furthermore, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation by or against the Company could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel, whether or not such litigation results in a favorable determination for the Company. In the event of an adverse result in any such litigation, the Company could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses for the infringing technology. There can be no assurance that the Company would be successful in such development or that such licenses would be available on reasonable terms, or at all, and any such development or license could require expenditures by the Company of substantial time and other resources. Although patent disputes in the semiconductor industry have often been settled through cross-licensing arrangements, there can be no assurance that in the event that any third party makes a successful claim against the Company or its customers, a cross-licensing arrangement could be reached. In such a case, if a license is not made available to the Company on commercially reasonable terms, the Company's business, financial condition and results of operations could be materially adversely affected. The Company currently licenses certain of the technology utilized by the Company in its products, and expects to continue to do so in the future. The Company has no current plans to grant licenses with respect to its products or technology; however, it may become necessary for the Company to enter into product licenses in the future in order, among other things, to secure foundry capacity. Although the Company has in the past granted licenses to certain of its technology, some of which have expired, such licenses have been limited and the Company has not derived material revenues from such licenses in recent periods. See "Factors That May Affect Future Results -- Uncertainty Regarding Patents and Protection of Proprietary Rights." EMPLOYEES As of December 31, 1998, the Company had 426 full-time employees, including 185 in research and development, 118 in marketing, sales and support and 123 in operations, finance and administration. The Company's future success will depend, in part, on its ability to continue to attract, retain and motivate highly qualified technical and management personnel, particularly highly skilled semiconductor design personnel and software engineers involved in new product development, for whom competition is intense. The Company's employees are not represented by any collective bargaining unit, and the Company has never experienced a work stoppage. See "Factors That May Affect Future Results -- Dependence on Key Personnel." 10 12 ITEM 2. PROPERTIES Prior to October 1996, the Company leased two facilities in Fremont, California. The leases for such facilities expired on June 30 and October 31, 1996. The facilities consisted of two buildings comprising approximately 62,000 square feet, which were used as the Company's headquarters. In October 1995, the Company purchased approximately 16 acres of land near its previous Fremont headquarters and constructed a new headquarters facility of 93,000 square feet. The Company relocated its operations from the leased facility to the new facility in September 1996. The Company completed construction of an additional building of 77,000 square feet to support headcount growth in August of 1998. The Company also completed construction of a dormitory of 11,000 square feet to house visitors and guest workers in August 1998. ITEM 3. LEGAL PROCEEDINGS On March 11, 1998, Creative Technology Ltd. and its subsidiary E-mu Systems, Inc. (together, "Creative") filed a lawsuit against the Company and one of its customers, Diamond Multimedia Systems, Inc. ("Diamond"), alleging infringement of U.S. Patent No. 5,698,803 (the "803 patent"), by the Company's Maestro products, one of which is included in products sold by Diamond. The complaint requests preliminary and permanent injunctions, and unspecified damages. Creative also claims willful infringement and requests treble damages and attorney's fees. The lawsuit, entitled Creative Technology Ltd. et al v. ESS Technology, Inc. et al, was filed in the U.S. District Court for the Central District of California. On September 25, 1998, the lawsuit between Company and Creative was settled to the parties' mutual satisfaction, and ESS is now under a license from Creative regarding sales of its Maestro products. Further terms of the settlement are confidential. On February 26, 1999, the Company was named in a complaint, along with 87 other defendants, brought by the Lemelson Medical, Education & Research Foundation (the "Lemelson Foundation") in the United States District Court for the District of Arizona, no. Civ99-0377PHXRGS. The complaint alleges infringement of unspecified claims in some or all of sixteen U.S. patents, and seeks both injunctive relief and unspecified damages, with a request for damage enhancement and attorneys' fees pursuant to 35 U.S.C. section 285. The Company has not yet been formally served with the complaint, and has been approached by representatives of the Lemelson Foundation suggesting that it agree to a license. The Company is studying this proposal, and is also investigating possible indemnification by its vendors and/or joint defense arrangements with other defendants. Although the ultimate outcome of this matter is not currently determinable, the Company believes, based in part on the licensing terms offered by Lemelson Foundation that the resolution of the matter will not have a material adverse effect on the Company's financial position or liquidity; however, there can be no assurance that the ultimate resolution of this matter will not have a material adverse effect on the Company's results of operation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended December 31, 1998. 11 13 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The Company's Common Stock has been trading on the Nasdaq National Market under the symbol "ESST" since October 6, 1995. The following table sets forth the high and low last reported sales prices for the Common Stock as reported by the Nasdaq National Market during the period indicated.
HIGH LOW ---------- -------- FISCAL 1997: First Quarter ending March 31, 1997......................... 34 1/4 21 3/8 Second Quarter ending June 30, 1997......................... 29 1/2 11 7/8 Third Quarter ending September 30, 1997..................... 18 1/4 13 1/4 Fourth Quarter ending December 31, 1997..................... 14 3/8 7 9/16 FISCAL 1998: First Quarter ending March 31, 1998......................... 8 7/16 6 1/4 Second Quarter ending June 30, 1998......................... 7 3/8 3 7/8 Third Quarter ending September 30, 1998..................... 4 15/32 2 1/32 Fourth Quarter ending December 31, 1998..................... 6 7/8 2 5/32
As of January 31, 1999, there were approximately 313 record holders of the Company's Common Stock. Since shareholders are listed under their brokerage firm's names, the actual number of shareholders is higher. In connection with the Company's acquisition of VideoCore Technology, Inc. in January 1996, the shareholders of VideoCore received an aggregate of approximately 525,000 shares of the Company's Common Stock and $5.7 million in cash. In connection with the Company's acquisition of OSEE Technology, Inc. in March 1996, the shareholders of OSEE received an aggregate of approximately 217,000 shares of the Company's Common Stock and $3.6 million in cash. Also outstanding stock options at OSEE were exchanged for 85,000 stock options of the Company. In connection with the Company's acquisition of Platform Technologies, Inc. in June, 1997, the shareholders of Platform Technologies received an aggregate of approximately 2.54 million shares of the Company's Common Stock, including approximately 954,000 options with a value of $32.7 million. The issuance of securities in this Item 5 was deemed to be exempt from registration under the Securities Act of 1933, as amended (the "Act"), in reliance on Section 4(2) of the Act as a transaction by an issuer not involving any public offering. The recipients of the securities in such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in such transaction. The recipients were given adequate access to information about the Company. The Company has never declared or paid any cash dividends on its Common Stock. The Company currently anticipates that it will retain all future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. 12 14 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1994 1995 1996 1997 1998 ------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net revenues......................... $33,435 $105,744 $226,455 $249,517 $218,252 Cost of revenues..................... 12,047 39,584 106,818 171,859 182,417 ------- -------- -------- -------- -------- Gross profit....................... 21,388 66,160 119,637 77,658 35,835 Operating expenses: Research and development........... 3,711 8,665 20,270 29,471 30,529 Research and development in-process...................... -- -- 30,355 22,200 -- Selling, general and administrative.................. 3,233 9,758 16,814 25,198 36,289 ------- -------- -------- -------- -------- Operating income (loss).............. 14,444 47,737 52,198 789 (30,983) Nonoperating income, net............. 283 2,694 3,241 2,183 1,478 ------- -------- -------- -------- -------- Income before income taxes........... 14,727 50,431 55,439 2,972 (29,505) Provision for (benefit from) income taxes.............................. 6,346 20,545 33,813 13,838 (1,489) ------- -------- -------- -------- -------- Net income (loss).................... $ 8,381 $ 29,886 $ 21,626 $(10,866) $(28,016) ------- -------- -------- -------- -------- Net income (loss) per share -- basic..................... $ 0.25 $ 0.96 $ 0.57 $ (0.27) $ (0.68) ======= ======== ======== ======== ======== Net income (loss) per share -- diluted(1)................ $ 0.22 $ 0.79 $ 0.52 $ (0.27) $ (0.68) ======= ======== ======== ======== ======== Shares used in calculating net income (loss) per share -- basic.......... 33,510 31,265 37,702 39,593 40,955 ======= ======== ======== ======== ======== Shares used in calculating net income (loss) per share -- diluted(1)..... 37,413 37,775 41,588 39,593 40,955 ======= ======== ======== ======== ========
DECEMBER 31, ------------------------------------------------------- 1994 1995 1996 1997 1998 ------- -------- -------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Cash, cash equivalents and short-term investments........................ $10,860 $ 78,124 $ 69,204 $ 42,284 $ 82,471 Working capital...................... 11,135 70,602 65,207 74,238 81,124 Total assets......................... 24,014 162,703 211,985 231,654 214,645 Long-term debt, less current portion............................ -- 15,960 -- -- -- Total shareholders' equity........... 14,458 105,208 143,176 171,107 142,072
- --------------- (1) See Note 6 of Notes to Consolidated Financial Statements for an explanation of shares used in calculating net income (loss) per share -- diluted. 13 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's Consolidated Financial Statements contained in Item 8 of this report. Except for the historical information contained herein, the matters discussed in this report are forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, without limitation, those mentioned in this report and, in particular, the factors described below under "Factors That May Affect Future Results." OVERVIEW ESS designs, develops and markets highly integrated mixed signal semiconductor products for sale to the Internet, PC and consumer marketplace. In 1998, ESS had revenues totaling $218.3 million, a 13% decrease from the 1997 total of $249.5 million and 4% decrease from 1996 revenues of $226.5 million. Net income decreased by 347% from $11.3 million in 1997, excluding a one-time pre and post-tax charge of $22.2 million related to acquired research and development in-process for the acquisition of Platform, to a net loss of $28.0 million in 1998. 1997 net income, excluding the one time pre and post- tax charge for acquired research and development in-process, decreased by 78% from 1996 net income of $52.0 million, excluding a one-time pre and post-tax charge of $30.4 million related to acquired research and development in-process for the VideoCore and OSEE acquisitions. The gross margin for 1998 was 16%, reflecting price competition offset in part by manufacturing cost reductions, compared to gross margin in 1997 of 31%. 1997 margin declined from 53% in 1996 primarily due to price competition in the audio segment offset in part by manufacturing cost reductions. The Company is a leader in semiconductor audio products for the PC marketplace and semiconductor video products for the VCD player market. In 1996, the Company entered the VCD player market after its January 1996 acquisition of VideoCore pursuant to which the Company acquired all of the outstanding capital stock of VideoCore in exchange for approximately 525,000 shares of the Company's Common Stock and $5.7 million in cash. VideoCore develops integrated circuits which incorporate advanced compression technology in digital video products under the trade-name VideoDrive. In March 1996, the Company completed its acquisition of OSEE pursuant to which the Company acquired all of the outstanding capital stock of OSEE in exchange for approximately 217,000 shares of the Company's Common Stock and $3.6 million in cash. Also outstanding stock options of OSEE were exchanged for 85,000 stock options of the Company. OSEE develops advanced modem algorithm technology that enables the Company to provide modem products under the trade name TeleDrive. Both acquisitions were accounted for as purchases and the portion of the purchase prices attributable to research and development in-process was expensed in the first quarter of 1996. In 1996, 1997 and 1998, the Company's AudioDrive products served the market for the ISA standard. In June 1997, the Company completed its acquisition of Platform pursuant to which the Company acquired all the outstanding capital stock of Platform in exchange for approximately 2.54 million shares of the Company's Common Stock including approximately 954,000 options. The acquisition was accounted for as a purchase and the portion of the purchase price attributable to research and development in-process was expensed in the second quarter of 1997. The acquisition of Platform allowed the Company to develop and subsequently introduce products for the PCI standard. ESS' AudioDrive products enable PC manufacturers to provide audio capabilities on add-in sound cards and directly on the motherboards of desktop and notebook computers. The Company has established itself as a leader in integrated audio solutions and counts many of the leading manufacturers of personal computers and sound cards among its customers. In 1996, the Company introduced its VideoDrive product, a single-chip MPEG-1 decoder that provides full-screen, full-motion video and selectable CD-quality audio for VCD players. Shipments of these chips to the VCD player market began in the second quarter of 1996. In 1997, the Company introduced its first MPEG-2 video chip solution, a fully programmable, single-chip processor that incorporates the additional features needed for consumer electronics applications such as DVD players, set-top boxes, multimedia personal computers and home entertainment units. 14 16 The TeleDrive products for the Internet and other modem markets were developed following the Company's first quarter of 1996 acquisition of OSEE. In 1997, the Company began shipment of V.34bis modem solutions and introduced the V.90 56K modem solutions. The Company is currently shipping both V.34bis and V.90 56K modem solutions. Prior to October 1996, the Company leased two facilities in Fremont, California. The leases for such facilities expired on June 30 and October 31, 1996. The facilities consisted of two buildings comprising approximately 62,000 square feet, which were used as the Company's headquarters. At the end of 1995, ESS purchased 16 acres of land in Fremont, California, near its previous facilities. By the end of 1996, the Company completed and occupied a two-story, 93,000-square-foot headquarters. In 1998, the Company completed construction of a 77,000 square foot building to support headcount growth. An 11,000 square foot dormitory was also completed during 1998. During the fourth quarter of 1997, the Company established a wholly-owned foreign subsidiary in the Cayman Islands, British West Indies and transferred a substantial portion of its business operations to it. RESULTS OF OPERATIONS The following table sets forth certain items from the Company's consolidated statements of operations as a percentage of net revenues for the periods indicated.
YEARS ENDED DECEMBER 31, --------------------------- 1996 1997 1998 ----- ----- ----- Net revenues.................................... 100.0% 100.0% 100.0% Cost of revenues................................ 47.2 68.9 83.6 ----- ----- ----- Gross margin.................................. 52.8 31.1 16.4 Operating expenses: Research and development...................... 9.0 11.8 14.0 Research and development in-process........... 13.4 8.9 -- Selling, general and administrative........... 7.4 10.1 16.6 ----- ----- ----- Operating income (loss)......................... 23.0 0.3 (14.2) Nonoperating income, net........................ 1.5 0.9 0.7 ----- ----- ----- Income (loss) before income taxes............... 24.5 1.2 (13.5) Provision for (benefit from) income taxes....... 14.9 5.5 (0.7) ----- ----- ----- Net income (loss)............................... 9.6%* (4.3)%** (12.8)% ===== ===== =====
- --------------- * Includes a one-time pre and post-tax charge of 13.4% related to acquired research and development in-process. ** Includes a one-time pre and post-tax charge of 8.9% related to acquired research and development in-process. Net Revenues. Net revenues were $226.5 million, $249.5 million and $218.3 million in 1996, 1997 and 1998, respectively. Net revenues decreased 13% between 1997 and 1998 primarily due to a decrease in ASP in both the audio and video markets. Net revenues rose by 10% between 1996 and 1997 primarily from increased sales of the Company's video products. The Company's PC audio products accounted for substantially all of the Company's net revenues for 1996 and a majority in 1997 and 1998. International revenues accounted for approximately 92%, 89% and 92% of net revenues for 1996, 1997 and 1998, respectively. The Company's net revenues are denominated in U.S. dollars. The Company expects that its percentage of international sales will remain high in the future. Gross Margin. Gross profit was $119.6 million, $77.7 million and $35.8 million in 1996, 1997 and 1998, respectively, representing corresponding gross margins of 52.8%, 31.1% and 16.4% of net revenues for such years. The decrease in gross margins from 1997 to 1998 was a result of lower ASPs on the Company's products throughout the year. The decrease in gross margins from 1996 to 1997 was a result of lower ASPs on the 15 17 Company's products throughout the year and an inventory charge to cost of goods sold during the fourth quarter of $18.3 million for excess inventory positions. During the third quarter of 1997, indication of strong demand led to a high order rate. After non-cancelable production orders were placed, yields improved dramatically and the marketplace demand was lower than expected. The Company was under contractual agreement to pay a pre-established per-die price, and was unable to realize the benefit of the enhanced yields and was committed to purchase the increased volume. These factors led to the inventory charge and the decrease in gross profit. 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 products and new features. In addition, the Company expects the overall ASPs for its existing products to decline significantly over the life of the products. The Company believes that in order to maintain or increase gross profit, it must achieve higher unit volume shipments, reduce costs, add new features and introduce new products. However, no assurance 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 Expenses. On-going research and development expenses were $20.3 million, $29.5 million and $30.5 million, or 9.0%, 11.8% and 14.0% of net revenues, in 1996, 1997 and 1998, respectively. Research and development in-process represents one-time pre and post-tax charges of $30.4 million from the acquisition of VideoCore and OSEE in the first quarter of 1996 and of $22.2 million from the acquisition of Platform in the second quarter of 1997. The growth in on-going research and development expenses between 1996 and 1997 was primarily due to the increase in the Company's engineering staff, engineering test runs, masks, internal and external consulting expenses and licensing fees associated with the research and development efforts to support the introduction of new products. The growth in on-going research and development expenses between 1997 and 1998 was primarily due to the increase in amortization of technical infrastructure and covenants not to compete related to the Company's acquisitions and a one-time charges for impaired assets related to previous acquisitions offset by lower engineering test run and mask charges. The Company expects that research and development expenses will remain relatively constant as a percentage of net revenues. There can be no assurance, however, that revenues will grow at the same rate as the anticipated research and development expenses. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $16.8 million, $25.2 million and $36.3 million, or 7.4%, 10.1% and 16.6% of net revenues, in 1996, 1997 and 1998, respectively. The increase in selling, general and administrative expenses from 1996 to 1997 was primarily attributable to increased spending for additional sales and administrative employees. The increase in expense was also due to commissions on higher sales levels and, to a lesser extent, promotional expenses and costs associated with the expansion of the Company's sales activities. The increase in selling, general and administrative expense from 1997 to 1998 was primarily due to the increase in reserves for accounts receivable, the amortization of covenants not to compete related to the Company's acquisitions, one-time charge for impaired assets related to a previous acquisition and the expenses associated with the Company's conversion to a new management information system. The Company expects to incur higher selling, general and administrative expenses in the future due to the need to increase selling activities, although these expenses are expected to remain relatively constant as a percentage of net revenues. There can be no assurance, however, that revenues will grow at the same rate as the anticipated selling, general and administrative expenses. Non-Operating Income. Non-operating income was $3.2 million, $2.2 million and $1.5 million in 1996, 1997 and 1998, respectively. In 1996, 1997 and 1998 non-operating income consisted primarily of interest income and gains on sale of short-term investments. Provision for Income Taxes. The Company's effective tax rate was 61%, 466% and (5%) for 1996, 1997 and 1998, respectively. The tax rate for 1996 of 61% reflects a non-deductible expense for the one-time pre and post-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 1996. The pro forma tax rate excluding this charge of $30.4 million was 39%. The Company's pro forma tax rate for 1996 was slightly lower than the combined 16 18 federal and state statutory rate of 41% as a result of tax exempt interest income and research and development credits. The reported tax rate for 1997 of 466% of pre-tax income significantly exceeds the combined federal and state statutory tax rate of 41% due to two charges that are not deductible in the federal and state tax returns. The first charge is the one-time pre- and post-tax charge of $22.2 million for the acquisition of Platform in the second quarter of 1997. The second is the charge to increase inventory reserves in the fourth quarter of 1997. Because the majority of the inventories were held by a foreign subsidiary, a majority of the charge was not deductible on the U.S. federal and state income tax returns. The reported tax benefit for 1998 of 5% of pre-tax losses is below the combined federal and state statutory rate of 41%. It is because a majority of the losses were by a foreign subsidiary and are not deductible on the U.S. federal and state income tax returns. See Note 4 of Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its cash requirements from cash generated by operations, the sale of equity securities, bank lines of credit and short-term and long-term debt. At December 31, 1998, ESS had cash and cash equivalents and short-term investments of $82.5 million and working capital of $81.1 million. As of December 31, 1998, the Company had a $15.0 million line of credit which expires on October 1, 2001 and was secured by land and buildings with a net book value of $23.8 million. The line of credit requires the Company to achieve certain financial ratios and operating results. At December 31, 1998, the Company was in compliance with its borrowing criteria. There were no borrowings under the line of credit as of December 31, 1998. In 1998, the Company generated net cash from operating activities of $31.7 million. This resulted from a reduction in inventory of $24.4 million, a decrease in prepaids and other assets of $13.3 million, an increase in accounts payable and accrued liabilities of $7.1 million, an increase in income taxes payable and deferred income taxes of $3.5 million, depreciation and amortization of $12.5 million and a charge for compensation expense related to stock options of $.5 million, partially offset by a net loss of $28.0 million and an increase in accounts receivable of $1.6 million. The Company received $22.4 million from sale of its UICC investment, $1.2 million from the issuance of common stock and the income tax credit from disqualifying disposition of common stock options. The Company invested $12.3 million in property and equipment, $2.8 million in the repurchase of stock and $2.2 million in the net purchase of short-term investments. For the year, cash and cash equivalents increased by $38.0 million. In 1997, the Company used net cash of $2.6 million in operating activities. This resulted from a net loss of $10.9 million, a gain on sale of short-term investments of $0.1 million, an increase in accounts receivable of $14.2 million, an increase in inventories of $14.0 million, a decrease in accounts payable and accrued expenses of $8.4 million and a decrease in income taxes payable and deferred income taxes of $7.5 million offset in part by reductions in prepaid expenses and other assets of $22.4 million, a one-time non-cash charge for research and development in-process of $22.2 million and depreciation and amortization of $7.9 million. The company received net proceeds of $5.6 million from sale of short term investments, $3.1 million from the issuance of common stock from exercise of stock options and employee stock purchase plan, $3.0 million in income tax credits from disqualifying disposition of common stock options and $2.5 million from the acquisition of Platform. The Company invested $17.7 million in UICC joint venture and $15.2 million in property and equipment. For the year, cash and cash equivalents declined $21.3 million. In 1996, the Company generated net cash from operating activities of $43.3 million. This resulted from net income of $21.6 million, a one-time non-cash charge for research and development in-process of $30.4 million, an increase in accounts payable and accrued expenses of $24.1 million, depreciation and amortization of $3.2 million and a charge for compensation expense related to stock options of $0.1 million, less a gain on sale of short-term investments of $1.0 million an increase in inventories of $14.0 million, an increase in accounts receivable of $11.8 million, an increase in prepaid expenses and other assets at $9.1 million and a decrease in income taxes and deferred income taxes of $0.2 million. The Company received net proceeds of $7.1 million from sale of short term investments, $3.8 million from the issuance of common stock from exercise of stock options and employee stock purchase plan, and $8.9 million in income tax credits from disqualifying disposition of common stock options. The Company invested $14.0 million in property and 17 19 equipment, repurchased stock for $19.7 million, paid $16.0 million on capacity commitments, $9.3 million for acquisition of VideoCore and OSEE and $6.9 million in UICC joint venture. For the year, cash and cash equivalents declined $2.8 million. The Company believes that its existing cash and cash equivalents as of December 31, 1998 together with the cash generated from operations, available borrowings under its line of credit and other financing options, 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 $14.1 million which will be primarily used to acquire capital equipment. 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. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" which was adopted by the Company in the first quarter of fiscal 1998. This Statement establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Such items may include foreign currency translation adjustments, unrealized gains/losses from investing and hedging activities, and other transactions. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. As the Company has no components of other comprehensive income, there are no disclosure requirements involved in the Company's adoption of this Statement. In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" which was adopted by the Company in the first quarter of fiscal 1998. This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company expanded its disclosure of geographical areas in accordance with the new standard. As the Company operates and tracks its results in only one segment, there are no additional disclosure requirements involved with the Company's adoption of this Statement. YEAR 2000 ISSUES General. The Company is currently conducting a company-wide Year 2000 readiness program ("Y2K Program"). The Y2K Program is addressing the issue of computer programs and embedded computer chips being unable to distinguish between the year 1900 and the year 2000. Therefore, some computer hardware and software will need to be modified prior to the Year 2000 in order to remain functional. The Company anticipates that Year 2000 compliance will be substantially complete by June 1999. Year 2000 Program. The Company's Year 2000 Program is divided into four major sections -- ESS manufactured products, internal information ("IT") systems, non-IT systems (e.g., testing equipment), and third-party suppliers and customers. The general phases common to all sections are: (1) inventorying Year 2000 items; (2) assessing the Year 2000 compliance of items determined to be material to the company; and (3) repairing or replacing material items that are determined not to be Year 2000 compliant. The Company has completed its review of substantially all ESS manufactured products for Year 2000 compliance purposes. The Company believes that substantially all of the Company's products are Year 2000 compliant and that those that are not Year 2000 compliant can be upgraded to be Year 2000 compliant by June 1999. 18 20 With respect to its internal IT computer systems, the Company has completed the inventory and review phases of the Y2K program and has been in the repair or replacement phase. In February 1998, the Company began to install Year 2000 compliant programs from Oracle Corporation for approximately 80 percent of its business systems. This installation was fully implemented by the end of 1998. With respect to the remaining internal IT computer systems that are not yet Year 2000 compliant, the Company plans to either replace or upgrade them by the end of September 1999. The Company has completed the inventory phase and Year 2000 compatibility of its non-IT systems. To date, about 80 percent of its non-IT systems are Year 2000 compliant. The Company plans to repair or replace those that are not yet Year 2000 compliant by the end of June 1999. The Company has been working with its key suppliers and contract manufacturers to assess the possible effects of their Year 2000 readiness on the Company's operations. Although these suppliers and contract manufacturers have notified the Company that they have been addressing the problem, they have not provided specific assurance regarding the Year 2000 compliance of their systems and software. The Company's reliance on suppliers and contract manufacturers and, therefore, on the proper functioning of their information systems and software, means that failure of such key suppliers and contract manufacturers to address Year 2000 issues could have a material adverse impact on the Company's operations and financial results; however, the potential impact and related costs are not known at this time. Costs of the Assessment and Modification. The total cost associated with required modifications to become Year 2000 compliant is not expected to be material to the Company's financial position. Through December 31, 1998, the Company has spent $2.6 million to implement Year 2000 compliant programs from Oracle Corporation. The Company estimates that it may spend up to an additional $250,000 for other replacements or upgrades and for communicating with key suppliers and customers. Risks. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. The Company believes that its Year 2000 Program will help to significantly reduce the Company's level of uncertainty about the Year 2000 problem and, in particular, about the Year 2000 compliance and readiness of its material key suppliers and customers. The Company believes that, with the implementation of new business systems and completion of the Year 2000 Program as scheduled, the possibility of significant interruptions of normal operations should be reduced. We are at work on the development of various types of contingency plans to address potential problems with critical internal systems and third party interactions. Our contingency plans include procedures for dealing with a major disruption of internal business systems, plans for factory shutdown and identification of alternative vendors of critical materials in the event of Year 2000 related disruption in supply. Contingency planning will continue through at least 1999, and will depend heavily on the results of the remediation and testing of critical systems. The potential ramifications of a Year 2000 type failure are potentially far-reaching and largely unknown. We cannot assure you that a contingency plan in effect at the time of a system failure will adequately address the immediate or long term effects of a failure, or that such a failure will not have a material adverse affect on the Company. FACTORS THAT MAY AFFECT FUTURE RESULTS This report contains certain forward-looking statements that are subject to risk and uncertainties. For such statements, the Company desires to take advantage of the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995 and of Section 21E of and Rule 3b-6 under the Securities Exchange Act of 1934. Such forward-looking statements include, without limitation, statements regarding the Company's expectations, intentions of future strategies and involve known and unknown risks, uncertainties and 19 21 other factors. All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update such forward-looking statements. 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 in various geographic areas where the Company or its customers do business, or order cancellations or rescheduling. 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. The Company currently places noncancelable orders to purchase its products from independent foundries on an approximately three month rolling basis, while its customers generally place purchase orders with the Company less than four weeks prior to delivery that may be canceled without significant penalty. Consequently, if anticipated sales and shipments in any quarter are canceled or do not occur as quickly as expected or forecasted sales levels are not realized, expense and inventory levels could be disproportionately high and the Company's business, financial condition and results of operations could be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Competition; Pricing Pressures. The markets in which the Company competes are intensely competitive and are characterized by rapid technological change, price declines and rapid product obsolescence. See "Item 1. Business -- Competition." Dependence on the PC and Consumer Markets. In 1996, 1997 and 1998, sales of PC audio semiconductor chips accounted for a majority of the Company's net revenues, and the Company expects that sales of audio semiconductors will continue to account for a significant portion of its net revenues for the foreseeable future. In 1998, sales of video semiconductor chips to the video compact disk ("VCD") player market accounted for a significant portion of the Company's revenues. Any reduction in ASPs or demand for the Company's semiconductor chips, whether because of a reduction in demand for PCs or VCD players in general, 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, video and modem semiconductor devices for the Internet, PC and consumer markets. 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. See "Item 1. Business -- Audio Drive Products," "-- Video Drive Products" and "TeleDrive Products." The Company's products are sold for incorporation into desktop and notebook computers and VCD players. Therefore, the Company is heavily dependent on the growth of the markets and the cost requirements for desktop and notebook computers and VCD players. There can be no assurance that these markets will be able to grow. A slowing in unit volume and a decrease in ASPs could result in a decline in revenues which would have a material adverse effect on the Company's business, financial condition and results of operations. Importance of New Products and Technological Changes. 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 20 22 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 its customers, the Company must anticipate market trends and meet performance, quality and functionality requirements of such OEMs and must successfully develop and manufacture products that adhere to 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. 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. See "Item 1. Business -- Research and Development." 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 UMC, which has manufactured certain of the Company's products since 1995. These relationships provide 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, in certain cases, 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. See "Item 1. Business -- Manufacturing." While the Company has entered into long-term agreements with its two foundries, the Company's reliance on these 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. In addition, the Company has pre-negotiated certain of its purchase orders and could be unable to benefit from enhanced yields realized by its vendors. The Company expects to rely upon TSMC and UMC to manufacture substantially all 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. 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. 21 23 Customer Concentration. A limited number of customers have accounted for a substantial portion of the Company's net revenues. In 1996, 1997 and 1998, sales to the Company's top five customers, including sales to distributors, accounted for approximately 40%, 49% and 54% respectively, of the Company's net revenues. In 1996, Compaq and Universe Electron Corporation each accounted for approximately 12% and 13%, respectively, of the Company's net revenues. In 1997, Eastbase and Dynax, a Hong Kong distributor, each accounted for approximately 13% of the Company's net revenues. In 1998, Dynax and Shinco accounted for approximately 16% and 15% of the Company's net revenues. Sales to distributors are generally subject to agreements allowing limited rights of return and price protection with respect to unsold products. Returns and allowances in excess of reserves could have a material adverse impact on the Company's business, financial condition and results of operation. During 1997, the Company adopted a policy of deferring revenue recognition on sales of devices to distributors in Hong Kong and Taiwan until devices are sold to the end customers. This has led to increased operational visibility on product moving through the channel. The Company expects that a limited number of customers may account for a substantial portion of its net revenues for the foreseeable future. The Company has experienced changes from year to year in the composition of its major customer base and believes this pattern may continue. The Company does not have long-term purchase agreements with any of its customers. The reduction, delay or cancellation of orders from one or more major customers for any reason or the loss of one or more of such major customers could materially and adversely affect the Company's business, financial condition and results of operations. In addition, since the Company's products are often sole sourced to its customers, the Company's operating results could be materially and adversely affected if one or more of its major customers were to develop other sources of supply. There can be no assurance that the Company's current customers will continue to place orders with the Company, that orders by existing customers will not be canceled or will continue at the levels of previous periods or that the Company will be able to obtain orders from new customers. Management of Growth. The Company has experienced significant growth in unit shipments and the addition of multiple product lines that require additional management systems and processes. To manage its future operations and growth effectively, the Company will need to hire and retain management, hire, train, motivate, manage and retain its employees, continue to improve its operational, financial and management information systems and implement additional systems and controls. There can be no assurance that the Company will be able to manage such growth effectively, and the failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company has implemented an enterprise-wide software package that integrates its core business functions. Should the implementation be incomplete or otherwise problematic, substantial disruption to the business operations of the Company could result. There can be no assurance that the software implementation will not cause business disruptions to the Company. International Operations. During 1996, 1997 and 1998, international sales accounted for a substantial majority of the Company's net revenues. Substantially all of the Company's international sales were to customers in Hong Kong, Taiwan, Singapore, Japan and Korea. 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 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 22 24 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 provide for pricing and payment in U.S. dollars. In 1998, the effect of significant currency fluctuations in Asia had no material impact on the Company. There can be no assurance that future fluctuations in currency exchange rates will not have a material adverse effect on the Company's business, financial condition and results of operations. 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. Uncertainty Regarding Patents and Protection of Proprietary Rights. The Company relies on a combination of patents, trademarks, copyrights, trade secret laws and confidentiality procedures to protect its intellectual property rights. See "Item 1. Business -- Patents and Proprietary Rights," "Item 3. Legal Proceedings." 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, President and Chairman of the Board of Directors. The present and 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. 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. Control by Existing Shareholders. As of December 31, 1998, Fred S.L. Chan, the Company's Chief Executive Officer, President and Chairman of the Board of Directors, together with his spouse, Annie M.H. Chan, a director of the Company, and certain trusts for the benefit of the Chan's children beneficially owned, in the aggregate, 37% of the Company's outstanding Common Stock. As a result, these shareholders, acting together, possess significant voting power over the Company, giving them the ability among other things to influence significantly the election of the Company's Board of Directors and approve significant corporate transactions. Such control could delay, defer or prevent a change in control of the Company, impede a merger, consolidation, takeover or other business combination involving the Company, or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of the Company. Additionally, Fred S.L. Chan and Annie M.H. Chan announced on April 28, 1998, that they would be purchasing between $5 and $10 million of the Company's common stock on the open market. As of December 31, 1998, such purchases had totaled $1.4 million representing 241,000 shares at prices ranging from $5.15 to $6.56. Possible Volatility of Stock Price. The price of the Company's Common Stock has in the past and may continue in the future to fluctuate widely. Future announcements concerning the Company, its competitors or its principal customers, including quarterly operating results, changes in earnings estimates by analysts, technological innovations, new product introductions, governmental regulations or litigation may cause the market price of the Company's Common Stock to continue to fluctuate substantially. Further, in recent years the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many high technology companies and that often have been unrelated or disproportionate to the operating performance of such companies. These fluctuations, as well as general 23 25 economic, political and market conditions such as recessions or international currency fluctuations, may materially adversely affect the market price of the Common Stock. Year 2000 Compliance. The dates on which the Company believes the Year 2000 Program (the "Y2K Program") will be completed are based on Management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved, or that there will not be a delay in, or increased costs associated with, the implementation of the Y2K Program. Specific factors that might cause differences between the estimates and actual results include, but are not limited to, the availability and cost of personnel trained in these areas, the ability to locate and correct all relevant computer code, timely responses to and corrections by third-parties and suppliers, the ability to implement interfaces between the new systems and the systems not being replaced, and similar uncertainties. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-parties and the interconnection of global businesses, the Company cannot ensure its ability to timely and cost-effectively resolve problems associated with the Year 2000 issue that may affect its operations and business, or expose it to third-party liability. Euro Conversion. The Company is in the process of addressing the issues raised by the introduction of the Single European Currency ("Euro") for initial implementation as of January 1, 1999, and through the transition period to January 1, 2002. The Company does not expect the cost of any system modifications to be material or result in any material increase in transaction costs. The Company will continue to evaluate the impact over time of the introduction of the Euro; however, based on currently available information management does not believe that the introduction of the Euro will have a material adverse impact on the Company's financial condition or the overall trends in results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Exchange Risks: The Company funds its operations from cash generated from its operations, the sale of marketable securities and short and long-term debt. As the Company operates primarily in Asia, the Company is exposed to market risk from changes in foreign exchange rates, which could affect its results of operations and financial condition. In order to reduce the risk from fluctuation in foreign exchange rates, the Company's product sales and all of its arrangements with its foundry and test and assembly vendors are denominated in U.S. dollars. The Company has not entered into any currency hedging activities. Interest Rate Risks: The Company also invests in short-term investments. Consequently, the Company is exposed to fluctuation in rates on these investments. Increases or decreases in interest rates generally translate into decreases and increases in the fair value of these investments. In addition, the credit worthiness of the issuer, relative values of alternative investments, the liquidity of the instrument and other general market conditions may affect the fair values of interest rate sensitive investments. In order to reduce the risk from fluctuation in rates, the Company invests in highly liquid governmental notes and bonds with contractual maturities of less than two years. All of the investments have been classified as available for sales and at December 31, 1998, the fair market value of the Company's investments approximated their costs. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (a) The following documents are filed as part of this Report. (1) Financial Statements: 24 26
Report of Independent Accountants Consolidated Balance Sheets as of December 31, 1997 and 1998 Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1997 and 1998 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998 Notes to Consolidated Financial Statements
(2) Financial Statement Schedules: Financial Statement Schedules have been omitted because they are not required or applicable, or the information required to be set forth therein is included in the Financial Statements or notes thereto. 25 27 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of ESS Technology, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity and of cash flows present fairly, in all material respects, the financial position of ESS Technology, Inc. and its subsidiaries at December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PRICEWATERHOUSECOOPERS LLP San Jose, California January 21, 1999 26 28 ESS TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1998 (AMOUNTS IN THOUSANDS) ASSETS
DECEMBER 31, -------------------- 1997 1998 -------- -------- Current assets: Cash and cash equivalents................................. $ 27,760 $ 65,752 Short-term investments.................................... 14,524 16,719 Accounts receivable, net.................................. 36,265 37,830 Inventories............................................... 47,285 22,882 Deferred income taxes..................................... 4,898 6,372 Prepaid expenses and other assets......................... 4,053 4,142 -------- -------- Total current assets.............................. 134,785 153,697 Property and equipment, net................................. 32,922 38,000 Other assets................................................ 63,947 22,948 -------- -------- $231,654 $214,645 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses..................... $ 50,858 $ 57,930 Income taxes payable and deferred income taxes............ 9,689 14,643 -------- -------- Total current liabilities......................... 60,547 72,573 -------- -------- Commitments and Contingencies (Note 9) Shareholders' equity: Preferred stock, no par value, 10,000 shares authorized; none issued and outstanding............................ -- -- Common stock, no par value, 100,000 shares authorized; 40,674 and 40,849 shares issued and outstanding at December 31, 1997 and 1998, respectively............... 137,452 137,312 Retained earnings......................................... 33,655 4,760 -------- -------- Total shareholders' equity........................ 171,107 142,072 -------- -------- Total liabilities and shareholders' equity........ $231,654 $214,645 ======== ========
The accompanying notes are an integral part of these financial statements. 27 29 ESS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, -------------------------------- 1996 1997 1998 -------- -------- -------- Net revenues............................................... $226,455 $249,517 $218,252 Cost of revenues........................................... 106,818 171,859 182,417 -------- -------- -------- Gross profit............................................. 119,637 77,658 35,835 Operating expenses: Research and development................................. 20,270 29,471 30,529 Research and development in-process...................... 30,355 22,200 -- Selling, general and administrative...................... 16,814 25,198 36,289 -------- -------- -------- Operating income (loss).................................... 52,198 789 (30,983) Interest income, net....................................... 2,276 2,117 1,478 Gain on sale of short-term investments..................... 965 66 -- -------- -------- -------- Income (loss) before provision for (benefit from) income taxes.................................................... 55,439 2,972 (29,505) Provision for (benefit from) income taxes.................. 33,813 13,838 (1,489) -------- -------- -------- Net income (loss).......................................... $ 21,626 $(10,866) $(28,016) ======== ======== ======== Net income (loss) per share -- basic....................... $ 0.57 $ (0.27) $ (0.68) ======== ======== ======== Net income (loss) per share -- diluted..................... $ 0.52 $ (0.27) $ (0.68) ======== ======== ======== Shares used in calculating net income (loss) per share -- basic........................................... 37,702 39,593 40,955 ======== ======== ======== Shares used in calculating net income (loss) per share -- diluted......................................... 41,588 39,593 40,955 ======== ======== ========
The accompanying notes are an integral part of these financial statements. 28 30 ESS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (AMOUNTS IN THOUSANDS)
COMMON STOCK ----------------- DEFERRED RETAINED SHARES AMOUNT COMPENSATION EARNINGS TOTAL ------ -------- ------------ --------- -------- Balance at December 31, 1995............ 35,473 $ 66,891 $(60) $ 38,377 $105,208 Issuance of common stock upon exercise of options......................... 3,667 3,152 -- -- 3,152 Issuance of common stock for acquisitions....................... 743 23,352 -- -- 23,352 Issuance of common stock for employee stock purchase plan................ 47 621 -- -- 621 Amortization of deferred compensation....................... -- -- 60 -- 60 Repurchase of common stock............ (1,803) (4,249) -- (15,482) (19,731) Income tax benefit on disqualifying disposition of common stock options............................ -- 8,888 -- -- 8,888 Net income............................ -- -- -- 21,626 21,626 ------ -------- ---- -------- -------- Balance at December 31, 1996............ 38,127 98,655 -- 44,521 143,176 Issuance of common stock upon exercise of options......................... 886 2,294 -- -- 2,294 Issuance of common stock for acquisition........................ 1,586 32,703 -- -- 32,703 Issuance of common stock for employee stock purchase plan................ 75 817 -- -- 817 Income tax benefit on disqualifying disposition of common stock options............................ -- 2,983 -- -- 2,983 Net loss.............................. -- -- -- (10,866) (10,866) ------ -------- ---- -------- -------- Balance at December 31, 1997............ 40,674 137,452 -- 33,655 171,107 Issuance of common stock upon exercise of options......................... 612 618 -- -- 618 Compensation expense related to common stock options issued to consultants........................ -- 535 -- -- 535 Issuance of common stock for employee stock purchase plan................ 86 395 -- -- 395 Income tax benefit on disqualifying disposition of common stock options............................ -- 202 -- -- 202 Repurchase of common stock............ (523) (1,890) -- (879) (2,769) Net loss.............................. -- -- -- (28,016) (28,016) ------ -------- ---- -------- -------- Balance at December 31, 1998............ 40,849 $137,312 -- $ 4,760 $142,072 ====== ======== ==== ======== ========
The accompanying notes are an integral part of these financial statements. 29 31 ESS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------ 1996 1997 1998 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)......................................... $ 21,626 $(10,866) $(28,016) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 3,234 7,865 12,446 Charges for research and development in-process........ 30,355 22,200 -- Gain on sale of short-term investments................. (965) (66) -- Deemed compensation expense and compensation related to stock options........................................ 60 -- 535 Change in assets and liabilities (net of effect of acquisitions) Accounts receivable.................... (11,818) (14,197) (1,565) Inventories.......................................... (13,969) (14,038) 24,403 Prepaid expenses and other assets.................... (9,120) 22,395 13,307 Accounts payable and accrued expenses................ 24,082 (8,359) 7,072 Income taxes payable and deferred income taxes....... (188) (7,520) 3,480 -------- -------- -------- Net cash provided by (used in) operating activities...................................... 43,297 (2,586) 31,662 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property and equipment..................... (14,015) (15,207) (12,336) Sale of short-term investments............................ 17,435 24,916 21,775 Purchase of short-term investments........................ (10,376) (19,291) (23,970) Sale (purchase) of joint venture investment............... (6,849) (17,750) 22,415 Payments associated with capacity commitments............. (15,960) -- -- Cash received from (paid for) acquisitions................ (9,288) 2,529 -- -------- -------- -------- Net cash used in investing activities............. (39,053) (24,803) 7,884 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of common stock................................ (19,731) -- (2,769) Issuance of common stock.................................. 3,773 3,111 1,013 Income tax benefit on disqualifying disposition of common stock options.......................................... 8,888 2,983 202 -------- -------- -------- Net cash provided by (used in) financing activities...................................... (7,070) 6,094 (1,554) -------- -------- -------- Net increase (decrease) in cash and cash equivalents........ (2,826) (21,295) 37,992 Cash and cash equivalents at beginning of period............ 51,881 49,055 27,760 -------- -------- -------- Cash and cash equivalents at end of period.................. $ 49,055 $ 27,760 $ 65,752 ======== ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Common stock issued for acquisitions...................... $ 23,352 $ 32,703 $ -- Cash paid for income taxes................................ $ 23,576 $ 18,300 $ -- ======== ======== ========
The accompanying notes are an integral part of these financial statements. 30 32 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES ESS Technology, Inc. (the "Company") was incorporated in California in February 1984. The Company and its wholly-owned subsidiaries design, develop and market highly integrated mixed signal semiconductor products for sale to the Internet, PC and consumer marketplaces. Use of Estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. 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. Short-term investments are comprised of primarily debt instruments have been classified as available for sale. Management determines the appropriate classification of securities at the time of purchase and reevaluates the classification at each reporting date. At December 31, 1998, the fair value of the Company's investments approximated their cost. Inventories Inventories are stated at the lower of cost or market, with cost being determined by the first-in, first-out (FIFO) method. Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is provided using the straight-line method over estimated useful lives that range from 3 to 5 years for machinery and equipment and furniture and fixtures and 4 to 30 years for buildings and building improvements. Technical Infrastructure and Covenants not to Compete Technical infrastructure and covenants not to compete are amortized over estimated useful lives that range from 3 to 4 years. Impairment of Long-Lived Assets Pursuant to Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"), the Company reviews long-lived assets based upon a gross cash flow basis and will reserve for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be fully recoverable. During 1998, Company recorded $3.1 million in write-down of impaired assets related to technical infrastructure, covenants not to compete and certain prepaid license fees. Revenue Recognition Revenue from products sales is recognized at the time of shipment except for certain shipments to distributors with rights of return and allowances, in which case revenue is deferred until the distributor resells the product. For sales recognized at the time of shipment, reserves for estimated returns and price adjustments are provided at the time of shipment. 31 33 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Research and Development Research and development costs are expensed as incurred. Income Taxes The Company accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of timing differences between the carrying amounts and the tax bases of assets and liabilities. U.S. deferred income taxes are provided on all unremitted earnings of the Company's foreign subsidiaries as such earning are not considered permanently invested. Stock Based Compensation The Company accounts for stock based employee compensation arrangements using the intrinsic value method as prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations thereof. Accordingly, compensation costs for stock options is measured as the excess, if any, of the market price of the Company's stock at the date of grant over the stock option exercise price. In addition, the Company complies with the disclosure provisions of Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). Comprehensive Income In 1998, the Company adopted the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income". SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The adoption of SFAS No. 130 did not have a material effect on the Company's results of operations or shareholders equity. Industry Segment In 1998, the Company adopted Statement of Financial Accounting Standard No. 131 ("SFAS No. 131"), "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14 and requires segment information be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments in quarterly and annual reports. The adoption of SFAS No. 131 did not have a material effect on the Company's results of operations or shareholders equity. 32 34 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
DECEMBER 31, ------------------- 1997 1998 -------- ------- Cash and cash equivalents: Cash and money market accounts........................ $ 23,318 $23,082 U.S. government notes and bonds....................... 4,342 42,570 Certificates of deposit............................... 100 100 -------- ------- $ 27,760 65,752 ======== ======= Short-term investments: U.S. government notes and bonds....................... $ 14,524 $16,719 ======== ======= Accounts receivable: Accounts receivable................................... $ 37,251 $41,758 Less: allowance for doubtful accounts................. (986) (3,928) -------- ------- $ 36,265 37,830 ======== ======= Inventories: Raw materials......................................... $ 1,776 $ 6,307 Work-in-process....................................... 18,237 4,429 Finished goods........................................ 27,272 12,146 -------- ------- $ 47,285 $22,882 ======== ======= Property and equipment: Land.................................................. $ 3,899 $ 3,899 Buildings and building improvements................... 15,838 22,033 Machinery and equipment............................... 22,080 27,790 Furniture and fixtures................................ 824 1,255 -------- ------- Cost of property and equipment........................ 42,641 54,977 Less: accumulated depreciation and amortization....... (9,719) (16,977) -------- ------- $ 32,922 $38,000 ======== ======= Other assets: Foundry prepayments and investments................... $ 44,733 $12,406 Prepaid license fees.................................. 1,725 -- Covenants not to compete.............................. 10,262 5,651 Technical infrastructure.............................. 6,339 3,897 Other................................................. 888 994 -------- ------- $ 63,947 $22,948 ======== ======= Accounts payable and accrued expenses: Accounts payable...................................... $ 42,373 $44,414 Accrued compensation costs............................ 2,449 4,578 Accrued commission and royalties...................... 1,196 2,739 Other accrued liabilities............................. 4,840 6,199 -------- ------- $ 50,858 $57,930 ======== =======
33 35 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. DEBT The Company has a secured line of credit agreement with a foreign bank of $15 million, which expires on October 1, 2001. As of December 31, 1998, the line was secured by the building and land of the Company with a net book value of $23.8 million. Under the terms of the agreement, the Company may borrow at a fixed rate of LIBOR plus 1.5% or a variable rate at the foreign bank's reference rate. The line of credit requires the Company to achieve certain financial ratios and operating results. At December 31, 1998, the Company was in compliance with its borrowing criteria. There were no borrowings under the line of credit as of December 31, 1998. 4. INCOME TAXES Income (loss) before provision for (benefit from) income taxes consisted of the following:
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1997 1998 ------- -------- -------- (IN THOUSANDS) Domestic.................................... $55,191 $ 13,947 $(11,014) Foreign..................................... 248 (10,975) (18,491) ------- -------- -------- $55,439 $ 2,972 $(29,505) ======= ======== ========
Provision for (benefit from) income taxes consisted of the following:
YEAR ENDED DECEMBER 31, ----------------------------- 1996 1997 1998 ------- ------- ------- (IN THOUSANDS) Current: Federal..................................... $29,406 $15,011 $ 1,432 State....................................... 3,955 1,769 280 Foreign..................................... 42 38 34 ------- ------- ------- 33,403 16,818 1,746 ------- ------- ------- Deferred: Federal..................................... 330 (2,550) (2,767) State....................................... 80 (430) (468) ------- ------- ------- 410 (2,980) (3,235) ------- ------- ------- Total............................... $33,813 $13,838 $(1,489) ======= ======= =======
A reconciliation between the provision for (benefit from) income taxes computed at the federal statutory rate of 35% for the years ended December 31, 1996, 1997 and 1998 and the provision for (benefit from) income taxes is as follows:
YEAR ENDED DECEMBER 31, ------------------------------ 1996 1997 1998 ------- ------- -------- (IN THOUSANDS) Provision (benefit) at statutory rate........ $19,404 $ 1,040 $(10,327) Taxes related to foreign jurisdictions....... -- 4,275 7,293 State income taxes, net of federal tax benefit.................................... 1,843 94 101 Tax-exempt interest income................... (509) (333) (53) General business credit...................... (371) (643) -- Nondeductible research and development costs...................................... 12,758 8,480 1,497 Other........................................ 688 925 -- ------- ------- -------- Provision for (benefit from) income taxes.... $33,813 $13,838 $ (1,489) ======= ======= ========
34 36 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Deferred tax assets (liabilities) are comprised of the following:
YEAR ENDED DECEMBER 31, ------------------ 1997 1998 ------- ------- (IN THOUSANDS) State income taxes....................................... $ 533 $ 55 Accounts receivable and inventory reserves............... 3,680 4,891 Accrued expenses......................................... 370 1,069 Legal reserves and other................................. 315 357 ------- ------- Total deferred tax assets...................... 4,898 6,372 Unremitted earnings of foreign subsidiary................ (4,069) (9,139) Covenants not to compete and technical infrastructure.... (5,437) (3,674) ------- ------- Net deferred tax liabilities................... $(4,608) $(6,441) ======= =======
5. SHAREHOLDERS' EQUITY Common Stock On July 15, 1996, the Company's Board of Directors authorized repurchase at management's discretion of up to 2 million shares of the Company's Common Stock over the subsequent 12 months at market prices and as the market and business conditions warrant. As of December 31, 1996, the Company had repurchased 1,802,500 shares at market prices ranging from $9.41 to $16.75 per share. On April 29, 1997, the Company's Board of Directors authorized repurchase at management's discretion of up to 2 million shares of the Company's Common Stock over the subsequent 12 months at market prices and as the market and business conditions warrant. There were no repurchases under this program. On November 5, 1998, the Company's Board of Directors authorized repurchase at managements' discretion of up to $7 million of the Company's Common Stock over the subsequent 12 months at market prices and as market and business conditions warrant. As of December 31, 1998, the Company had repurchased 523,000 shares at market prices ranging from $3.17 to $6.45 per share. 1986 Stock Option Plan In February 1986, the Company adopted the 1986 Stock Option Plan (the "1986 Plan"). Under the 1986 Plan, 3,600,000 shares of Common Stock were reserved for issuance to employees, consultants and investors as approved by the Board of Directors. The 1986 Plan provides for incentive stock options. The plan was terminated during fiscal year 1996 by operation of its terms. Options under the 1986 Plan are granted, subject to certain conditions, at estimated fair value as determined by the Board of Directors. Options granted under the 1986 Plan generally vest 25% each year after the date of grant. Options are adjusted on a pro rata basis for certain changes in the capitalization of the Company, such as stock splits and stock dividends. In addition, the outstanding options issued under the 1986 Plan terminate within 90 days after termination of an option holder's employment with the Company. 1992 Stock Option Plan In January 1992, the Company adopted the 1992 Stock Option Plan (the "1992 Plan"). The 1992 Plan authorized 6,966,000 shares to be reserved for issuance. The terms of the 1992 Plan are generally similar to those of the 1986 Plan outlined above. In February 1998, the Company canceled 165,000 options under the 1992 Plan with exercise prices greater than $7.69 and reissued the options with an exercise price of $7.69. 35 37 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In August 1998, the Company canceled 230,000 options under the 1992 Plan with exercise prices greater than $2.69 and reissued the options with an exercise price of $2.69. Executive Plan In January 1990 and March 1991, the Company granted 5,400,000 and 1,080,000 options, respectively, outside of the 1986 Plan to officers of the Company under the Executive Plan. The options were granted at the then fair value of $0.083 per share, as determined by the Board of Directors. The options generally vested over periods of one to four years. 1995 Equity Incentive Plan In August 1995, the Company adopted the 1995 Equity Incentive Plan (the "Incentive Plan"), which provides for the grant of stock options and stock bonuses and the issuance of restricted stock by the Company to its employees, directors and others. The Company has reserved 3,000,000 shares of the Company's Common Stock for issuance under the Incentive Plan. The terms of the Incentive Plan are generally similar to those of the 1986 Plan outlined above. In September 1996, the Company canceled 326,000 options under the Incentive Plan with exercise prices greater than $14.75 and reissued the options with an exercise price of $14.75. In May 1997, the Company canceled 720,000 options under the Incentive Plan with exercise prices greater than $13.94 and reissued the options with an exercise price of $13.94. In February 1998, the Company canceled 1,612,000 options under the Incentive Plan with exercise prices greater than $7.69 and reissued the options with an exercise price of $7.69. In August 1998, the Company canceled 1,298,000 options under the Incentive Plan with exercise prices greater than $2.69 and reissued the options with an exercise price of $2.69. 1995 Employee Stock Purchase Plan In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan (the "Purchase Plan") and reserved a total of 225,000 shares of the Company's Common Stock for issuance thereunder. The Purchase Plan, as amended in May, 1998, authorizes the issuance of 425,000 shares under the Purchase Plan. The Purchase Plan permits eligible employees to acquire shares of the Company's Common Stock through payroll deductions at a price equal to the lower of 85% of the fair market value of the Company's common stock at the beginning of the offering period or on the purchase date. As of Decembers 31, 1998, 208,000 shares have been issued under the Purchase Plan. 1995 Directors Stock Option Plan In August 1995, the Company adopted the 1995 Directors Stock Option Plan (the "Directors Plan") and reserved a total of 300,000 shares of the Company's Common Stock for issuance thereunder. The Directors Plan allows for granting of stock options to members of the Board of Directors of the Company. 1997 Equity Incentive Plan In May 1997, the Company adopted the 1997 Equity Incentive Plan (the "1997 Incentive Plan") and reserved a total of 3,000,000 shares of the Company's Common Stock for issuance thereunder. The 1997 Incentive Plan, as amended in May, 1998, authorizes the issuance of 5,000,000 shares under the 1997 Incentive Plan. The terms of the 1997 Incentive Plan are generally similar to those of the 1986 Plan outlined above. 36 38 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In February 1998, the Company canceled 1,602,000 options under the 1997 Incentive Plan with exercise prices greater than $7.69 and reissued the options with an exercise price of $7.69. In August 1998, the Company canceled 2,037,000 options under the 1997 Incentive Plan with exercise prices greater than $2.69 and reissued the options with an exercise price of $2.69 except for 100,000 options issued to Mr. Fred Chan, President and CEO of the Company which were reissued at $2.96 in accordance with the 1997 Incentive Plan.. Platform Stock Option Plan In June 1997, in connection with the acquisition of Platform Technologies, Inc. ("Platform"), the Company assumed the Platform Stock Option Plan (the "Platform Plan"). The Company does not plan to issue any additional options under the Platform Plan and has reserved approximately 954,000 shares of Common Stock for issuance under the Platform Plan pursuant to the exercise of options that were outstanding at the time of the Platform acquisition. The Platform options vest ratably over four years. Stock Based Compensation: Transactions under the Company's various Stock Option Plans are summarized as follows (in thousands except per share amounts):
AVAILABLE FOR OPTIONS WEIGHTED AVERAGE GRANT OUTSTANDING EXERCISE PRICE --------- ----------- ---------------- Balance at December 31, 1995........................... 3,871 6,767 $ 2.11 Granted.............................................. (2,595) 2,595 15.79 Exercised............................................ -- (3,666) 0.85 Canceled............................................. 863 (863) 13.79 ------ ------ Balance at December 31, 1996........................... 2,139 4,833 8.30 Authorized........................................... 3,000 -- -- Reserved for Platform acquisition.................... 954 -- -- Granted.............................................. (4,129) 4,129 11.78 Exercised............................................ -- (886) 2.59 Canceled............................................. 1,426 (1,426) 17.70 ------ ------ Balance at December 31, 1997........................... 3,390 6,650 9.20 Authorized........................................... 2,000 -- -- Granted.............................................. (9,478) 9,478 4.87 Exercised............................................ -- (612) 1.01 Canceled............................................. 8,286 (8,286) 10.48 ------ ------ Balance at December 31, 1998........................... 4,198 7,230 $ 2.79 ====== ======
At December 31, 1998, 2,188,000 options were vested, of which 1,288,000 options were exercisable. The remaining vested options were subject to the blackout period as a result of the August 26, 1998 option reprice. The weighted average grant date fair value of options granted during the years ended December 31, 1996, 1997 and 1998 were $8.68, $8.91 and $3.16, respectively. 37 39 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------------------- ------------------------------------ NUMBER NUMBER OUTSTANDING AT AVERAGE REMAINING EXERCISABLE AT RANGE OF DECEMBER 31, 1998 CONTRACTUAL LIFE WEIGHTED AVERAGE DECEMBER 31, 1998 WEIGHTED AVERAGE EXERCISE PRICES (IN THOUSANDS) (YEARS) EXERCISE PRICE (IN THOUSANDS) EXERCISE PRICE - --------------------- ----------------- ----------------- ---------------- ----------------- ---------------- $0.03 - 1.40 1,184 6.24 $ 0.46 930 $ 0.44 $2.12 - 2.69 4,867 6.20 $ 2.65 318 $ 2.67 $2.81 - 4.75 590 7.68 $ 3.77 0 $ 0.00 $5.12 - 7.69 509 6.71 $ 6.43 5 $ 6.60 $8.00 - 29.25 80 5.91 $15.08 35 $13.91 ----- ----- 7,230 6.36 $ 2.79 1,288 $ 1.38 ===== =====
Fair Value Disclosures The Company's pro forma net income (loss) and pro forma net income (loss) per share would have been as follows had compensation costs for options granted since 1995 under the Company's option plans been determined based on the fair value at the grant dates, as prescribed in SFAS 123, (in thousands except per share amounts):
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1997 1998 ------- -------- -------- Net income (loss): As reported............................... $21,626 $(10,866) $(28,016) Pro forma................................. $18,902 $(17,278) (35,069) Net income (loss) per share -- basic: As reported............................... $ 0.57 $ (0.27) $ (0.68) Pro forma................................. $ 0.50 $ (0.44) $ (0.86) Net income (loss) per share -- diluted: As reported............................... $ 0.52 $ (0.27) $ (0.68) Pro forma................................. $ 0.45 $ (0.44) $ (0.86)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during the years ended December 31, 1996, 1997 and 1998: dividend yield of 0.0% for these periods; expected volatility of 64% for the year ended December 31, 1996, 70% for the year ended December 31, 1997 and 85% for year ended December 31, 1998; risk-free interest rates of 6.30%, 6.23% and 5.50% for the years ended December 31, 1996, 1997 and 1998, respectively; and a weighted average expected option term of 5 years for the years ended December 31, 1996 and 1997 and 4 years for the year ended December 31, 1998. Sales under the Purchase Plan in 1997 and 1998 were approximately 75,000 shares and 86,000 shares, respectively, at an average price per share of $10.89 and $4.60, respectively. Pro forma compensation expense for the grant date fair value, as defined by SFAS 123, of the purchase rights granted under the Purchase Plan was calculated using the Black-Scholes model with the following assumptions for 1996, 1997 and 1998: an expected life of six months for these periods; expected volatility of 69%, 70% and 85%, respectively; expected dividend yield of 0% for these periods and risk-free interest rates of 5.31%, 6.00% and 5.00%, respectively. The weighted average estimated grant date fair value, as defined by SFAS 123, of rights to purchase stock under the Purchase Plan in 1996, 1997 and 1998 were $5.34, $5.00 and $3.57 per share, respectively. Because additional option grants are expected to be made each year, the above pro forma disclosures are not representative of pro forma effects of reported net income (loss) for future years. 38 40 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. EARNINGS PER SHARE Earnings per share are calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 128 -- "Earnings per Share" (SFAS No. 128). SFAS No. 128 requires the Company to report both basic earnings per share, which is based on the weighted-average number of common shares outstanding, and diluted earnings per share, which is based on the weighted average number of common shares outstanding and all dilutive potential common shares outstanding.
PER SHARE INCOME SHARES AMOUNT -------- ------- --------- YEAR ENDED DECEMBER 31, 1996 Earnings per share of common stock.......................... $ 21,626 37,702 $ 0.57 Effect of dilutive securities: Stock options............................................. -- 3,886 -------- ------- Earnings per share of common stock -- assuming dilution..... $ 21,626 41,588 $ 0.52 -------- ------- YEAR ENDED DECEMBER 31, 1997 Loss per share of common stock.............................. $(10,866) 39,593 $(0.27) Effect of dilutive securities: Stock options............................................. -- -- -------- ------- Loss per share of common stock -- assuming dilution......... $(10,866) 39,593 $(0.27) -------- ------- YEAR ENDED DECEMBER 31, 1998 Loss per share of common stock.............................. $(28,016) 40,995 $(0.68) Effect of dilutive securities: Stock options............................................. -- -- -------- ------- Loss per share of common stock -- assuming dilution......... $(28,016) 40,955 $(0.68) -------- -------
39 41 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. INDUSTRY SEGMENT AND FOREIGN OPERATIONS The Company and its wholly-owned subsidiaries are engaged in the design, manufacture and marketing of semiconductor products for the Internet, PC and consumer marketplaces. Sales and purchase transactions are generally denominated in U.S. dollars. Most of the Company's revenues outside the U.S. are made in the Far East. The geographic location of the Company's revenue is based upon destination of the shipment. Most of the identified assets located outside the U.S. are in the Far East. The following is a summary of the Company's geographic operations:
HONG TOTAL U.S. TAIWAN JAPAN SINGAPORE KONG ROW FOREIGN TOTAL -------- ------- ------- --------- -------- ------- -------- -------- (IN THOUSANDS) Year ended December 31, 1996: Net revenues................ $ 18,790 $99,746 $33,861 $31,773 $ 30,252 $12,033 $207,665 $226,455 Income from operations...... 52,198 -- -- -- -- -- -- 52,198 Identifiable assets......... 210,964 -- -- -- -- -- 1,021 211,985 Year ended December 31, 1997: Net revenues................ $ 26,793 $20,388 $19,670 $19,804 $102,900 $ 9,962 $222,724 $249,517 Income (loss) from operations................ 10,025 -- -- -- -- -- (9,236) 789 Identifiable assets......... 194,053 -- -- -- -- -- 37,601 231,654 Year ended December 31, 1998: Net revenues................ $ 17,363 73,566 16,546 19,812 80,717 10,248 200,889 218,252 Loss from operations........ (13,250) -- -- -- -- -- (17,733) (30,983) Identifiable assets......... 167,203 -- -- -- -- -- 47,442 214,645
In October 1997, the Company established a wholly owned subsidiary in the Cayman Island, British West Indies. The Cayman Island subsidiary and its branch offices are responsible for the manufacturing and for the international sales of the Company's products. 8. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF RISK Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of cash equivalents, short-term investments and trade accounts receivable. Cash equivalents and short-term investments, which primarily comprised of investments in money market funds and municipal debt instruments, are maintained with high quality institutions and the composition and maturities are regularly monitored by management. The following table summarizes the percentage of net revenues accounted for by the Company's significant customers for any year in which a customer or distributor accounts for 10% or more of revenues.
YEAR ENDED DECEMBER 31, ------------------------ 1996 1997 1998 ---- ---- ---- Compaq Computer............................. 12% -- -- Dynax....................................... -- 13% 16% Eastbase.................................... -- 13% -- Universe Electron........................... 13% -- -- Shinco...................................... -- -- 15%
A majority of the Company's trade receivables are derived from sales to manufacturers of computer systems. The Company generally extends 30-day credit terms to its customers, which is consistent with industry business practices. The Company performs ongoing credit evaluations of its customers' financial condition and generally, requires letters of credit from international customers. The Company maintains an 40 42 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) allowance for doubtful accounts on its receivables based upon the expected collectibility of all accounts receivable. At December 31, 1997 and 1998, approximately 35% and 36%, respectively, of trade accounts receivable represent amounts due from two customers. 9. COMMITMENTS AND CONTINGENCIES In November 1995, the Company entered into agreements with two wafer foundries, TSMC and 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 two years as deposits for wafers through 1999. The cash requirements associated with this agreement were paid by the Company in the form of two $16 million payments in 1996 and 1997. The payments can be applied to offset wafers purchased from 1996 to 1999 provided that the Company purchases not less than a certain specified number of wafers during each of the four years ending December 31, 1999. As of December 31, 1998, $21.8 million of the payment was applied and $10.1 million was included in other assets. 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 has invested approximately $24.6 million in the joint venture. Under the terms of the agreement, the Company received a 5% equity ownership in the joint venture company and certain capacity rights. The facility was scheduled to open during 1998, but several fires during construction have delayed opening. UMC has stated that it expects insurance will cover its recent fire losses at the joint venture foundry. On October 17, 1998, the Company entered into an agreement with UMC to sell UMC approximately 63.8 million shares of the joint venture for a purchase price of $22.4 million which approximated net book value. Following the sale, the Company continues to hold 6 million shares of stock. The Company is involved in litigation in the normal course of operations. Management believes that the outcome of the litigation will not have a material adverse effect on the Company's financial position or results of operations. 10. ACQUISITIONS AND RELATED CHARGES On June 11, 1997, the Company acquired Platform Technologies, Inc. ("Platform"), a California based company, for approximately 2.54 million shares of the Company's Common Stock including approximately 954,000 options with a value of $32.7 million. Platform, a wholly owned subsidiary of the Company, is developing integrated circuits for the PC audio market incorporating the PCI standard. On January 3, 1996, the Company acquired VideoCore Technology, Inc. ("VideoCore"), a California based company, for approximately 525,000 shares of the Company's Common Stock and $5.7 million in cash. VideoCore, a wholly owned subsidiary of the Company, is developing integrated circuits which incorporates advanced compression technology for digital video products. On March 29, 1996, the Company acquired OSEE Technology, Inc. ("OSEE"), a California based company, for approximately 217,000 shares of the Company's Common Stock and $3.6 million in cash. Also outstanding stock options of OSEE were exchanged for 85,000 stock options of the Company. OSEE, a wholly owned subsidiary of the Company, is a developer of advanced fax/modem algorithm technology which enables the Company to provide modem and computer fax/modem applications on the Company's multimedia processor. 41 43 ESS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The purchase price of these companies was allocated to assets acquired and liabilities assumed based upon the book value of VideoCore's, OSEE's and Platform's current assets, equipment and liabilities, which management believes approximates their fair value, and independent appraisal for all other identifiable assets as follows:
VIDEOCORE & OSEE PLATFORM --------- -------------- (IN THOUSANDS) Research and development in-process................. $30,355 $22,200 Technical infrastructure............................ -- 7,245 Covenants not to compete............................ 4,600 6,100 Current assets...................................... 12 3,209 Property and equipment.............................. 120 222 Current liabilities assumed......................... (607) (369) Other liabilities assumed........................... (1,541) (5,204) ------- ------- 32,939 33,403 Acquisition costs................................... (299) (700) ------- ------- Value of consideration for acquisition.............. $32,640 $32,703 ======= =======
These acquisitions were 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. Acquired research and development in-process aggregating $22.2 million for the Platform acquisition and $30.4 million for the VideoCore and OSEE acquisitions were charged in the second quarter of 1997 and in the first quarter of 1996, respectively. Additionally, the pro forma effect of the 1996 and 1997 acquisitions was not significant on the Company's reported operating results for the fiscal years 1996 or 1997. 11. RELATED PARTY TRANSACTION Fred S.L. Chan, the Company's Chief Executive Officer, President and Chairman of the Board of Directors and his spouse Annie M.H. Chan, a director of the Company, announced on April 28, 1998, that they would be purchasing between $5 and $10 million of the Company's common stock on the open market. As of December 31, 1998, such purchases had totaled $1.4 million representing 241,000 shares at prices ranging from $5.15 to $6.56. 42 44 SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED) The following table presents unaudited quarterly financial information for each of the Company's last eight quarters. This information has been derived from the Company's unaudited financial statements and has been prepared on the same basis as the audited Consolidated Financial Statements appearing elsewhere in this Form 10-K. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the quarterly results.
1997 1998 ---------------------------------------- ---------------------------------------- MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31 -------- ------- -------- -------- ------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues............................. $ 81,468 $45,142 $52,172 $ 70,735 $52,876 34,835 52,309 78,232 Cost of revenues......................... 41,772 27,220 35,200 67,668 49,146 33,262 43,683 56,326 -------- ------- ------- -------- ------- -------- ------- -------- Gross profit........................... 39,696 17,922 16,972 3,067 3,730 1,573 8,626 21,906 Operating expenses: Research and development............... 5,571 7,057 8,343 8,501 8,092 6,933 8,134 7,370 Research and development in-process.... -- 22,200 -- -- -- -- -- -- Selling, general and administrative.... 5,611 5,560 6,303 7,722 9,029 8,632 8,815 9,813 -------- ------- ------- -------- ------- -------- ------- -------- Operating income (loss).................. 28,514 (16,895) 2,326 (13,156) (13,391) (13,992) (8,323) 4,723 Nonoperating income, net................. 640 806 417 320 369 347 466 296 -------- ------- ------- -------- ------- -------- ------- -------- Income (loss) before income taxes........ 29,154 (16,089) 2,743 (12,836) (13,022) (13,645) (7,857) 5,019 Provision for (benefit from) income taxes.................................. 11,327 2,284 1,025 (798) (669) (683) (388) 251 -------- ------- ------- -------- ------- -------- ------- -------- Net income (loss)........................ $ 17,827 $(18,373) $ 1,718 $(12,038) $(12,353) $(12,962) $(7,469) $ 4,768 ======== ======= ======= ======== ======= ======== ======= ======== Net income (loss) per share -- basic..... $ 0.46 $(0.47) $ 0.04 $ (0.30) $ (0.30) $ (0.32) $ (0.18) $ 0.12 ======== ======= ======= ======== ======= ======== ======= ======== Net income (loss) per share -- diluted... $ 0.43 $(0.47) $ 0.04 $ (0.30) $ (0.30) $ (0.32) $ (0.18) $ 0.11 ======== ======= ======= ======== ======= ======== ======= ======== Shares used in calculating net income (loss) per share -- basic.............. 38,440 38,990 40,376 40,537 40,776 40,967 41,094 40,991 ======== ======= ======= ======== ======= ======== ======= ======== Shares used in calculating net income (loss) per share -- diluted............ 41,469 38,990 43,390 40,537 40,776 40,967 41,094 44,566 ======== ======= ======= ======== ======= ======== ======= ========
The following table sets forth the above quarterly financial information as a percentage of net revenues:
1997 1998 -------------------------------------- -------------------------------------- MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31 ------- ------- -------- ------- ------- ------- -------- ------- Net revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues............................ 51.3 60.3 67.5 95.7 92.9 95.5 83.5 72.0 ----- ----- ----- ----- ----- ----- ----- ----- Gross margin.............................. 48.7 39.7 32.5 4.3 7.1 4.5 16.5 28.0 Operating expenses: Research and development.................. 6.8 15.6 16.0 12.0 15.3 19.9 15.5 9.4 Research and development in-process....... -- 49.2 -- -- -- -- -- -- Selling, general and administrative....... 6.9 12.3 12.1 10.9 17.1 24.8 16.9 12.6 ----- ----- ----- ----- ----- ----- ----- ----- Operating income (loss)..................... 35.0 (37.4) 4.4 (18.6) (25.3) (40.2) (15.9) 6.0 Nonoperating income, net.................... 0.8 1.8 0.8 0.5 0.7 1.0 0.9 0.4 ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) before income taxes........... 35.8 (35.6) 5.2 (18.1) (24.6) (39.2) (15.0) 6.4 Provision for (benefit from) income taxes... 13.9 5.1 2.0 (1.1) (1.2) (2.0) (0.7) 0.3 ----- ----- ----- ----- ----- ----- ----- ----- Net income (loss)........................... 21.9% (40.7)% 3.2% (17.0)% (23.4)% (37.2)% (14.3)% 6.1% ===== ===== ===== ===== ===== ===== ===== =====
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable. 43 45 PART III Certain information required by Part III is omitted from this Report since the Company plans to file with the Securities and Exchange Commission the definitive proxy statement for its 1999 Annual Meeting of Shareholders (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information concerning the Company's directors required by this Item is incorporated by reference in the Company's Proxy Statement which the Company will file with the Commission not later than 120 days after its fiscal year-end. The following table sets forth certain information regarding the Company's current executive officers:
NAME AGE POSITION ---- --- -------- Fred S.L. Chan......................... 51 President, Chief Executive Officer and Chairman of the Board of Directors Dale R. Lindly......................... 39 Vice President of Finance, Chief Financial Officer and Secretary Robert L. Blair........................ 51 Executive Vice President, Operations Frank Effler........................... 52 Vice President, Sales and Marketing -- PC Products Johnston Chen.......................... 38 Vice President, Sales -- Consumer Products Howard Hideshima....................... 39 Controller and Chief Accounting Officer
Mr. Chan joined the Company in November 1985 as President and served as such until October 1996 and then began to serve as President again since February 1997. Mr. Chan has been a director since January 1986. He was appointed Chairman of the Board of Directors in October 1992 and Chief Executive Officer in June 1994. Mr. Chan has been serving as President since February 1997. Mr. Chan served as Secretary of the Company from October 1992 to August 1995 and its Chief Financial Officer from October 1992 to May 1995. From 1984 to 1985, Mr. Chan was founder, President and Chief Executive Officer of AC Design Inc., a VLSI chip design center providing CAD, engineering and design services. From 1982 to 1984, he was co-founder, President and Chief Executive Officer of CADCAM Technology, Inc., a company in the business of CAE systems development. Mr. Chan holds B.S.E.E. and M.S.C. degrees from the University of Hawaii. Mr. Chan is the husband of Annie M. H. Chan, a director of the Company. Mr. Lindly has been Vice President of Finance, Chief Financial Officer and Secretary of the Company since September 1998. From February 1997 to August 1998, he was Vice President and Corporate Controller at S3, Inc. From September 1995 to January 1997, he was Vice President Finance and Chief Financial Officer at Echelle, Inc. From September 1990 to August 1995, he was Director of Finance at Adaptec, Inc. and from May 1986 to August 1990, he was Vice President Finance and Chief Financial Officer of International Microcircuits, Inc. Mr. Lindly holds a B.S. degree in Business from San Jose State University. Mr. Blair has been Executive Vice President, Operations of the Company since April 1997. From December 1994 to March 1997, he was Vice President of Operations of the Company. From December 1991 to November 1994, he was Senior Vice President Operations (Software Packaging & Printing Division) of Logistix Corporation, a software turnkey company, and from 1989 to November 1991, he was Vice President and co-owner of Rock Canyon Investments, a real estate development planning firm in California. From 1986 to 1989, he held various positions at Xidex Corporation, a computer diskette manufacturer, including President/General Manager, at XEMAG, a division of Xidex Corporation. From 1973 to 1986 he was Vice President, High Reliability Operations at Precision Monolithics, Inc. Mr. Effler has been Vice President, Sales and Marketing -- PC Products of the Company since April 1998. From October 1993 to March 1998, he was Director of Sales and Marketing, Flat Panel Display Division at Hitachi America, Ltd. From April 1992 to September 1993, he was Area Sales Manager of the western United States at Hitachi America Ltd. From 1988 to 1992, he was a regional sales manager for 44 46 Toshiba America Electronic Components. Mr. Effler holds a B.A. degree from California State University at Northridge. Mr. Chen has been Vice President of Consumer Products of the Company since January 1998. From January 1997 to December 1997, he was Vice President of APAC Sales of the Company. From February 1995 to December 1996, he was Director of APAC Sales of the Company. Prior to joining the Company, he was co-owner of Internet Corporation, a semiconductor sales representation company for the Far East market, and served as Director of Sales and Marketing from February 1992 to February 1995. From 1988 to 1992, he was Product Marketing Manager at FIFO Division of Integrated Device Technology. From 1983 to 1988, Mr. Chen held various engineering, marketing, and management positions at PMI Division of Analog Devices, Inc., Siliconix, and Soletron. Mr. Chen holds a B.S.E.E. degree from San Jose State University and an MBA degree from Santa Clara University. Mr. Hideshima has been Chief Accounting Officer of the Company since July 1997 and Controller of the Company since December 1994. Prior to joining the Company, he was Controller of Hoya MicroMask, Inc., a semiconductor mask company from August 1991 to November 1994 and Accounting Manager at Hoya Corporation USA from July 1990 to July 1991. From June 1985 through June 1990, Mr. Hideshima was an auditor with Arthur Andersen & Company. Mr. Hideshima holds a MBA degree from San Francisco State University and BS degree in Business from University of California -- Berkeley. The information concerning compliance with Section 16 of the Securities Exchange Act of 1934 is incorporated by reference to the section in the Company's proxy statement entitled "Compliance under Section 16(a) of the Securities Exchange Act of 1934." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the sections in the Company's Proxy Statement entitled "Executive Compensation," which the Company will file with the Commission not later than 120 days after its fiscal year-end. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference in the Company's Proxy Statement which the Company will file with the Commission not later than 120 days after its fiscal year-end. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference in the Company's Proxy Statement which the Company will file with the Commission not later than 120 days after its fiscal year-end. 45 47 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1)(2)FINANCIAL STATEMENTS AND SCHEDULES. The financial statements and schedules filed as part of this report are listed in Item 8 on page 24. (3) EXHIBITS
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 2.01 Agreement and Plan of Reorganization dated December 12, 1995 among Registrant, ESS Acquisition Corporation and VideoCore Technology, Inc. ("VideoCore") (Incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated January 17, 1996 (the "Form 8-K")). 2.02 Agreement of Merger dated as of January 3, 1996 among Registrant, ESS Acquisition Corporation and VideoCore. (Incorporated herein by reference to Exhibit 2.2 to the Form 8-K). 2.03 First Amended and Restated Agreement and Plan of Reorganization dated as of April 27, 1997 among Registrant, EP Acquisition Corporation and Platform Technologies, Inc. (Incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated April 30, 1997). 3.01 Registrant's Articles of Incorporation (Incorporated herein by reference to Exhibit 3.01 to the Registrant's Form S-1 registration statement (File No. 33-95388) declared effective by the Securities and Exchange Commission on October 5, 1995 (the "Form S-1")). 3.02 Registrant's Bylaws as amended (Filed herewith). 4.01 Registrant's Registration Rights Agreement dated May 28, 1993 among the Registrant and certain security holders (Incorporated herein by reference to Exhibit 10.07 to the Form S-1). 10.01 Registrant's 1986 Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.01 to the Form S-1).* 10.02 Registrant's 1992 Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.02 to the Form S-1).* 10.03 Registrant's 1995 Equity Incentive Plan and related documents as amended (Filed herewith).* 10.04 Registrant's 1995 Directors Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.04 to the Form S-1).* 10.05 Registrant's 1995 Employee Stock Purchase Plan and related documents as amended (Filed herewith).* 10.06 Registrant's Amended 401(k) Plan (Incorporated herein by reference to Exhibit 10.06 to the Form S-1).* 10.11 Form of Indemnity Agreement entered into by Registrant with each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.11 to the Form S-1). 10.18 Foundry Agreement dated March 29, 1993 between Registrant and Integrated Circuit Works Incorporated (Incorporated herein by reference to Exhibit 10.18 to the Form S-1).** 10.19 Purchase Agreement dated June 17, 1994 between Compaq Computer Corporation and Registrant (Incorporated herein by reference to Exhibit 10.19 to the Form S-1).** 10.20 International Distributorship Agreement dated July 1, 1994 between Registrant and Universe Electron Corporation (Incorporated herein by reference to Exhibit 10.20 to the Form S-1). 10.21 Option I Agreement between Registrant and Taiwan Semiconductor Manufacturing Co., Ltd. ("TSMC") dated November 30, 1995, as amended December 28, 1995. (Incorporated herein by reference to Exhibit 10.21 to the Registrant's Annual Report on Form 10-K, dated February 29, 1996 as amended March 29, 1996 (the "1995 Form 10-K").** 10.22 Option II Agreement between Registrant and TSMC dated November 30, 1995. (Incorporated herein by reference to Exhibit 10.22 to the 1995 Form 10-K).**
46 48
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 10.23 Foundry Venture Agreement between Registrant and United Microelectronics Corporation ("UMC") dated November 28, 1995, as amended January 31, 1996. (Incorporated herein by reference to Exhibit 10.23 to the 1995 Form 10-K).** 10.24 FabVen Foundry Capacity Agreement among FabVen, UMC and Registrant dated November 28, 1995. (Incorporated herein by reference to Exhibit 10.24 to the 1995 Form 10-K).** 10.25 Form of Employment and Non-Competition Agreement among the Registrant, VideoCore and Jan Fandrianto dated December 12, 1995. (Incorporated herein by reference to Exhibit 2.1 to the Form 8-K).* 10.26 Form of Employment and Non-Competition Agreement among the Registrant, VideoCore and Chi-Shin Wang dated December 12, 1995. (Incorporated herein by reference to Exhibit 21 to the Form 8-K).* 10.27 Form of Employment Agreement and Promissory Note among the Registrant and John H. Barnet dated August 22 and September 16, 1996, respectively. (Incorporated herein by reference to Exhibit 10.27 to the Registrant's Report on Form 10-Q, dated November 14, 1996.)* 10.30 1997 Equity Incentive Plan and related agreements, as amended (Filed herewith).* 11.01 Computation of Net Income Per Share. 21.01 List of Registrant's subsidiaries. 23.01 Consent of Independent Accountants. 27.01 Financial Data Schedule.
- --------------- * Represents a management contract or compensatory plan of arrangement. ** Confidential treatment has been granted with respect to certain portions of this agreement. (b) Reports on Form 8-K: The Company did not file a report on Form 8-K during the quarter ended December 31, 1998. With the exception of the information incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders in Items 10, 11, 12 and 13 of Part III, the Proxy Statement is not deemed to be filed as part of this Report. 47 49 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. ESS TECHNOLOGY, INC. (Registrant) Date: March 31, 1999 By: /s/ FRED S.L. CHAN ------------------------------------ Fred S.L. Chan President, Chief Executive Officer and Chairman of the Board Date: March 31, 1999 By: /s/ DALE R. LINDLY ------------------------------------ Dale R. Lindly Vice President of Finance, Chief Financial Officer and Secretary Date: March 31, 1999 By: /s/ HOWARD N. HIDESHIMA ------------------------------------ Howard N. Hideshima Controller and Chief Accounting Officer 48 50 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Fred S.L. Chan and Dale R. Lindly, jointly and severally, his or her true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done or by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ------------------------------------------------ ------------------------------------ -------------- /s/ FRED S.L. CHAN President, Chief Executive Officer March 31, 1999 - ------------------------------------------------ and Chairman of the Board of Fred S.L. Chan Directors (Principal Executive Officer) /s/ DALE R. LINDLY Vice President of Finance and March 31, 1999 - ------------------------------------------------ Chief Financial Officer and Dale R. Lindly Secretary (Principal Financial Officer) /s/ HOWARD N. HIDESHIMA Controller and Chief Accounting March 31, 1999 - ------------------------------------------------ Officer Howard N. Hideshima (Principal Accounting Officer) /s/ ANNIE M.H. CHAN Director March 31, 1999 - ------------------------------------------------ Annie M.H. Chan /s/ DOMINIC NG Director March 31, 1999 - ------------------------------------------------ Dominic Ng /s/ ILBOK LEE Director March 31, 1999 - ------------------------------------------------ Ilbok Lee /s/ PETER T. MOK Director March 31, 1999 - ------------------------------------------------ Peter T. Mok /s/ MATTHEW FONG Director March 31, 1999 - ------------------------------------------------ Matthew Fong
49 51 INDEX TO EXHIBITS
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 2.01 Agreement and Plan of Reorganization dated December 12, 1995 among Registrant, ESS Acquisition Corporation and VideoCore Technology, Inc. ("VideoCore") (Incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated January 17, 1996 (the "Form 8-K")). 2.02 Agreement of Merger dated as of January 3, 1996 among Registrant, ESS Acquisition Corporation and VideoCore. (Incorporated herein by reference to Exhibit 2.2 to the Form 8-K). 2.03 First Amended and Restated Agreement and Plan of Reorganization dated as of April 27, 1997 among Registrant, EP Acquisition Corporation and Platform Technologies, Inc. (Incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated April 30, 1997). 3.01 Registrant's Articles of Incorporation (Incorporated herein by reference to Exhibit 3.01 to the Registrant's Form S-1 registration statement (File No. 33-95388) declared effective by the Securities and Exchange Commission on October 5, 1995 (the "Form S-1")). 3.02 Registrant's Bylaws as amended (Filed herewith). 4.01 Registrant's Registration Rights Agreement dated May 28, 1993 among the Registrant and certain security holders (Incorporated herein by reference to Exhibit 10.07 to the Form S-1). 10.01 Registrant's 1986 Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.01 to the Form S-1).* 10.02 Registrant's 1992 Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.02 to the Form S-1).* 10.03 Registrant's 1995 Equity Incentive Plan and related documents as amended (Filed herewith).* 10.04 Registrant's 1995 Directors Stock Option Plan and related documents (Incorporated herein by reference to Exhibit 10.04 to the Form S-1).* 10.05 Registrant's 1995 Employee Stock Purchase Plan and related documents as amended (Filed herewith).* 10.06 Registrant's Amended 401(k) Plan (Incorporated herein by reference to Exhibit 10.06 to the Form S-1).* 10.11 Form of Indemnity Agreement entered into by Registrant with each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.11 to the Form S-1). 10.18 Foundry Agreement dated March 29, 1993 between Registrant and Integrated Circuit Works Incorporated (Incorporated herein by reference to Exhibit 10.18 to the Form S-1).** 10.19 Purchase Agreement dated June 17, 1994 between Compaq Computer Corporation and Registrant (Incorporated herein by reference to Exhibit 10.19 to the Form S-1).** 10.20 International Distributorship Agreement dated July 1, 1994 between Registrant and Universe Electron Corporation (Incorporated herein by reference to Exhibit 10.20 to the Form S-1). 10.21 Option I Agreement between Registrant and Taiwan Semiconductor Manufacturing Co., Ltd. ("TSMC") dated November 30, 1995, as amended December 28, 1995. (Incorporated herein by reference to Exhibit 10.21 to the Registrant's Annual Report on Form 10-K, dated February 29, 1996 as amended March 29, 1996 (the "1995 Form 10-K").** 10.22 Option II Agreement between Registrant and TSMC dated November 30, 1995. (Incorporated herein by reference to Exhibit 10.22 to the 1995 Form 10-K).** 10.23 Foundry Venture Agreement between Registrant and United Microelectronics Corporation ("UMC") dated November 28, 1995, as amended January 31, 1996. (Incorporated herein by reference to Exhibit 10.23 to the 1995 Form 10-K).** 10.24 FabVen Foundry Capacity Agreement among FabVen, UMC and Registrant dated November 28, 1995. (Incorporated herein by reference to Exhibit 10.24 to the 1995 Form 10-K).**
52
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 10.25 Form of Employment and Non-Competition Agreement among the Registrant, VideoCore and Jan Fandrianto dated December 12, 1995. (Incorporated herein by reference to Exhibit 2.1 to the Form 8-K).* 10.26 Form of Employment and Non-Competition Agreement among the Registrant, VideoCore and Chi-Shin Wang dated December 12, 1995. (Incorporated herein by reference to Exhibit 21 to the Form 8-K).* 10.27 Form of Employment Agreement and Promissory Note among the Registrant and John H. Barnet dated August 22 and September 16, 1996, respectively. (Incorporated herein by reference to Exhibit 10.27 to the Registrant's Report on Form 10-Q, dated November 14, 1996.)* 10.30 1997 Equity Incentive Plan and related agreements, as amended (Filed herewith).* 11.01 Computation of Net Income Per Share. 21.01 List of Registrant's subsidiaries. 23.01 Consent of Independent Accountants. 27.01 Financial Data Schedule.
- --------------- * Represents a management contract or compensatory plan of arrangement. ** Confidential treatment has been granted with respect to certain portions of this agreement. (b) Reports on Form 8-K: The Company did not file a report on Form 8-K during the quarter ended December 31, 1998. With the exception of the information incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders in Items 10, 11, 12 and 13 of Part III, the Proxy Statement is not deemed to be filed as part of this Report. EX-3.02 2 REGISTRANT'S BYLAWS 1 EXHIBIT 3.02 AMENDED AND RESTATED BYLAWS OF ESS TECHNOLOGY, INC. (A California corporation) (As Amended Through January 5, 1999) 2 BYLAWS OF ESS TECHNOLOGY, INC. A California corporation TABLE OF CONTENTS
PAGE ---- ARTICLE I - OFFICES............................................................4 Section 1.1: Principal Office.........................................4 Section 1.2: Other Offices............................................4 ARTICLE II - DIRECTORS.........................................................4 Section 2.1: Exercise of Corporate Powers.............................4 Section 2.2: Number...................................................4 Section 2.3: Need Not Be Shareholders.................................5 Section 2.4: Compensation.............................................5 Section 2.5: Election and Term of Office..............................5 Section 2.6: Vacancies................................................5 Section 2.7: Removal..................................................6 Section 2.8: Powers and Duties........................................6 ARTICLE III - MEETINGS OF DIRECTORS............................................8 Section 3.1: Place of Meetings........................................8 Section 3.2: Regular Meetings.........................................8 Section 3.3: Special Meetings.........................................8 Section 3.4: Notice of Special Meetings...............................8 Section 3.5: Quorum...................................................9 Section 3.6: Conference Telephone.....................................9 Section 3.7: Waiver of Notice and Consent.............................9 Section 3.8: Action Without a Meeting.................................9 Section 3.9: Committees...............................................9 ARTICLE IV - COMMITTEES.......................................................10 Section 4.1: Appointment and Procedure...............................10 Section 4.2: Executive Committee Powers..............................10 Section 4.3: Powers of Other Committees..............................10 Section 4.4: Limitations on Powers of Committees.....................10 ARTICLE V - OFFICERS..........................................................11 Section 5.1: Election and Qualifications.............................11 Section 5.2: Term of Office and Compensation.........................11 Section 5.3: Chief Executive Officer.................................11 Section 5.4: Chairman of the Board...................................12
-2- 3
PAGE ---- Section 5.5: President...............................................12 Section 5.6: President Pro Tem.......................................12 Section 5.7: Vice President..........................................12 Section 5.8: Secretary...............................................12 Section 5.9: Chief Financial Officer.................................13 Section 5.10: Instruments in Writing.................................14 ARTICLE VI - INDEMNIFICATION..................................................14 Section 6.1: Indemnification of Directors and Officers...............14 Section 6.2: Advancement of Expenses.................................14 Section 6.3: Non-Exclusivity of Rights...............................15 Section 6.4: Indemnification Contracts...............................15 Section 6.5: Effect of Amendment.....................................15 ARTICLE VII - MEETINGS OF, AND REPORTS TO, SHAREHOLDERS.......................15 Section 7.1: Place of Meetings.......................................15 Section 7.2: Annual Meetings.........................................15 Section 7.3: Special Meetings........................................16 Section 7.4: Notice of Meetings......................................16 Section 7.5: Consent to Shareholders' Meetings.......................17 Section 7.6: Quorum..................................................17 Section 7.7: Adjourned Meetings......................................18 Section 7.8: Voting Rights...........................................18 Section 7.9: Action by Written Consents..............................18 Section 7.10: Election of Directors..................................19 Section 7.11: Proxies................................................19 Section 7.12: Inspectors of Election.................................20 Section 7.13: Annual Reports.........................................20 ARTICLE VIII - SHARES AND SHARE CERTIFICATES..................................20 Section 8.l: Shares Held By the Company..............................20 Section 8.2: Certificates for Shares.................................20 Section 8.3: Lost Certificates.......................................21 ARTICLE IX - CONSTRUCTION OF BYLAWS WITH REFERENCE TO PROVISIONS OF LAW.....................................................21 Section 9.1: Bylaw Provisions Construed as Additional and Supplemental to Provisions of Law.......................21 Section 9.2: Bylaw Provisions Contrary to or Inconsistent with Provisions of Law.......21 ARTICLE X - CERTIFICATION, ADOPTION, AMENDMENT OR REPEAL OF BYLAWS......................................................21 Section 10.1: By Shareholders........................................21 Section 10.2: By the Board of Directors..............................22 Section 10.3: Certification and Inspection of Bylaws.................22
-3- 4 BYLAWS OF ESS TECHNOLOGY, INC. (A California corporation) (As Amended Through January 5, 1999) ARTICLE I OFFICES Section 1.1: Principal Office. The principal executive office for the transaction of the business of this corporation (the "Company") shall be located at such place as the Board of Directors may from time to time decide. The Board of Directors is hereby granted full power and authority to change the location of the principal executive office from one location to another. Section 1.2: Other Offices. One or more branch or other subordinate offices may at any time be fixed and located by the Board of Directors at such place or places within or outside the State of California as it deems appropriate. ARTICLE II DIRECTORS Section 2.1: Exercise of Corporate Powers. Except as otherwise provided by these Bylaws, by the Articles of Incorporation of the Company or by the laws of the State of California now or hereafter in force, the business and affairs of the Company shall be managed and all corporate powers shall be exercised by or under the ultimate direction of a board of directors (the "Board of Directors"). Section 2.2: Number: The authorized number of directors of the Company shall be six (6). The authorized number of directors may be varied from time to time by resolution of the Board of Directors, provided that the minimum authorized number shall be not less than five (5) and the maximum authorized number shall not be more than nine (9). Until changed by an amendment of this Section by the shareholders of the Company, the authorized number of directors of the Company may be varied by the Board of Directors, as opposed to being fixed, within the range of the minimum and the maximum authorized numbers of directors provided above. Any amendment to these Bylaws reducing such minimum number of authorized directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting, or the shares not consenting in the case of action by written consent, are equal to more than 16-2/3% of the outstanding shares entitled to vote. 5 Section 2.3: Need Not Be Shareholders. The directors of the Company need not be shareholders of this Company. Section 2.4: Compensation. Directors and members of committees may receive such compensation, if any, for their services as may be fixed or determined by resolution of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving the Company in any other capacity and receiving compensation therefor. Section 2.5: Election and Term of Office. The directors shall be elected annually by the shareholders at the annual meeting of the shareholders. The term of office of the directors shall begin immediately after their election and shall continue until the next annual meeting of the shareholders and until their respective successors are elected. A reduction of the authorized number of directors shall not shorten the term of any incumbent director or remove any incumbent director prior to the expiration of such director's term of office. Section 2.6: Vacancies. A vacancy or vacancies on the Board of Directors shall exist: (a) in the case of the death of any director; or (b) in the case of the resignation or removal of any director; or (c) if the authorized number of directors is increased; or (d) if the shareholders fail, at any annual meeting of shareholders at which any director is elected, to elect the full authorized number of directors at that meeting. The Board of Directors may declare vacant the office of a director if he or she is declared of unsound mind by an order of court or convicted of a felony or if, within 60 days after notice of his or her election, he or she does not accept the office. Any vacancy, except for a vacancy created by removal of a director as provided in Section 2.7 hereof, may be filled by a person selected by a majority of the remaining directors then in office, whether or not less than a quorum, or by a sole remaining director. Vacancies occurring in the Board of Directors by reason of removal of directors shall be filled only by approval of shareholders. The shareholders may elect a director at any time to fill any vacancy not filled by the directors. Any such election by the written consent of shareholders, other than to fill a vacancy created by removal, requires the consent of shareholders holding a majority of the outstanding shares entitled to vote. If, after the filling of any vacancy by the directors, the directors then in office who have been elected by the shareholders shall constitute less than a majority of the directors then in office, any holder or holders of an aggregate of 5% or more of the total number of shares at that time having the right to vote for such directors may call a special meeting of shareholders to be held to elect the entire Board of Directors. The term of office of any director then in office shall terminate upon the election of such director's successor. Any director may resign effective upon giving written notice to the Chairman of the Board, if any, the President, the Secretary or the Board of Directors, unless the notice specifies a later time for the effectiveness of such resignation. After the notice is given and if the resignation is effective at a future time, a successor may be elected or appointed to take office when the resignation becomes effective. -5- 6 Section 2.7: Removal. The entire Board of Directors or any individual director may be removed from office without cause by an affirmative vote of shareholders holding a majority of the outstanding shares entitled to vote. If the entire Board of Directors is not removed, however, then no individual director shall be removed if the votes cast against removal of that director, plus the votes not consenting in writing to such removal, would be sufficient to elect that director if voted cumulatively in an election at which the following were true: (a) the same total number of votes were cast, or, if such action is taken by written consent, all shares entitled to vote were voted; and (b) the entire number of directors authorized at the time of the director's most recent election were then being elected. if any or all directors are so removed, new directors may be elected at the same meeting or at a subsequent meeting. if at any time a class or series of shares is entitled to elect one or more directors under authority granted by the Articles of Incorporation, the provisions of this Section 2.7 shall apply to the vote of that class or series and not to the vote of the outstanding shares as a whole. Section 2.8: Powers and Duties. Without limiting the generality or extent of the general corporate powers to be exercised by the Board of Directors pursuant to Section 2.1 of these Bylaws, it is hereby provided that the Board of Directors shall have full power with respect to the following matters: (a) To purchase, lease and acquire any and all kinds of property, real, personal or mixed, and at its discretion to pay therefor in money, in property and/or in stocks, bonds, debentures or other securities of the Company. (b) To enter into any and all contracts and agreements which in its judgment may be beneficial to the interests and purposes of the Company. (c) To fix and determine and to vary from time to time the amount or amounts to be set aside or retained as reserve funds or as working capital of the Company or for maintenance, repairs, replacements or enlargements of its properties. (d) To declare and pay dividends in cash, shares and/or property out of any funds of the Company at the time legally available for the declaration and payment of dividends on its shares. (e) To adopt such rules and .regulations for the conduct of its meetings and the management of the affairs of the Company as it may deem proper. (f) To prescribe the manner in which and the person or persons by whom any or all of the checks, drafts, notes, bills of exchange, contracts and other corporate instruments shall be executed. -6- 7 (g) To accept resignations of directors; to declare vacant the office of a director as provided in Section 2.6 hereof; and, in case of vacancy in the office of directors, to fill the same to the extent provided in Section 2.6 hereof. (h) To create offices in addition to those for which provision is made by law or these Bylaws; to elect and remove at pleasure all officers of the Company, fix their terms of office, prescribe their titles, powers and duties, limit their authority and fix their salaries in any way it may deem advisable that is not contrary to law or these Bylaws. (i) To designate one or more persons to perform the duties and exercise the powers of any officer of the Company during the temporary absence or disability of such officer. (j) To appoint or employ and to remove at pleasure such agents and employees as it may see fit, to prescribe their titles, powers and duties, limit their authority and fix their salaries in any way it may deem advisable that is not contrary to law or these Bylaws. (k) To fix a time in the future, which shall not be more than 60 days nor less than 10 days prior to the date of the meeting nor more than 60 days prior to any other action for which it is fixed, as a record date for the determination of the shareholders entitled to notice of and to vote at any meeting, or entitled to receive any payment of any dividend or other distribution, or allotment of any rights, or entitled to exercise any rights in respect of any other lawful action; and in such case only shareholders of record on the date so fixed shall be entitled to notice of and to vote at the meeting or to receive the dividend, distribution or allotment of rights or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the Company after any record date fixed as aforesaid. The Board of Directors may close the books of the Company against transfers of shares during the whole or any part of such period. (l) To fix and locate from time to time the principal office for the transaction of the business of the Company and one or more branch or other subordinate offices of the Company within or without the State of California; to designate any place within or without the State of California for the holding of any meeting or meetings of the shareholders or the Board of Directors, as provided in Sections 3.1 and 7.1 hereof; to adopt, make and use a corporate seal, and to prescribe the forms of certificates for shares and to alter the form of such seal and of such certificates from time to time as in its judgment it may deem best, provided such seal and such certificates shall at all times comply with the provisions of law now or hereafter in effect. (m) To authorize the issuance of shares of stock of the Company in accordance with the laws of the State of California and the Articles of Incorporation. (n) Subject to the limitation provided in Section 10.2 hereof, to adopt, amend or repeal from time to time and at any time these Bylaws and any and all amendments thereof. (o) To borrow money, make guarantees of indebtedness or other obligations of third parties and incur indebtedness on behalf of the Company, including the power and authority to borrow money from any of the shareholders, directors or officers of the Company; and to cause to be executed and delivered therefor in the corporate name promissory notes, bonds, debentures, -7- 8 deeds of trust, mortgages, pledges (or other transfers of property as security or collateral for a debt), or other evidences of debt and securities therefor; and the note or other obligation given for any indebtedness of the Company, signed officially by any officer or officers thereunto duly authorized by the Board of Directors, shall be binding on the Company. (p) To approve a loan of money or property to any officer or director of the Company or any parent or subsidiary company, guarantee the obligation of any such officer or director, or approve an employee benefit plan authorizing such a loan or guaranty to any such officer or director; provided that, on the date of approval of such loan or guaranty, the Company has outstanding shares held of record by 100 or more persons. Such approval shall require a determination by the Board of Directors that the loan or guaranty may reasonably be expected to benefit the Company and must be by vote sufficient without counting the vote of any interested director. (q) Generally to do and perform every act and thing whatsoever that may pertain to the office of a director or to a board of directors. ARTICLE III MEETINGS OF DIRECTORS Section 3.1: Place of Meetings. Meetings (whether regular, special or adjourned) of the Board of Directors of the Company shall be held at the principal executive office of the Company or at any other place within or outside the State of California which may be designated from time to time by resolution of the Board of Directors or which is designated in the notice of the meeting. Section 3.2: Regular Meetings. Regular meetings of the Board of Director shall be held at such times as may be designated from time to time by resolution of the Board of Directors. Notice of the time and place of all regular meetings shall be given in the same manner as for special meetings, except that no such notice need be given if the time and place of such meetings are fixed by the Board of Directors. Section 3.3: Special Meetings. Special meetings of the Board of Directors may be called at any time by the Chairman of the Board, if any, or the President, or any Vice President, or the Secretary or by any two or more directors. Section 3.4: Notice of Special Meetings. Special meetings of the Board of Directors shall be held upon no less than 4 days' notice by mail or 48 hours' notice delivered personally or by telephone or telegraph to each director. Notice need not be given to any director who signs a waiver of notice or a consent to holding the meeting or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director. MI such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Any oral notice given personally or by telephone may be communicated either to the director or to a person at the home or office of the director who the person giving the notice has reason to -8- 9 believe will promptly communicate it to the director. A notice or waiver of notice need not specify the purpose of any meeting of the Board of Directors. If the address of a director is not shown on the records of the Company and is not readily ascertainable, notice shall be addressed to him or her at the city or place in which meetings of the directors are regularly held. If a meeting is adjourned for more than 24 hours, notice of any adjournment to another time or place shall be given prior to the time of the adjourned meeting to all directors not present at the time of adjournment. Section 3.5: Quorum. A majority of the authorized number of directors constitutes a quorum of the Board of Directors for the transaction of business. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present is the act of the Board of Directors subject to provisions of law relating to interested directors and indemnification of agents of the Company. A majority of the directors present, whether or not a quorum is present, may adjourn any meeting to another time and place. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting. Section 3.6: Conference Telephone. Members of the Board of Directors may participate in a meeting through use of conference telephone or similar communications equipment, so long as all directors participating in such meeting can bear one another. Participation in a meeting pursuant to this Section constitutes presence in person at such meeting. Section 3.7: Waiver of Notice and Consent. The transactions of any meeting of the Board of Directors, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice if a quorum is present, and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding such meeting or an approval of the minutes thereof. Ml such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Section 3.8: Action Without a Meeting. Any action required or permitted by law to be taken by the Board of Directors may be taken without a meeting, if all members of the Board of Directors shall individually or collectively consent in writing to the taking of such action. Such written consent or consents shall be filed with the minutes of the proceedings of the Board of Directors. Such action by written consent shall have the same force and effect as a unanimous vote of such directors at a duly held meeting. Section 3.9: Committees. The provisions of this Article apply also to committees of the Board of Directors and action by such committees. ARTICLE IV COMMITTEES Section 4.1: Appointment and Procedure. The Board of Directors may, by resolution adopted by a majority of the authorized number of directors, appoint from among its members -9- 10 one or more committees, including without limitation an executive committee, an audit committee and a compensation committee, of two or more directors. Each committee may make its own rules of procedure subject to Section 3.9 hereof, and shall meet as provided by such rules or by a resolution adopted by the Board of Directors (which resolution shall take precedence). A majority of the members of the committee shall constitute a quorum, and in every case the affirmative vote of a majority of all members of the committee shall be necessary to the adoption of any resolution. Section 4.2: Executive Committee Powers. During the intervals between the meetings of the Board of Directors, the Executive Committee, if any, in all cases in which specific directions shall not have been given by the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Company in such manner as the Executive Committee may deem best for the interests of the Company. Section 4.3: Powers of Other Committees. Other committees shall have such powers as are given them in a resolution of the Board of Directors. Section 4.4: Limitations on Powers of Committees. No committee shall have the power to act with respect to: (a) any action for which the laws of the State of California also require shareholder approval or approval of the outstanding shares; (b) the filling of vacancies on the Board of Directors or in any committee; (c) the fixing of compensation of the directors for serving on the Board of Directors or on any committee; (d) the amendment or repeal of these Bylaws or the adoption of new Bylaws; (e) the amendment or repeal of any resolution of the Board of Directors which by its express terms is not amendable or repealable; (f) a distribution to the shareholders of the Company. except at a rate or in a periodic amount or within a price range as set forth in the Articles of Incorporation or determined by the Board of Directors; and (g) the appointment of other committees of the Board of Directors or the members thereof. ARTICLE V OFFICERS Section 5.1: Election and Qualifications. The officers of the Company shall consist of a President and/or a Chief Executive Officer, a Secretary, a Chief Financial Officer and such other -10- 11 officers, including, but not limited to, a Chairman of the Board of Directors, one or more Vice Presidents, a Treasurer, and Assistant Vice Presidents, Assistant Secretaries and Assistant Treasurers, as the Board of Directors shall deem expedient, who shall be chosen in such manner and hold their offices for such terms as the Board of Directors may prescribe. Any number of offices may be held by the same person. Any Vice President, Assistant Treasurer or Assistant Secretary, respectively, may exercise any of the powers of the President, the Chief Financial Officer or the Secretary, respectively, as directed by the Board of Directors, and shall perform such other duties as are imposed upon him or her by these Bylaws or the Board of Directors. Section 5.2: Term of Office and Compensation. The term of office and salary of each of said officers and the manner and time of the payment of such salaries shall be fixed and determined by the Board of Directors and may be altered by said Board of Directors from time to time at its pleasure, subject to the rights, if any, of any officer under any contract of employment. Any officer may resign at any time upon written notice to the Company, without prejudice to the rights, if any, of the Company under any contract to which the officer is a party, if any vacancy occurs in any office of the Company, the Board of Directors may appoint a successor to fill such vacancy. Section 5.3: Chief Executive Officer. Subject to the control of the Board of Directors and such supervisory powers, if any, as may be given by the Board of Directors, the powers and duties of the Chief Executive Officer of the Company are: (a) To act as the general manager and, subject to the control of the Board of Directors, to have general supervision, direction and control of the business and affairs of the Company. (b) To preside at all meetings of the shareholders and, in the absence of the Chairman of the Board of Directors or if there be no Chairman, at all meetings of the Board of Directors. (c) To call meetings of the shareholders and meetings of the Board of Directors to be held at such times and, subject to the limitations prescribed by law or by these Bylaws, at such places as he or she shall deem proper. (d) To affix the signature of the Company to all deeds, conveyances, mortgages, leases, obligations, bonds, certificates and other papers and instruments in writing which have been authorized by the Board of Directors or which, in the judgment of the Chief Executive Officer, should be executed on behalf of the Company; to sign certificates for shares of stock of the Company; and, subject to the direction of the Board of Directors, to have general charge of the property of the Company and to supervise and control all officers, agents and employees of the Company. The President shall be the Chief Executive Officer of the Company unless the Board of Directors shall designate the Chairman of the Board or another officer to be the Chief Executive Officer. If there is no President, then the Chairman of the Board shall be the Chief Executive Officer. -11- 12 Section 5.4: Chairman of the Board. The Chairman of the Board of Directors, if there be one, shall have the power to preside at all meetings of the Board of Directors and shall have such other powers and shall be subject to such other duties as the Board of Directors may from time to time prescribe. Section 5.5: President. Subject to the supervisory powers of the Chief Executive Officer, if not the President, and to such supervisory powers as may be given by the Board of Directors to the Chairman of the Board, if one is elected, or to any other officer, the President shall have the general powers and duties of management usually vested in the office of president of a corporation and shall have such other powers and duties as may be prescribed by the Board of Directors or these Bylaws. Section 5.6: President Pro Tem. If neither the Chairman of the Board of Directors, the President, nor any Vice President is present at any meeting of the Board of Directors, a President pro tem may be chosen by the directors present at the meeting to preside and act at such meeting. if neither the President nor any Vice President is present at any meeting of the shareholders, a President pro tem may be chosen by the shareholders present at the meeting to preside at such meeting. Section 5.7: Vice President. The titles, powers and duties of the Vice President or Vice Presidents, if any, shall be as prescribed by the Board of Directors. In case of the resignation, disability or death of the President, the Vice President, or one of the Vice Presidents, shall exercise all powers and duties of the President. If there is more than one Vice President, the order in which the Vice Presidents shall succeed to the powers and duties of the President shall be as fixed by the Board of Directors. Section 5.8: Secretary. The powers and duties of the Secretary are: (a) To keep a book of minutes at the principal executive office of the Company, or such other place as the Board of Directors may order, of all meetings of its directors and shareholders with the time and place of holding of such meeting, whether regular or special, and, if special, how authorized, the notice thereof given, the names of those present at directors' meetings, the number of shares present or represented at shareholders' meetings and the proceedings thereof. 9 (b) To keep the seal of the Company and to affix the same to all instruments which may require it. (c) To keep or cause to be kept at the principal executive office of the Company, or at the office of the transfer agent or agents, a record of the shareholders of the Company, giving the names and addresses of all shareholders and the number and class of shares held by each, the number and date of certificates issued for shares and the number and date of cancellation of every certificate surrendered for cancellation. (d) To keep a supply of certificates for shares of the Company, to rill in all certificates issued, and to make a proper record of each such issuance; provided that, so long as -12- 13 the Company shall have one or more duly appointed and acting transfer agents of the shares, or any class or series of shares, of the Company, such duties with respect to such shares shall be performed by such transfer agent or transfer agents. (e) To transfer upon the share books of the Company any and all shares of the Company; provided that, so long as the Company shall have one or more duly appointed and acting transfer agents of the shares, or any class or series of shares, of the Company, such duties with respect to such shares shall be performed by such transfer agent or transfer agents, and the method of transfer of each certificate shall be subject to the reasonable regulations of the transfer agent to whom the certificate is presented for transfer and, if the Company then has one or more duly appointed and acting registrars, subject to the reasonable regulations of the registrar to which a new certificate is presented for registration; and, provided further, that no certificate for shares of stock shall be issued or delivered or, if issued or delivered, shall have any validity whatsoever until and unless it has been signed or authenticated in the manner provided in Section 8.2 hereof. (f) To make service and publication of all notices that may be necessary or proper in connection with meetings of the Board of Directors of the shareholders of the Company. In case of the absence, disability, refusal or neglect of the Secretary to make service or publication of any notices, then such notices may be served and/or published by the President or a Vice President, or by any person thereunto authorized by either of them, or by the Board of Directors, or by the holders of a majority of the outstanding shares of the Company. (b) Generally to do and perform all such duties as pertain to such office and as may be required by the Board of Directors. Section 5.9: Chief Financial Officer. The powers and duties of the Chief Financial Officer are: (a) To supervise and control the keeping and maintaining of adequate and correct accounts of the Company's properties and business transactions, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, surplus and shares. The books of account shall at all reasonable times be open to inspection by any director. (b) To have the custody of all funds, securities, evidences of indebtedness and other valuable documents of the Company and, at his or her discretion, to cause any or all thereof to be deposited for the account of the Company with such depository as may be designated from time to time by the Board of Directors. (c) To receive or cause to be received, and to give or cause to be given, receipts and acquaintances for monies paid in for the account of the Company. (d) To disburse, or cause to be disbursed, all funds of the Company as may be directed by the President or the Board of Directors, taking proper vouchers for such disbursements. -13- 14 (e) To render to the President or to the Board of Directors, whenever either may require, accounts of all transactions as Chief Financial Officer and of the financial condition of the Company. (f) Generally to do and perform all such duties as pertain to such office and as may be required by the Board of Directors. Section 5.10: Instruments in Writing. All checks, drafts, demands for money, notes and written contracts of the Company shall be signed by such officer or officers, agent or agents, as the Board of Directors may from time to time designate. No officer, agent, or employee of the Company shall have the power to bind the Company by contract or otherwise unless authorized to do so by these Bylaws or by the Board of Directors. ARTICLE VI INDEMNIFICATION Section 6.1: Indemnification of Directors and Officers. The Company shall indemnify each person who was or is a party, or is threatened to be made a party, to any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative (a "Proceeding") by reason of the fact that such person is or was a director or officer of the Company, or is or was serving at the request of the Company as a director or officer of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or was a director or officer of a foreign or domestic corporation which was a predecessor corporation of the Company or of another enterprise at the request of such predecessor corporation, to the fullest extent permitted by the California Corporations Code, against all expenses, including, without limitation, attorneys' fees and any expenses of establishing a right to indemnification, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with such Proceeding, and such indemnification shall continue as to a person who has ceased to be such a director or officer, and shall inure to the benefit of the heirs, executors and administrators of such person; provided, however, that the Company shall indemnify any such person seeking indemnity in connection with a Proceeding (or part thereof) initiated by such person only if such Proceeding (or part thereof) was authorized by the Board of Directors of the Company. Section 6.2: Advancement of Expenses. The Company shall pay all expenses incurred by such a director or officer in defending any Proceeding as they are incurred in advance of its final disposition; provided, however, that the payment of such expenses incurred by a director 01. officer in advance of the final disposition of a Proceeding shall be made only upon receipt by the Company of an agreement by or on behalf of such director or officer to repay such amount if it shall be determined ultimately that such person is not entitled to be indemnified under this Article VI or otherwise; and provided further that the Company shall not be required to advance any expenses to a person against whom the Company brings an action, alleging that such person committed an act or omission not in good faith or that involved intentional misconduct or a knowing violation of law, or that was contrary to the best interest of the Company, or derived an improper personal benefit from a transaction. -14- 15 Section 6.3: Non-Exclusivity of Rights. The rights conferred on any person in this Article VI shall not be deemed exclusive of any other rights that such person may have or hereafter acquire under any statute, by law, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office. Additionally, nothing in this Article VI shall limit the ability of the Company, in its discretion, to indemnify or advance expenses to persons whom the Company is not obligated to indemnify or advance expenses to pursuant to this Article VI. Section 6.4: Indemnification Contracts. The Board of Directors is authorized to cause the Company to enter into a contract with any director, officer, employee or agent of the Company, or any person serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, providing for indemnification rights equivalent to or, if the Board of Directors so determines, greater than (to the extent permitted by the Company's Articles of Incorporation and the California Corporations Code) those provided for in this Article VI. Section 6.5: Effect of Amendment. Any amendment, repeal or modification of any provision of this Article VI shall be prospective only, and shall not adversely affect any right or protection conferred on a person pursuant to this Article VI and existing at the time of such amendment, repeal or modification. ARTICLE VII MEETINGS OF, AND REPORTS TO, SHAREHOLDERS Section 7.1: Place of Meetings. Meetings (whether regular, special or adjourned) of the shareholders of the Company shall be held at the principal executive office for the transaction of business of the Company, or at any place within or outside the State of California which may be designated by written consent of all the shareholders entitled to vote thereat, or which may be designated by resolution of the Board of Directors. Any meeting shall be valid wherever held if held by the written consent of all the shareholders entitled to vote thereat, given either before or after the meeting and filed with the Secretary of the Company. Section 7.2: Annual Meetings. The annual meetings of the shareholders shall be held at the place provided pursuant to Section 7.1 hereof and at such time in a particular year as may be designated by written consent of all the shareholders entitled to vote thereat or which may be designated by resolution of the Board of Directors of the Company. Said annual meetings shall be held for the purpose of the election of directors, for the making of reports of the affairs of the Company and for the transaction of such other business as may properly come before the meeting. Section 7.3: Special Meetings. Special meetings of the shareholders for any purpose or purposes whatsoever may be called at any time by the President, the Chairman of the Board of Directors or by the Board of Directors, or by two or more members thereof. or by one or more holders of shares entitled to cast not less than 10% of the votes at the meeting. Upon request in writing sent by registered mail to the Chairman of the Board of Directors, President, Vice President or Secretary, or delivered to any such officer in person, by any person entitled to call a -15- 16 special meeting of shareholders, it shall be the duty of such officer forthwith to cause notice to be given to the shareholders entitled to vote that a meeting will be held at a time requested by the person or persons calling the meeting, which (except where called by the Board of Directors) shall be not less than 35 days nor more than 60 days after the receipt of such request. if the notice is not given within 20 days after receipt of the request, the person entitled to call the meeting may give the notice. Notices of meetings called by the Board of Directors shall be given in accordance with Section 7.4. Section 7.4: Notice of Meetings. Notice of any meeting of shareholders shall be given in writing not less than 10 (or, if sent by third-class mail, 30) nor more than 60 days before the date of the meeting to each shareholder entitled to vote thereat by the Secretary or an Assistant Secretary, or such other person charged with that duty, or if there be no such officer or person, or in case of his or her neglect or refusal, by any director or shareholder. The notice shall state the place, date and hour of the meeting and (a) in the case of a special meeting, the general nature of the business to be transacted, and no other business may be transacted, or (b) in the case of the annual meeting, those matters which the Board of Directors, at the time of the mailing of the notice, intends to present for action by the shareholders, but any proper matter may be presented at the meeting for such action, except that notice must be given or waived in writing of any proposal relating to any shareholder approval pursuant to Sections 310, 902, 1201, 1900 or 2007 of the California Corporations Code. The notice of any meeting at which directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by the Board of Directors for election. Notice of a shareholders' meeting or any report shall be given to any shareholder, either (a) personally or (b) by first-class mail, or, in case the Company has outstanding shares held of record by 500 or more persons on the record date for the shareholders' meeting, notice may be sent by third-class mail, or other means of written communication, charges prepaid, addressed to such shareholder at such shareholder's address appearing on the books of the Company or given by such shareholder to the Company for the purpose of notice. If a shareholder gives no address or no such address appears on the books of the Company, notice shall be deemed to have been given if sent by mail or other means of written communication addressed to the place where the principal executive office of the Company is located, or if published at least once in a newspaper of general circulation in the county in which such office is located. The notice or report shall be deemed to have been given at the time when delivered personally or deposited in the United States mail, postage prepaid, or sent by other means of written communication and addressed as hereinbefore provided. An affidavit or declaration of delivery or mailing of any notice or report in accordance with the provisions of this Section 7.4, executed by the Secretary, Assistant Secretary or any transfer agent, shall be prima facie evidence of the giving of the notice or report. if any notice or report addressed to the shareholder at the address of such shareholder appearing on the books of the Company is returned to the Company by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice or report to the shareholder at such address, all future notices or reports shall be deemed to have been duly given without further mailing if the same shall be available for the shareholder upon written demand of the shareholder at the principal executive office of the Company for a period of one year from the date of the giving of the notice or report to all other shareholders. -16- 17 Section 7.5: Consent to Shareholders' Meetings. The transactions of any meeting of shareholders, however called and noticed, and wherever held, are as valid as though they had taken place at a meeting duly held after regular call and notice, if the following conditions are met: (a) a quorum is present, either in person or by proxy, and (b) either before or after the meeting, each of the shareholders entitled to vote, who was not present in person or by proxy, signs a written waiver of notice or a consent to the holding of such meeting or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance of a person at a meeting shall constitute both a waiver of notice of and presence at such meeting, except: (a) when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened; or ~) when the person expressly makes an objection at some time during the meeting to the consideration of matters required by law to be included in the notice but not so included. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of shareholders need be specified in any written waiver of notice, consent to the holding of the meeting or approval of the minutes thereof, except as to approval pursuant to Sections 310, 902, 1201, 1900 or 2007 of the California Corporations Code. Section 7.6: Quorum. The presence in person or by proxy of the holders of a majority of the shares entitled to vote at any meeting of the shareholders shall constitute a quorum for the transaction of business. Shares shall not be counted to make up a quorum for a meeting if voting of such shares at the meeting has been enjoined or for any reason they cannot be lawfully voted at the meeting. Shareholders present at a duly called or held meeting at which a quorum is present may continue to transact business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. Except as provided herein, the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required. Section 7.7: Adjourned Meetings. Any shareholders meeting, whether or not a quorum is present, may be adjourned from time to time by the vote of a majority of the shares, the holders of which are either present in person or represented by proxy thereat, but, except as provided in Section 7.6 hereof, in the absence of a quorum, no other business may be transacted at such meeting. When a meeting is adjourned for more than 45 days or if after adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at a meeting. Except as aforesaid, it shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted thereat other than by announcement at the meeting at which such adjournment is taken. At any adjourned meeting the shareholders may transact any business which might have been transacted at the original meeting. -17- 18 Section 7.8: Voting Rights. Only persons in whose names shares entitled to vote stand on the stock records of the Company at: (a) the close of business on the business day immediately preceding the day on which notice is given; or (b) if notice is waived, at the close of business on the business day immediately preceding the day on which the meeting is held; or (c) if some other day be fixed for the determination of shareholders of record pursuant to Section 2.8(k) hereof, then on such other day, shall be entitled to vote at such meeting. The record date for determining shareholders entitled to give consent to corporate action in writing without a meeting, when no prior action by the Board of Directors has been taken, shall be the day on which the first written consent is given. In the absence of any contrary provision in the Articles of Incorporation or in any applicable statute relating to the election of directors or to other particular matters, each such person shall be entitled to one vote for each share. Section 7.9: Action by Written Consents. Any action which may be taken at any annual or special meeting of shareholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, shall be signed by holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Unless the consents of all shareholders entitled to vote have been solicited in writing, the Company shall provide notice of any shareholder approval pursuant to Section 310, 317, 1201 or 2007 of the California Corporations Code obtained without a meeting by less than unanimous written consent to those shareholders entitled to vote but who have not yet consented in writing at least 10 days before the consummation of the action authorized by such approval. In addition, the Company shall provide, to those shareholders entitled to vote who have not consented in writing, prompt notice of the taking of any other corporate action approved by the shareholders without a meeting by less than unanimous written consent. All notices given hereunder shall conform to the requirements of Section 7.4 hereto and applicable law. When written consents are given with respect to any shares, they shall be given by and accepted from the persons in whose names such shares stand on the books of the Company at the time such respective consents are given, or their proxies. Any shareholder giving a written consent (including any shareholder's proxy holder, or a transferee of the shares or a personal representative of the shareholder, or their respective proxy holders) may revoke the consent by a writing. This writing must be received by the Company prior to the time that written consents of the number of shares required to authorize the proposed action have been filed with the Secretary of the Company. Such revocation is effective upon its receipt by the Secretary of the Company. Notwithstanding anything herein to the contrary, and subject to Section 305(b) of the California Corporations Code, directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors. -18- 19 Section 7.10: Election of Directors. Unless cumulative voting has been eliminated pursuant to the terms of the Company's Articles of Incorporation pursuant to Section 301.5 of the California Corporations Code, every shareholder entitled to vote at any election of directors of `he Company may cumulate such shareholder's votes and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which the shareholder's shares are normally entitled, or distribute the shareholder's votes on the same principle among as many candidates as such shareholder thinks fit. No shareholder, however, may cumulate such shareholder's votes for one or more candidates unless such candidate's or candidates' names have been placed in nomination prior to the voting and the shareholder has given notice at the meeting, prior to voting, of such shareholder's intention to cumulate such shareholder's votes. If any one shareholder has given such notice, all shareholders may cumulate their votes for candidates in nomination. The candidates receiving the highest number of affirmative votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares shall be declared elected. Votes against the director and votes withheld shall have no legal effect. Election of directors need not be by ballot except upon demand made by a shareholder at the meeting and before the voting begins. Section 7.11: Proxies. Every person entitled to vote or execute consents shall have the right to do so either in person or by one or more agents authorized by a written proxy executed by such person or such person's duly authorized agent and filed with the Secretary of the Company. No proxy shall be valid (a) after revocation thereof, unless the proxy is specifically made irrevocable and otherwise conforms to this Section and applicable law, or (b) after the expiration of eleven months from the date thereof, unless the person executing it specifies therein the length of time for which such proxy is to continue in force. Revocation may be effected by a writing delivered to the Secretary of the Company stating that the proxy is revoked or by a subsequent proxy executed by the person executing the prior proxy and presented to the meeting, or as to any meeting by attendance at the meeting and voting in person by the person executing the proxy. A proxy is not revoked by the death or incapacity of the maker unless, before the vote is counted a written notice of such death or incapacity is received by the Secretary of the Company. In addition, a proxy may be revoked, notwithstanding a provision making it irrevocable, by a transferee of shares without knowledge of the existence of the provision unless the existence of the proxy and its irrevocability appears on the certificate representing such shares. Section 7.12: Inspectors of Election. Before any meeting of shareholders, the Board of Directors may appoint any persons other than nominees for office as inspectors of election. This appointment shall be valid at the meeting and at any subsequent meeting that is a continuation of the meeting at which the persons were originally appointed to be inspectors. if no inspectors of election are so appointed, the Chairman of the meeting may, and on the request of any shareholder or a shareholder's proxy shall, appoint inspectors of election at the meeting. The number of inspectors shall be either one or three. If inspectors are appointed at a meeting on the request of one or more shareholders or proxies, the holders of a majority of shares or their proxies present at the meeting shall determine whether one or three inspectors are to be appointed. if any person appointed as inspector fails to appear or fails or refuses to act, the Chairman of the meeting may, and upon the request of any shareholder or a shareholder's proxy shall, appoint a person to fill that vacancy. These inspectors shall: -19- 20 (a) determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity, and effect of proxies; (b) receive votes, ballots, or consents; (c) hear and determine all challenges and questions in any way arising in connection with the right to vote; (d) count and tabulate all votes or consents; (e) determine when the polls shall close; (f) determine the result; and (g) do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. Section 7.13: Annual Reports. Provided that the Company has 100 or fewer shareholders, the making of annual reports to the shareholders is dispensed with and the requirement that such annual reports be made to shareholders is expressly waived, except as may be directed from time to time by the Board of Directors or the President. ARTICLE VIII SHARES AND SHARE CERTIFICATES Section 8.l: Shares Held By the Company. Shares in other companies standing in the name of the Company may be voted or represented and all rights incident thereto may be exercised on behalf of the Company by any officer of the Company authorized to do so by resolution of the Board of Directors. Section 8.2: Certificates for Shares. There shall be issued to every holder of shares in the Company a certificate or certificates signed in the name of the Company by the Chairman of the Board, if any, or the President or a Vice President and by the Chief Financial Officer or an Assistant Chief Financial Officer or the Secretary or any Assistant Secretary, certifying the 17 342368.1 number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Company with the same effect as if such person were an officer, transfer agent or registrar at the date of issue. Section 8.3: Lost Certificates. Where the owner of any certificate for shares of the Company claims that the certificate has been lost, stolen or destroyed, a new certificate shall be issued in place of the original certificate if the owner (a) so requests before the Company has notice that the original certificate has been acquired by a bona fide purchaser and (b) satisfies any -20- 21 reasonable requirements imposed by the Company, including without limitation the filing with the Company of an indemnity bond or agreement in such form and in such amount as shall be required by the President or a Vice President of the Company. The Board of Directors may adopt such other provisions and restrictions with reference to lost certificates, not inconsistent with applicable law, as it shall in its discretion deem appropriate. ARTICLE IX CONSTRUCTION OF BYLAWS WITH REFERENCE TO PROVISIONS OF LAW Section 9.1: Bylaw Provisions Construed as Additional and Supplemental to Provisions of Law. All restrictions, limitations, requirements and other provisions of these Bylaws shall be construed, insofar as possible, as supplemental and additional to all provisions of law applicable to the subject matter thereof and shall be fully complied with in addition to the said provisions of law unless such compliance shall be illegal. Section 9.2: Bylaw Provisions Contrary to or Inconsistent with Provisions of Law. Any article, section, subsection, subdivision, sentence, clause or phrase of these Bylaws which, upon being construed in the manner provided in Section 9.1 hereof, shall be contrary to or inconsistent with any applicable provision of law, shall not apply so long as said provisions of law shall remain in effect, but such result shall not affect the validity or applicability of any other portion of these Bylaws, it being hereby declared that these Bylaws, and each article, section, subsection, subdivision, sentence, clause or phrase thereof, would have been adopted irrespective of the fact that any one or more articles, sections, subsections, subdivisions, sentences, clauses or phrases is or are illegal. ARTICLE X CERTIFICATION, ADOPTION, AMENDMENT OR REPEAL OF BYLAWS Section 10.1: By Shareholders. Bylaws may be adopted, amended or repealed by the vote or written consent of holders of a majority of the outstanding shares entitled to vote. Bylaws specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable board or vice versa may be adopted only by the shareholders. Section 10.2: By the Board of Directors. Subject to the right of shareholders to adopt, amend or repeal Bylaws, and other than a Bylaw or amendment thereof specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable board or vice versa, these Bylaws may be adopted, amended or repealed by the Board of Directors. A Bylaw adopted by the shareholders may restrict or eliminate the power of the Board of Directors to adopt, amend or repeal Bylaws. Section 10.3: Certification and Inspection of Bylaws. The Company shall keep at its principal executive office the original or a copy of these Bylaws as amended or otherwise altered to date, which shall be open to inspection by the shareholders at all reasonable times during office hours. -21- EX-10.03 3 1995 EQUITY INCENTIVE PLAN 1 EXHIBIT 10.03 ESS TECHNOLOGY, INC. 1995 EQUITY INCENTIVE PLAN (AS AMENDED ON JULY 18, 1998) 1. PURPOSE. The purpose of this Plan is to provide incentives to attract, retain and motivate eligible persons whose present and potential contributions are important to the success of the Company, its Parent, Subsidiaries and Affiliates, by offering them an opportunity to participate in the Company's future performance through awards of Options, Restricted Stock and Stock Bonuses. Capitalized terms not defined in the text are defined in Section 23. 2. SHARES SUBJECT TO THE PLAN. 2.1 Number of Shares Available. Subject to Sections 2.2 and 18, the total number of Shares reserved and available for grant and issuance pursuant to this Plan will be 3,000,000 Shares. Subject to Sections 2.2 and 18, Shares that: (a) are subject to issuance upon exercise of an Option but cease to be subject to such Option for any reason other than exercise of such Option; (b) are subject to an Award granted hereunder but are forfeited or are repurchased by the Company at the original issue price; or (c) are subject to an Award that otherwise terminates without Shares being issued; will again be available for grant and issuance in connection with future Awards under this Plan. At all times the Company shall reserve and keep available a sufficient number of Shares as shall be required to satisfy the requirements of all outstanding Options granted under this Plan and all other outstanding but unvested Awards granted under this Plan. 2.2 Adjustment of Shares. In the event that the number of outstanding Shares is changed by a stock dividend, recapitalization, stock split, reverse stock split, subdivision, combination, reclassification or similar change in the capital structure of the Company without consideration, then (a) the number of Shares reserved for issuance under this Plan, (b) the Exercise Prices of and number of Shares subject to outstanding Options, and (c) the number of Shares subject to other outstanding Awards will be proportionately adjusted, subject to any required action by the Board or the stockholders of the Company and compliance with applicable securities laws; provided, however, that fractions of a Share will not be issued but will either be replaced by a cash payment equal to the Fair Market Value of such fraction of a Share or will be rounded up to the nearest whole Share, as determined by the Committee. 3. ELIGIBILITY. ISOs (as defined in Section 5 below) may be granted only to employees (including officers and directors who are also employees) of the Company or of a Parent or Subsidiary of the Company. All other Awards may be granted to employees, officers, directors, consultants, independent contractors and advisors of the Company or any Parent, Subsidiary or Affiliate of the Company; provided such consultants, contractors and advisors render bona fide services not in connection with the offer and sale of securities in a capital-raising transaction. No person will be eligible to receive more than 375,000 Shares in any calendar year under this Plan pursuant to the grant of Awards hereunder, other than new employees of the Company or of a Parent, Subsidiary or Affiliate of the Company (including 2 new employees who are also officers and directors of the Company or any Parent, Subsidiary or Affiliate of the Company) who are eligible to receive up to a maximum of 750,000 Shares in the calendar year in which they commence their employment. A person may be granted more than one Award under this Plan. 4. ADMINISTRATION. 4.1 Committee Authority. This Plan will be administered by the Committee or by the Board acting as the Committee. Subject to the general purposes, terms and conditions of this Plan, and to the direction of the Board, the Committee will have full power to implement and carry out this Plan. Without limitation, the Committee will have the authority to: (a) construe and interpret this Plan, any Award Agreement and any other agreement or document executed pursuant to this Plan; (b) prescribe, amend and rescind rules and regulations relating to this Plan; (c) select persons to receive Awards; (d) determine the form and terms of Awards; (e) determine the number of Shares or other consideration subject to Awards; (f) determine whether Awards will be granted singly, in combination with, in tandem with, in replacement of, or as alternatives to, other Awards under this Plan or any other incentive or compensation plan of the Company or any Parent, Subsidiary or Affiliate of the Company; (g) grant waivers of Plan or Award conditions; (h) determine the vesting, exercisability and payment of Awards; (i) correct any defect, supply any omission or reconcile any inconsistency in this Plan, any Award or any Award Agreement; (j) determine whether an Award has been earned; and (k) make all other determinations necessary or advisable for the administration of this Plan. 4.2 Committee Discretion. Any determination made by the Committee with respect to any Award will be made in its sole discretion at the time of grant of the Award or, unless in contravention of any express term of this Plan or Award, at any later time, and such determination will be final and binding on the Company and on all persons having an interest in any Award under this Plan. The Committee may delegate to one or more officers of the -2- 3 Company the authority to grant an Award under this Plan to Participants who are not Insiders of the Company. 4.3 Exchange Act Requirements. If two or more members of the Board are Outside Directors, the Committee will be comprised of at least two (2) members of the Board, all of whom are Outside Directors and Disinterested Persons. During all times that the Company is subject to Section 16 of the Exchange Act, the Company will take appropriate steps to comply with the disinterested administration requirements of Section 16(b) of the Exchange Act, which will consist of the appointment by the Board of a Committee consisting of not less than two (2) members of the Board, each of whom is a Disinterested Person. 5. OPTIONS. The Committee may grant Options to eligible persons and will determine whether such Options will be Incentive Stock Options within the meaning of the Code ("ISOS") or Nonqualified Stock Options ("NQSOS"), the number of Shares subject to the Option, the Exercise Price of the Option, the period during which the Option may be exercised, and all other terms and conditions of the Option, subject to the following: 5.1 Form of Option Grant. Each Option granted under this Plan will be evidenced by an Award Agreement which will expressly identify the Option as an ISO or an NQSO ("STOCK OPTION AGREEMENT"), and will be in such form and contain such provisions (which need not be the same for each Participant) as the Committee may from time to time approve, and which will comply with and be subject to the terms and conditions of this Plan. 5.2 Date of Grant. The date of grant of an Option shall, for all purposes, be the date on which the Committee makes the determination granting such Option or such other date as is determined by the Committee; provided however that that grant date shall be the later of the date on which the Committee makes the determination granting such Option or the date of commencement of the Optionee's employment relationship with the Company. Notice of the determination shall be given to each Participant within a reasonable time after the date of such grant. 5.3 Exercise Period. Options will be exercisable within the times or upon the events determined by the Committee as set forth in the Stock Option Agreement governing such Option; provided, however, that no Option will be exercisable after the expiration of ten (10) years from the date the Option is granted; and provided further that no ISO granted to a person who directly or by attribution owns more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or of any Parent or Subsidiary of the Company ("TEN PERCENT STOCKHOLDER") will be exercisable after the expiration of five (5) years from the date the ISO is granted. The Committee also may provide for the exercise of Options to become exercisable at one time or from time to time, periodically or otherwise, in such number of Shares or percentage of Shares as the Committee determines. 5.4 Exercise Price. The Exercise Price of an Option will be determined by the Committee when the Option is granted and may be not less than 85% of the Fair Market Value of the Shares on the date of grant; provided that: (i) the Exercise Price of an ISO will be not less than 100% of the Fair Market Value of the Shares on the date of grant; and (ii) the Exercise Price -3- 4 of any ISO granted to a Ten Percent Stockholder will not be less than 110% of the Fair Market Value of the Shares on the date of grant. Payment for the Shares purchased may be made in accordance with Section 8 of this Plan. 5.5 Method of Exercise. Options may be exercised only by delivery to the Company of a written stock option exercise agreement (the "EXERCISE AGREEMENT") in a form approved by the Committee (which need not be the same for each Participant), stating the number of Shares being purchased, the restrictions imposed on the Shares purchased under such Exercise Agreement, if any, and such representations and agreements regarding Participant's investment intent and access to information and other matters, if any, as may be required or desirable by the Company to comply with applicable securities laws, together with payment in full of the Exercise Price for the number of Shares being purchased. 5.6 Termination. Notwithstanding the exercise periods set forth in the Stock Option Agreement, exercise of an Option will always be subject to the following: (a) If the Participant is Terminated for any reason except death or Disability, then the Participant may exercise such Participant's Options only to the extent that such Options would have been exercisable upon the Termination Date no later than three (3) months after the Termination Date (or such shorter or longer time period not exceeding five (5) years as may be determined by the Committee, with any exercise beyond three (3) months after the Termination Date deemed to be an NQSO), but in any event, no later than the expiration date of the Options. (b) If the Participant is Terminated because of Participant's death or Disability (or the Participant dies within three (3) months after a Termination other than because of Participant's death or disability), then Participant's Options may be exercised only to the extent that such Options would have been exercisable by Participant on the Termination Date and must be exercised by Participant (or Participant's legal representative or authorized assignee) no later than twelve (12) months after the Termination Date (or such shorter or longer time period not exceeding five (5) years as may be determined by the Committee, with any such exercise beyond (a) three (3) months after the Termination Date when the Termination is for any reason other than the Participant's death or Disability, or (b) twelve (12) months after the Termination Date when the Termination is for Participant's death or Disability, deemed to be an NQSO), but in any event no later than the expiration date of the Options. 5.7 Limitations on Exercise. The Committee may specify a reasonable minimum number of Shares that may be purchased on any exercise of an Option, provided that such minimum number will not prevent Participant from exercising the Option for the full number of Shares for which it is then exercisable. 5.8 Limitations on ISOs. The aggregate Fair Market Value (determined as of the date of grant) of Shares with respect to which ISOs are exercisable for the first time by a Participant during any calendar year (under this Plan or under any other incentive stock option plan of the Company or any Affiliate, Parent or Subsidiary of the Company) will not exceed $100,000. If the Fair Market Value of Shares on the date of grant with respect to which ISOs are -4- 5 exercisable for the first time by a Participant during any calendar year exceeds $100,000, then the Options for the first $100,000 worth of Shares to become exercisable in such calendar year will be ISOs and the Options for the amount in excess of $100,000 that become exercisable in that calendar year will be NQSOs. In the event that the Code or the regulations promulgated thereunder are amended after the Effective Date of this Plan to provide for a different limit on the Fair Market Value of Shares permitted to be subject to ISOs, such different limit will be automatically incorporated herein and will apply to any Options granted after the effective date of such amendment. 5.9 Modification, Extension or Renewal. The Committee may modify, extend or renew outstanding Options and authorize the grant of new Options in substitution therefor, provided that any such action may not, without the written consent of a Participant, impair any of such Participant's rights under any Option previously granted. Any outstanding ISO that is modified, extended, renewed or otherwise altered will be treated in accordance with Section 424(h) of the Code. The Committee may reduce the Exercise Price of outstanding Options without the consent of Participants affected by a written notice to them; provided, however, that the Exercise Price may not be reduced below the minimum Exercise Price that would be permitted under Section 5.4 of this Plan for Options granted on the date the action is taken to reduce the Exercise Price. 5.10 No Disqualification. Notwithstanding any other provision in this Plan, no term of this Plan relating to ISOs will be interpreted, amended or altered, nor will any discretion or authority granted under this Plan be exercised, so as to disqualify this Plan under Section 422 of the Code or, without the consent of the Participant affected, to disqualify any ISO under Section 422 of the Code. 6. RESTRICTED STOCK. A Restricted Stock Award is an offer by the Company to sell to an eligible person Shares that are subject to restrictions. The Committee will determine to whom an offer will be made, the number of Shares the person may purchase, the price to be paid (the "PURCHASE PRICE"), the restrictions to which the Shares will be subject, and all other terms and conditions of the Restricted Stock Award, subject to the following: 6.1 Form of Restricted Stock Award. All purchases under a Restricted Stock Award made pursuant to this Plan will be evidenced by an Award Agreement ("RESTRICTED STOCK PURCHASE AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. The offer of Restricted Stock will be accepted by the Participant's execution and delivery of the Restricted Stock Purchase Agreement and full payment for the Shares to the Company within thirty (30) days from the date the Restricted Stock Purchase Agreement is delivered to the person. If such person does not execute and deliver the Restricted Stock Purchase Agreement along with full payment for the Shares to the Company within thirty (30) days, then the offer will terminate, unless otherwise determined by the Committee. -5- 6 6.2 Purchase Price. The Purchase Price of Shares sold pursuant to a Restricted Stock Award will be determined by the Committee and will be at least 85% of the Fair Market Value of the Shares on the date the Restricted Stock Award is granted, except in the case of a sale to a Ten Percent Stockholder, in which case the Purchase Price will be 100% of the Fair Market Value. Payment of the Purchase Price may be made in accordance with Section 8 of this Plan. 6.3 Restrictions. Restricted Stock Awards will be subject to such restrictions (if any) as the Committee may impose. The Committee may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions, in whole or part, based on length of service, performance or such other factors or criteria as the Committee may determine. 7. STOCK BONUSES. 7.1 Awards of Stock Bonuses. A Stock Bonus is an award of Shares (which may consist of Restricted Stock) for services rendered to the Company or any Parent, Subsidiary or Affiliate of the Company. A Stock Bonus may be awarded for past services already rendered to the Company, or any Parent, Subsidiary or Affiliate of the Company pursuant to an Award Agreement (the "STOCK BONUS AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. A Stock Bonus may be awarded upon satisfaction of such performance goals as are set out in advance in the Participant's individual Award Agreement (the "PERFORMANCE STOCK BONUS AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. Stock Bonuses may vary from Participant to Participant and between groups of Participants, and may be based upon the achievement of the Company, Parent, Subsidiary or Affiliate and/or individual performance factors or upon such other criteria as the Committee may determine. 7.2 Terms of Stock Bonuses. The Committee will determine the number of Shares to be awarded to the Participant and whether such Shares will be Restricted Stock. If the Stock Bonus is being earned upon the satisfaction of performance goals pursuant to a Performance Stock Bonus Agreement, then the Committee will determine: (a) the nature, length and starting date of any period during which performance is to be measured (the "PERFORMANCE PERIOD") for each Stock Bonus; (b) the performance goals and criteria to be used to measure the performance, if any; (c) the number of Shares that may be awarded to the Participant; and (d) the extent to which such Stock Bonuses have been earned. Performance Periods may overlap and Participants may participate simultaneously with respect to Stock Bonuses that are subject to different Performance Periods and different performance goals and other criteria. The number of Shares may be fixed or may vary in accordance with such performance goals and criteria as may be determined by the Committee. The Committee may adjust the performance goals applicable to the Stock Bonuses to take into account changes in law and accounting or tax rules and to make such adjustments as the Committee deems necessary or appropriate to reflect the impact of extraordinary or unusual items, events or circumstances to avoid windfalls or hardships. -6- 7 7.3 Form of Payment. The earned portion of a Stock Bonus may be paid currently or on a deferred basis with such interest or dividend equivalent, if any, as the Committee may determine. Payment may be made in the form of cash, whole Shares, including Restricted Stock, or a combination thereof, either in a lump sum payment or in installments, all as the Committee will determine. 7.4 Termination During Performance Period. If a Participant is Terminated during a Performance Period for any reason, then such Participant will be entitled to payment (whether in Shares, cash or otherwise) with respect to the Stock Bonus only to the extent earned as of the date of Termination in accordance with the Performance Stock Bonus Agreement, unless the Committee will determine otherwise. 8. PAYMENT FOR SHARE PURCHASES. 8.1 Payment. Payment for Shares purchased pursuant to this Plan may be made in cash (by check) or, where expressly approved for the Participant by the Committee and where permitted by law: (a) by cancellation of indebtedness of the Company to the Participant; (b) by surrender of shares that either: (1) have been owned by Participant for more than six (6) months and have been paid for within the meaning of SEC Rule 144 (and, if such shares were purchased from the Company by use of a promissory note, such note has been fully paid with respect to such shares); or (2) were obtained by Participant in the public market; (c) by tender of a full recourse promissory note having such terms as may be approved by the Committee and bearing interest at a rate sufficient to avoid imputation of income under Sections 483 and 1274 of the Code; provided, however, that Participants who are not employees or directors of the Company will not he entitled to purchase Shares with a promissory note unless the note is adequately secured by collateral other than the Shares; (d) by waiver of compensation due or accrued to the Participant for services rendered; (e) with respect only to purchases upon exercise of an Option, and provided that a public market for the Company's stock exists: (1) through a "same day sale" commitment from the Participant and a broker-dealer that is a member of the National Association of Securities Dealers (an "NASD DEALER") whereby the Participant irrevocably elects to exercise the Option and to sell a portion of the Shares so purchased to pay for the Exercise Price, and whereby the NASD Dealer irrevocably commits upon receipt of such Shares to forward the Exercise Price directly to the Company; or -7- 8 (2) through a "margin" commitment from the Participant and a NASD Dealer whereby the Participant irrevocably elects to exercise the Option and to pledge the Shares so purchased to the NASD Dealer in a margin account as security for a loan from the NASD Dealer in the amount of the Exercise Price, and whereby the NASD Dealer irrevocably commits upon receipt of such Shares to forward the Exercise Price directly to the Company; or (f) by any combination of the foregoing. 8.2 Loan Guarantees. The Committee may help the Participant pay for Shares purchased under this Plan by authorizing a guarantee by the Company of a third-party loan to the Participant. 9. WITHHOLDING TAXES. 9.1 Withholding Generally. Whenever Shares are to be issued in satisfaction of Awards granted under this Plan, the Company may require the Participant to remit to the Company an amount sufficient to satisfy federal, state and local withholding tax requirements prior to the delivery of any certificate or certificates for such Shares. Whenever, under this Plan, payments in satisfaction of Awards are to be made in cash, such payment will be net of an amount sufficient to satisfy federal, state, and local withholding tax requirements. 9.2 Stock Withholding. When, under applicable tax laws, a Participant incurs tax liability in connection with the exercise or vesting of any Award that is subject to tax withholding and the Participant is obligated to pay the Company the amount required to be withheld, the Committee may allow the Participant to satisfy the minimum withholding tax obligation by electing to have the Company withhold from the Shares to be issued that number of Shares having a Fair Market Value equal to the minimum amount required to be withheld, determined on the date that the amount of tax to be withheld is to be determined (the "TAX DATE"). All elections by a Participant to have Shares withheld for this purpose will be made in writing in a form acceptable to the Committee and will be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; (b) once made, then except as provided below, the election will be irrevocable as to the particular Shares as to which the election is made; (c) all elections will be subject to the consent or disapproval of the Committee; (d) if the Participant is an Insider and if the Company is subject to Section 16(b) of the Exchange Act: (1) the election may not be made within six (6) months of the date of grant of the Award, except as otherwise permitted by SEC Rule 16b-3(e) under the Exchange Act, and (2) either (A) the election to use stock withholding must be irrevocably made at least six (6) months prior to the Tax Date (although such election may be revoked at any time at least six (6) months prior to the Tax Date) or (B) the exercise of the Option or election to use -8- 9 stock withholding must be made in the ten (10) day period beginning on the third day following the release of the Company's quarterly or annual summary statement of sales or earnings; and (e) in the event that the Tax Date is deferred until six (6) months after the delivery of Shares under Section 83(b) of the Code, the Participant will receive the full number of Shares with respect to which the exercise occurs, but such Participant will be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 10. PRIVILEGES OF STOCK OWNERSHIP. 10.1 Voting and Dividends. No Participant will have any of the rights of a stockholder with respect to any Shares until the Shares are issued to the Participant. After Shares are issued to the Participant, the Participant will be a stockholder and have all the rights of a stockholder with respect to such Shares, including the right to vote and receive all dividends or other distributions made or paid with respect to such Shares; provided, that if such Shares are Restricted Stock, then any new, additional or different securities the Participant may become entitled to receive with respect to such Shares by virtue of a stock dividend, stock split or any other change in the corporate or capital structure of the Company will be subject to the same restrictions as the Restricted Stock; provided, further, that the Participant will have no right to retain such stock dividends or stock distributions with respect to Shares that are repurchased at the Participant's original Purchase Price pursuant to Section 12. 10.2 Financial Statements. The Company will provide financial statements to each Participant prior to such Participant's purchase of Shares under this Plan, and to each Participant annually during the period such Participant has Awards outstanding; provided, however, the Company will not be required to provide such financial statements to Participants whose services in connection with the Company assure them access to equivalent information. 11. TRANSFERABILITY. Awards granted under this Plan, and any interest therein, wilt not be transferable or assignable by Participant, and may not be made subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution or as consistent with the specific Plan and Award Agreement provisions relating thereto During the lifetime of the Participant an Award will be exercisable only by the Participant, and any elections with respect to an Award, may be made only by the Participant. 12. RESTRICTIONS ON SHARES. At the discretion of the Committee, the Company may reserve to itself and/or its assignee(s) in the Award Agreement (a) a right of first refusal to purchase all Shares that a Participant (or a subsequent transferee) may propose to transfer to a third party, and/or (b) a right to repurchase a portion of or all Shares held by a Participant following such Participant's Termination at any time within ninety (90) days after the later of Participant's Termination Date and the date Participant purchases Shares under this Plan, for cash and/or cancellation of purchase money indebtedness, at: (A) with respect to Shares that are "Vested" (as defined in the Award Agreement), the higher of: (1) Participant's original Purchase Price, or (2) the Fair Market Value of such Shares on Participant's Termination Date, provided, that such right of repurchase (i) must be exercised as to all such "Vested" Shares unless -9- 10 a Participant consents to the Company's repurchase of only a portion of such "Vested" Shares and (ii) terminates when the Company's securities become publicly traded; or (B) with respect to Shares that are not "Vested" (as defined in the Award Agreement), at the Participant's original Purchase Price, provided, that the right to repurchase at the original Purchase Price lapses at the rate of at least 20% per year over five (5) years from the date the Shares were purchased (or from the date of grant of options in the case of Shares obtained pursuant to a Stock Option Agreement and Stock Option Exercise Agreement), and if the right to repurchase is assignable, the assignee must pay the Company, upon assignment of the right to repurchase, cash equal to the excess of the Fair Market Value of the Shares over the original Purchase Price. 13. CERTIFICATES. All certificates for Shares or other securities delivered under this Plan will be subject to such stock transfer orders, legends and other restrictions as the Committee may deem necessary or advisable, including restrictions under any applicable federal, state or foreign securities law, or any rules, regulations and other requirements of the SEC or any stock exchange or automated quotation system upon which the Shares may be listed or quoted. 14. ESCROW; PLEDGE OF SHARES. To enforce any restrictions on a Participant's Shares, the Committee may require the Participant to deposit all certificates representing Shares, together with stock powers or other instruments of transfer approved by the Committee, appropriately endorsed in blank, with the Company or an agent designated by the Company to hold in escrow until such restrictions have lapsed or terminated, and the Committee may cause a legend or legends referencing such restrictions to be placed on the certificates. Any Participant who is permitted to execute a promissory note as partial or full consideration for the purchase of Shares under this Plan will be required to pledge and deposit with the Company all or part of the Shares so purchased as collateral to secure the payment of Participant's obligation to the Company under the promissory note; provided, however, that the Committee may require or accept other or additional forms of collateral to secure the payment of such obligation and, in any event, the Company will have full recourse against the Participant under the promissory note notwithstanding any pledge of the Participant's Shares or other collateral. In connection with any pledge of the Shares, Participant will be required to execute and deliver a written pledge agreement in such form as the Committee will from time to time approve. The Shares purchased with the promissory note may be released from the pledge on a pro rata basis as the promissory note is paid. 15. EXCHANGE AND BUYOUT OF AWARDS. The Committee may, at any time or from time to time, authorize the Company, with the consent of the respective Participants, to issue new Awards in exchange for the surrender and cancellation of any or all outstanding Awards. The Committee may at any time buy from a Participant an Award previously granted with payment in cash, Shares (including Restricted Stock) or other consideration, based on such terms and conditions as the Committee and the Participant may agree. 16. SECURITIES LAW AND OTHER REGULATORY COMPLIANCE. An Award will not be effective unless such Award is in compliance with all applicable federal and state securities laws, rules and regulations of any governmental body, and the requirements of any stock exchange or automated quotation system upon which the Shares may then be listed or -10- 11 quoted, as they are in effect on the date of grant of the Award and also on the date of exercise or other issuance. Notwithstanding any other provision in this Plan, the Company will have no obligation to issue or deliver certificates for Shares under this Plan prior to: (a) obtaining any approvals from governmental agencies that the Company determines are necessary or advisable; and/or (b) completion of any registration or other qualification of such Shares under any state or federal law or ruling of any governmental body that the Company determines to be necessary or advisable. The Company will be under no obligation to register the Shares with the SEC or to effect compliance with the registration, qualification or listing requirements of any state securities laws, stock exchange or automated quotation system, and the Company will have no liability for any inability or failure to do so. 17. NO OBLIGATION TO EMPLOY. Nothing in this Plan or any Award granted under this Plan will confer or be deemed to confer on any Participant any right to continue in the employ of, or to continue any other relationship with, the Company or any Parent, Subsidiary or Affiliate of the Company or limit in any way the right of the Company or any Parent, Subsidiary or Affiliate of the Company to terminate Participant's employment or other relationship at any time, with or without cause. 18. CORPORATE TRANSACTIONS. 18.1 Assumption or Replacement of Awards by Successor. In the event of (a) a dissolution or liquidation of the Company, (b) a merger or consolidation in which the Company is not the surviving corporation (other than a merger or consolidation with a wholly-owned subsidiary, a reincorporation of the Company in a different jurisdiction, or other transaction in which there is no substantial change in the stockholders of the Company or their relative stock holdings and the Awards granted under this Plan are assumed, converted or replaced by the successor corporation, which assumption will be binding on all Participants), (c) a merger in which the Company is the surviving corporation but after which the stockholders of the Company (other than any stockholder which merges (or which owns or controls another corporation which merges) with the Company in such merger) cease to own their shares or other equity interests in the Company, (d) the sale of substantially all of the assets of the Company, or (e) any other transaction which qualifies as a "corporate transaction" under Section 424(a) of the Code wherein the stockholders of the Company give up all of their equity interest in the Company (except for the acquisition, sale or transfer of all or substantially all of the outstanding shares of the Company from or by the stockholders of the Company), any or all outstanding Awards may be assumed, converted or replaced by the successor corporation (if any), which assumption, conversion or replacement will be binding on all Participants. In the alternative, the successor corporation may substitute equivalent Awards or provide substantially similar consideration to Participants as was provided to stockholders (after taking into account the existing provisions of the Awards). The successor corporation may also issue, in place of outstanding Shares of the Company held by the Participant, substantially similar shares or other property subject to repurchase restrictions no less favorable to the Participant. In the event such successor corporation (if any) refuses to assume or substitute Options, as provided above, pursuant to a transaction described in this Subsection 18.1, such Options will expire on such transaction at such time and on such conditions as the Board will determine. -11- 12 18.2 Other Treatment of Awards. Subject to any greater rights granted to Participants under the foregoing provisions of this Section 18, in the event of the occurrence of any transaction described in Section 18.1, any outstanding Awards will be treated as provided in the applicable agreement or plan of merger, consolidation, dissolution, liquidation, sale of assets or other "corporate transaction." 18.3 Assumption of Awards by the Company. The Company, from time to time, also may substitute or assume outstanding awards granted by another company, whether in connection with an acquisition of such other company or otherwise, by either: (a) granting an Award under this Plan in substitution of such other company's award; or (b) assuming such award as if it had been granted under this Plan if the terms of such assumed award could be applied to an Award granted under this Plan. Such substitution or assumption will be permissible if the holder of the substituted or assumed award would have been eligible to be granted an Award under this Plan if the other company had applied the rules of this Plan to such grant. In the event the Company assumes an award granted by another company, the terms and conditions of such award will remain unchanged (except that the exercise price and the number and nature of Shares issuable upon exercise of any such option will be adjusted appropriately pursuant to Section 424(a) of the Code). In the event the Company elects to grant a new Option rather than assuming an existing option, such new Option may be granted with a similarly adjusted Exercise Price. 19. ADOPTION AND STOCKHOLDER APPROVAL. This Plan will become effective on the date on which the registration statement filed by the Company with the SEC under the Securities Act registering the initial public offering of the Company's Common Stock is declared effective by the SEC (the "EFFECTIVE DATE"); provided, however, however that if the Effective Date does not occur on or before December 31, 1995, this Plan will terminate as of December 31, 1995 having never become effective. This Plan shall be approved by the stockholders of the Company (excluding Shares issued pursuant to this Plan), consistent with applicable laws, within twelve (12) months before or after the date this Plan is adopted by the Board. Upon the Effective Date, the Board may grant Awards pursuant to this Plan; provided, however, that: (a) no Option may be exercised prior to initial stockholder approval of this Plan; (b) no Option granted pursuant to an increase in the number of Shares subject to this Plan approved by the Board will be exercised prior to the time such increase has been approved by the stockholders of the Company; and (c) in the event that stockholder approval of such increase is not obtained within the time period provided herein, all Awards granted hereunder will be canceled, any Shares issued pursuant to any Award will be canceled, and any purchase of Shares hereunder will be rescinded. So long as the Company is subject to Section 16(b) of the Exchange Act, the Company will comply with the requirements of Rule 16b-3 (or its successor), as amended, with respect to stockholder approval. 20. TERM OF PLAN. Unless earlier terminated as provided herein, this Plan will terminate ten (10) years from the date this Plan is adopted by the Board or, if earlier, the date of stockholder approval. -12- 13 21. AMENDMENT OR TERMINATION OF PLAN. The Board may at any time terminate or amend this Plan in any respect, including without limitation amendment of any form of Award Agreement or instrument to be executed pursuant to this Plan; provided, however, that the Board will not, without the approval of the stockholders of the Company, amend this Plan in any manner that requires such stockholder approval pursuant to the Code or the regulations promulgated thereunder as such provisions apply to ISO plans or (if the Company is subject to the Exchange Act or Section 16(b) of the Exchange Act) pursuant to the Exchange Act or Rule 16b-3 (or its successor), as amended, thereunder, respectively. 22. NONEXCLUSIVITY OF THE PLAN. Neither the adoption of this Plan by the Board, the submission of this Plan to the stockholders of the Company for approval, nor any provision of this Plan will be construed as creating any limitations on the power of the Board to adopt such additional compensation arrangements as it may deem desirable, including, without limitation, the granting of stock options and bonuses otherwise than under this Plan, and such arrangements may be either generally applicable or applicable only in specific cases. 23. DEFINITIONS. As used in this Plan, the following terms will have the following meanings: "AFFILIATE" means any corporation that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, another corporation, where "control" (including the terms "controlled by" and "under common control with") means the possession, direct or indirect, of the power to cause the direction of the management and policies of the corporation, whether through the ownership of voting securities, by contract or otherwise. "AWARD" means any award under this Plan, including any Option, Restricted Stock or Stock Bonus. "AWARD AGREEMENT" means, with respect to each Award, the signed written agreement between the Company and the Participant setting forth the terms and conditions of the Award. "BOARD" means the Board of Directors of the Company. "CODE" means the Internal Revenue Code of 1986, as amended. "COMMITTEE" means the committee appointed by the Board to administer this Plan, or if no such committee is appointed, the Board. "COMPANY" means ESS Technology, Inc., a corporation organized under the laws of the State of California, or any successor corporation. "DISABILITY" means a disability, whether temporary or permanent, partial or total, within the meaning of Section 22(e)(3) of the Code, as determined by the Committee. -13- 14 "DISINTERESTED PERSON" means a director who has not, during the period that person is a member of the Committee and for one year prior to commencing service as a member of the Committee, been granted or awarded equity securities pursuant to this Plan or any other plan of the Company or any Parent, Subsidiary or Affiliate of the Company, except in accordance with the requirements set forth in Rule 16b-3(c)(2)(i) (and any successor regulation thereto) as promulgated by the SEC under Section 16(b) of the Exchange Act, as such rule is amended from time to time and as interpreted by the SEC. "EXCHANGE ACT" means the Securities Exchange Act of 1934 as amended. "EXERCISE PRICE" means the price at which a holder of an Option may purchase the Shares issuable upon exercise of the Option. "FAIR MARKET VALUE" means, as of any date, the value of a share of the Company's Common Stock determined as follows: (a) if such Common Stock is then quoted on the Nasdaq National Market, its closing price on the Nasdaq National Market on the last trading day prior to the date of determination as reported in The Wall Street Journal; (b) if such Common Stock is publicly traded and is then listed on a national securities exchange, its closing price on the last trading day prior to the date of determination on the principal national securities exchange on which the Common Stock is listed or admitted to trading as reported in The Wall Street Journal; (c) if such Common Stock is publicly traded but is not quoted on the Nasdaq National Market nor listed or admitted to trading on a national securities exchange, the average of the closing bid and asked prices on the last trading day prior to the date of determination as reported in The Wall Street Journal; or (d) if none of the foregoing is applicable, by the Committee in good faith. "INSIDER" means an officer or director of the Company or any other person whose transactions in the Company's Common Stock are subject to Section 16 of the Exchange Act. "OUTSIDE DIRECTOR" means any director who is not: (a) a current employee of the Company or any Parent, Subsidiary or Affiliate of the Company; (b) a former employee of the Company or any Parent, Subsidiary or Affiliate of the Company who is receiving compensation for prior services (other than benefits under a tax-qualified pension plan); (c) a current or former officer of the Company or any Parent, Subsidiary or Affiliate of the Company; or (d) currently receiving compensation for personal services in any capacity, other than as a director, from the Company or any Parent, Subsidiary or Affiliate of the Company; provided, however, that at such time as the term "Outside Director," as used in Section 162(m) of the Code is defined in regulations promulgated under Section 162(m) of the Code, "Outside Director" will have the -14- 15 meaning set forth in such regulations, as amended from time to time and as interpreted by the Internal Revenue Service. "OPTION" means an award of an option to purchase Shares pursuant to Section 5. "PARENT" means any corporation (other than the Company) in an unbroken chain of corporations ending with the Company, if at the time of the granting of an Award under this Plan, each of such corporations other than the Company owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. "PARTICIPANT" means a person who receives an Award under this Plan. "PLAN" means this ESS Technology, Inc. 1995 Equity Incentive Plan, as amended from time to time. "RESTRICTED STOCK AWARD" means an award of Shares pursuant to Section 6. "SEC" means the Securities and Exchange Commission. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SHARES" means shares of the Company's Common Stock reserved for issuance under this Plan, as adjusted pursuant to Sections 2 and 18, and any successor security. "STOCK BONUS" means an award of Shares, or cash in lieu of Shares, pursuant to Section 7. "SUBSIDIARY" means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, at the time of granting of the Award, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. "TERMINATION" or "TERMINATED" means, for purposes of this Plan with respect to a Participant, that the Participant has for any reason ceased to provide services as an employee, director, consultant, independent contractor or advisor to the Company or a Parent, Subsidiary or Affiliate of the Company, except in the case of sick leave, military leave, or any other leave of absence approved by the Committee, provided that such leave is for a period of not more than ninety (90) days, or reinstatement upon the expiration of such leave is guaranteed by contract or statute. The Committee will have sole discretion to determine whether a Participant has ceased to provide services and the effective date on which the Participant ceased to provide services (the "TERMINATION DATE"). -15- EX-10.05 4 1995 EMPLOYEE STOCK PURCHASE PLAN 1 EXHIBIT 10.05 ESS TECHNOLOGY, INC. 1995 EMPLOYEE STOCK PURCHASE PLAN (AS AMENDED ON JULY 18, 1998) 1. ESTABLISHMENT OF PLAN. ESS Technology, Inc., a California corporation (the "COMPANY"), proposes to grant options for purchase of the Company's Common Stock to eligible employees of the Company and its Subsidiaries (as hereinafter defined) pursuant to this Employee Stock Purchase Plan (this "PLAN"). For purposes of this Plan, "PARENT CORPORATION" and "SUBSIDIARY" (collectively, "SUBSIDIARIES") shall have the same meanings as "parent corporation" and "subsidiary corporation" in Sections 424(e) and 424(f), respectively, of the Internal Revenue Code of 1986, as amended (the "CODE"). The Company intends this Plan to qualify as an "employee stock purchase plan" under Section 423 of the Code (including any amendments to or replacements of such Section), and this Plan shall be so construed. Any term not expressly defined in this Plan but defined for purposes of Section 423 of the Code shall have the same definition herein. A total of 425,000 shares of the Company's Common Stock is reserved for issuance under this Plan. Such number shall be subject to adjustments effected in accordance with Section 14 of this Plan. 2. PURPOSE. The purpose of this Plan is to provide employees of the Company and Subsidiaries designated by the Board of Directors of the Company (the "BOARD") as eligible to participate in this Plan with a convenient means of acquiring an equity interest in the Company through payroll deductions, to enhance such employees' sense of participation in the affairs of the Company and Subsidiaries, and to provide an incentive for continued employment. 3. ADMINISTRATION. This Plan shall be administered by a committee appointed by the Board (the "COMMITTEE") consisting of at least two (2) members of the Board, each of whom is a Disinterested Person as defined in Rule 16b-3(d) of the Securities Exchange Act of 1934 (the "EXCHANGE ACT"). As used in this Plan, references to the "Committee" shall mean either such committee or the Board if no committee has been established. After registration of the Company under the Exchange Act, Board members who are not Disinterested Persons may not vote on any matters affecting the administration of this Plan, but any such member may be counted for determining the existence of a quorum at any meeting of the Board. Subject to the provisions of this Plan and the limitations of Section 423 of the Code or any successor provision in the Code, all questions of interpretation or application of this Plan shall be determined by the Board and its decisions shall be final and binding upon all participants. Members of the Board shall receive no compensation for their services in connection with the administration of this Plan, other than standard fees as established from time to time by the Board for services rendered by Board members serving on Board committees. All expenses incurred in connection with the administration of this Plan shall be paid by the Company. 4. ELIGIBILITY. Any employee of the Company or the Subsidiaries is eligible to participate in an Offering Period (as hereinafter defined) under this Plan except the following: 2 (a) employees who are not employed by the Company or Subsidiaries one (1) month before the beginning of such Offering Period; (b) employees who are customarily employed for less than twenty (20) hours per week; (c) employees who are customarily employed for less than five (5) months in a calendar year; (d) employees who, together with any other person whose stock would be attributed to such employee pursuant to Section 424(d) of the Code, own stock or hold options to purchase stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or any of its Subsidiaries or who, as a result of being granted an option under this Plan with respect to such Offering Period, would own stock or hold options to purchase stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or any of its Subsidiaries. 5. OFFERING DATES. The offering periods of this Plan (each, an "Offering Period") shall be of six (6) months duration commencing on May 1 and November 1 of each year and ending on July 31 and January 31 of each year; provided, however, that notwithstanding the foregoing, the first such Offering Period shall commence on the first business day after the date on which the registration statement filed by the Company with the Securities and Exchange Commission ("SEC") under the Securities Act of 1933, as amended (the "Securities Act") registering the initial public offering of the Company's Common Stock is declared effective by the SEC (the "First Offering Date") and shall end on January 31. Each Offering Period shall consist of one (1) six-month purchase period (individually, a Purchase Period") during which payroll deductions of the participants are accumulated under this Plan. The first business day of each Offering Period is referred to as the "OFFERING DATE." The last business day of each Purchase Period is referred to as the "PURCHASE DATE." The Board shall have the power to change the duration of Offering Periods or Purchase Periods with respect to future offerings without stockholder approval if such change is announced at least fifteen (15) days prior to the scheduled beginning of the first Offering Period or Purchase Period to be affected. 6. PARTICIPATION IN THIS PLAN. Eligible employees may become participants in an Offering Period under this Plan on the first Offering Date after satisfying the eligibility requirements by delivering a subscription agreement to the Company's treasury department (the "TREASURY DEPARTMENT") not later than the 15th day of the month before such Offering Date unless a later time for filing the subscription agreement authorizing payroll deductions is set by the Board for all eligible employees with respect to a given Offering Period. An eligible employee who does not deliver a subscription agreement to the Treasury Department by such date after becoming eligible to participate in such Offering Period shall not participate in that Offering Period or any subsequent Offering Period unless such employee enrolls in this Plan by filing a subscription agreement with the Treasury Department not later than the 15th day of the month preceding a subsequent Offering Date. Once an employee becomes a participant in an Offering Period, such employee will automatically participate in the Offering Period -2- 3 commencing immediately following the last day of the prior Offering Period unless the employee withdraws or is deemed to withdraw from this Plan or terminates further participation in the Offering Period as set forth in Section 11 below. Such participant is not required to file any additional subscription agreement in order to continue participation in this Plan. 7. GRANT OF OPTION ON ENROLLMENT. Enrollment by an eligible employee in this Plan with respect to an Offering Period will constitute the grant (as of the Offering Date) by the Company to such employee of an option to purchase on the Purchase Date up to that number of shares of Common Stock of the Company determined by dividing (a) the amount accumulated in such employee's payroll deduction account during such Purchase Period by (b) the lower of (i) eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Offering Date (but in no event less than the par value of a share of the Company's Common Stock), or (ii) eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Purchase Date (but in no event less than the par value of a share of the Company's Common Stock); provided, however, that the number of shares of the Company's Common Stock subject to any option granted pursuant to this Plan shall not exceed the lesser of (a) the maximum number of shares set by the Board pursuant to Section 10(c) below with respect to the applicable Offering Period, or (b) the maximum number of shares which may be purchased pursuant to Section 10(b) below with respect to the applicable Offering Period. The fair market value of a share of the Company's Common Stock shall be determined as provided in Section 8 hereof. 8. PURCHASE PRICE. The purchase price per share at which a share of Common Stock will be sold in any Offering Period shall be eighty-five percent (85%) of the lesser of: (a) The fair market value on the Offering Date; or (b) The fair market value on the Purchase Date; provided, however, that in no event may the purchase price per share of the Company's Common Stock be below the par value per share of the Company's Common Stock. For purposes of this Plan, the term "fair market value" on a given date shall mean the fair market value of the Company's Common Stock as determined by the Board in its sole discretion, exercised in good faith; provided, however, that where there is a public market for the Common Stock, the fair market value per share shall be the average of the last reported bid and asked prices of the Common Stock on the last trading day prior to the date of determination (or the average closing price over the number of consecutive trading days preceding the date of determination as the Board shall deem appropriate), or, in the event the Common Stock is listed on a stock exchange or on the Nasdaq National Market, the fair market value per share shall be the closing price on such exchange or quotation system on the last trading date prior to the date of determination (or the average closing price over the number of consecutive trading days preceding the date of determination as the Board shall deem appropriate); and provided further, that notwithstanding the foregoing, the fair market value of the Company's Common Stock on the First Offering Date (which is the first business day of the first Offering Period under this Plan) shall be deemed to be the price per share at which shares of the Company's Common Stock -3- 4 are initially offered for sale to the public in the Company's initial public offering of its Common Stock pursuant to a registration statement filed with the SEC under the Securities Act 9. PAYMENT OF PURCHASE PRICE; CHANGES IN PAYROLL DEDUCTIONS; ISSUANCE OF SHARES. (a) The purchase price of the shares is accumulated by regular payroll deductions made during each Offering Period. The deductions are made as a percentage of the participant's compensation in one percent (1%) increments not less than two percent (2%), nor greater than ten percent (10%) or such lower limit set by the Committee. Compensation shall mean all W-2 compensation, including, but not limited to base salary, wages, commissions, overtime, shift premiums and bonuses, plus draws against commissions; provided, however, that for purposes of determining a participant's compensation, any election by such participant to reduce his or her regular cash remuneration under Sections 125 or 401(k) of the Code shall be treated as if the participant did not make such election. Payroll deductions shall commence on the first payday following the Offering Date and shall continue to the end of the Offering Period unless sooner altered or terminated as provided in this Plan. (b) A participant may lower (but not increase) the rate of payroll deductions during an Offering Period by filing with the Treasury Department a new authorization for payroll deductions, in which case the new rate shall become effective for the next payroll period commencing more than fifteen (15) days after the Treasury Department's receipt of the authorization and shall continue for the remainder of the Offering Period unless changed as described below. Such change in the rate of payroll deductions may be made at any time during an Offering Period, but not more than one (1) change may be made effective during any Offering Period. A participant may increase or decrease the rate of payroll deductions for any subsequent Offering Period by filing with the Treasury Department a new authorization for payroll deductions not later than the 15th day of the month before the beginning of such Offering Period. (c) All payroll deductions made for a participant are credited to his or her account under this Plan and are deposited with the general funds of the Company. No interest accrues on the payroll deductions. All payroll deductions received or held by the Company may be used by the Company for any corporate purpose, and the Company shall not be obligated to segregate such payroll deductions. (d) On each Purchase Date, so long as this Plan remains in effect and provided that the participant has not submitted a signed and completed withdrawal form before that date which notifies the Company that the participant wishes to withdraw from that Offering Period under this Plan and have all payroll deductions accumulated in the account maintained on behalf of the participant as of that date returned to the participant, the Company shall apply the funds then in the participant's account to the purchase of whole shares of Common Stock reserved under the option granted to such participant with respect to the Offering Period to the extent that such option is exercisable on the Purchase Date. The purchase price per share shall be as specified in Section 8 of this Plan. Any cash remaining in a participant's account after such purchase of shares shall be refunded to such participant in cash, without interest. In the event -4- 5 that this Plan has been oversubscribed, all funds not used to purchase shares on the Purchase Date shall be returned to the participant, without interest. No Common Stock shall be purchased on a Purchase Date on behalf of any employee whose participation in this Plan has terminated prior to such Purchase Date. (e) As promptly as practicable after the Purchase Date, the Company shall arrange the delivery to each participant of a certificate representing the shares purchased upon exercise of his option. (f) During a participant's lifetime, such participant's option to purchase shares hereunder is exercisable only by him or her. The participant will have no interest or voting right in shares covered by his or her option until such option has been exercised. Shares to be delivered to a participant under this Plan will be registered in the name of the participant or in the name of the participant and his or her spouse. 10. LIMITATIONS ON SHARES TO BE PURCHASED. (a) No employee shall be entitled to purchase stock under this Plan at a rate which, when aggregated with his or her rights to purchase stock under all other employee stock purchase plans of the Company or any Subsidiary, exceeds $25,000 in fair market value, determined as of the Offering Date (or such other limit as may be imposed by the Code) for each calendar year in which the employee participates in this Plan. (b) No more than two hundred percent (200%) of the number of shares determined by using eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Offering Date as the denominator may be purchased by a participant on any single Purchase Date. (c) No employee shall be entitled to purchase more than the Maximum Share Amount (as defined below) on any single Purchase Date. Not less than thirty (30) days prior to the commencement of any Offering Period, the Board may, in its sole discretion, set a maximum number of shares which may be purchased by any employee at any single Purchase Date, which until changed by the Board shall be 250 Shares of Common Stock (hereinafter the "MAXIMUM SHARE AMOUNT"). In no event shall the Maximum Share Amount exceed the amounts permitted under Section 10(b) above. If a new Maximum Share Amount is set, then all participants must be notified of such Maximum Share Amount not less than fifteen (15) days prior to the commencement of the next Offering Period. Once the Maximum Share Amount is set, it shall continue to apply with respect to all succeeding Purchase Dates and Offering Periods unless revised by the Board as set forth above. (d) If the number of shares to be purchased on a Purchase Date by all employees participating in this Plan exceeds the number of shares then available for issuance under this Plan, then the Company will make a pro rata allocation of the remaining shares in as uniform a manner as shall be reasonably practicable and as the Board shall determine to be equitable. In such event, the Company shall give written notice of such reduction of the number of shares to be purchased under a participant's option to each participant affected thereby. -5- 6 (e) Any payroll deductions accumulated in a participant's account which are not used to purchase stock due to the limitations in this Section 10 shall be returned to the participant as soon as practicable after the end of the applicable Purchase Period, without interest. 11. WITHDRAWAL. (a) Each participant may withdraw from an Offering Period under this Plan by signing and delivering to the Treasury Department a written notice to that effect on a form provided for such purpose. Such withdrawal may be elected at any time at least fifteen (15) days prior to the end of an Offering Period. (b) Upon withdrawal from this Plan, the accumulated payroll deductions shall be returned to the withdrawn participant, without interest, and his or her interest in this Plan shall terminate. In the event a participant voluntarily elects to withdraw from this Plan, he or she may not resume his or her participation in this Plan during the same Offering Period, but he or she may participate in any Offering Period under this Plan which commences on a date subsequent to such withdrawal by filing a new authorization for payroll deductions in the same manner as set forth above for initial participation in this Plan. 12. TERMINATION OF EMPLOYMENT. Termination of a participant's employment for any reason, including retirement, death or the failure of a participant to remain an eligible employee, immediately terminates his or her participation in this Plan. In such event, the payroll deductions credited to the participant's account will be returned to him or her or, in the case of his or her death, to his or her legal representative, without interest. For purposes of this Section 12, an employee will not be deemed to have terminated employment or failed to remain in the continuous employ of the Company in the case of sick leave, military leave, or any other leave of absence approved by the Board; provided that such leave is for a period of not more than ninety (90) days or reemployment upon the expiration of such leave is guaranteed by contract or statute. 13. RETURN OF PAYROLL DEDUCTIONS. In the event a participant's interest in this Plan is terminated by withdrawal, termination of employment or otherwise, or in the event this Plan is terminated by the Board, the Company shall promptly deliver to the participant all payroll deductions credited to such participant's account. No interest shall accrue on the payroll deductions of a participant in this Plan. 14. CAPITAL CHANGES. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each option under this Plan which has not yet been exercised and the number of shares of Common Stock which have been authorized for issuance under this Plan but have not yet been placed under option (collectively, the "RESERVES"), as well as the price per share of Common Stock covered by each option under this Plan which has not yet been exercised, shall be proportionately adjusted for any increase or decrease in the number of issued and outstanding shares of Common Stock of the Company resulting from a stock split or the payment of a stock dividend (but only on the Common Stock) or any other increase or decrease in the number of issued and outstanding shares of Common Stock effected without receipt of any consideration by the Company; provided, however, that -6- 7 conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration"; and provided further, that the price per share of Common Stock shall not be reduced below its par value per share. Such adjustment shall be made by the Board, whose determination shall be final, binding and conclusive. Except as expressly provided herein, no issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an option. In the event of the proposed dissolution or liquidation of the Company, the Offering Period will terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Board. The Board may, in the exercise of its sole discretion in such instances, declare that the options under this Plan shall terminate as of a date fixed by the Board and give each participant the right to exercise his or her option as to all of the optioned stock, including shares which would not otherwise be exercisable. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger or consolidation of the Company with or into another corporation, each option under this Plan shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Board determines, in the exercise of its sole discretion and in lieu of such assumption or substitution, that the participant shall have the right to exercise the option as to all of the optioned stock. If the Board makes an option exercisable in lieu of assumption or substitution in the event of a merger, consolidation or sale of assets, the Board shall notify the participant that the option shall be fully exercisable for a period of twenty (20) days from the date of such notice, and the option will terminate upon the expiration of such period. The Board may, if it so determines in the exercise of its sole discretion, also make provision for adjusting the Reserves, as well as the price per share of Common Stock covered by each outstanding option, in the event that the Company effects one or more reorganizations, recapitalizations, rights offerings or other increases or reductions of shares of its outstanding Common Stock, or in the event of the Company being consolidated with or merged into any other corporation; provided, that the price per share of Common Stock shall not be reduced below its par value per share. 15. NONASSIGNABILITY. Neither payroll deductions credited to a participant's account nor any rights with regard to the exercise of an option or to receive shares under this Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section 22 hereof) by the participant. Any such attempt at assignment, transfer, pledge or other disposition shall be void and without effect. 16. REPORTS. Individual accounts will be maintained for each participant in this Plan. Each participant shall receive promptly after the end of each Purchase Period a report of his or her account setting forth the total payroll deductions accumulated, the number of shares purchased, the per share price thereof and the remaining cash balance. if any, carried forward to the next Purchase Period or Offering Period, as the case may be. -7- 8 17. NOTICE OF DISPOSITION. Each participant shall notify the Company if the participant disposes of any of the shares purchased in any Offering Period pursuant to this Plan if such disposition occurs within two (2) years from the Offering Date or within one (1) year from the Purchase Date on which such shares were purchased (the "NOTICE Period"). Unless such participant is disposing of any of such shares during the Notice Period, such participant shall keep the certificates representing such shares in his or her name (and not in the name of a nominee) during the Notice Period. The Company may, at any time during the Notice Period, place a legend or legends on any certificate representing shares acquired pursuant to this Plan requesting the Company's transfer agent to notify the Company of any transfer of the shares. The obligation of the participant to provide such notice shall continue notwithstanding the placement of any such legend on the certificates. 18. NO RIGHTS TO CONTINUED EMPLOYMENT. Neither this Plan nor the grant of any option hereunder shall confer any right on any employee to remain in the employ of the Company or any Subsidiary, or restrict the right of the Company or any Subsidiary to terminate such employee's employment. 19. EQUAL RIGHTS AND PRIVILEGES. All eligible employees shall have equal rights and privileges with respect to this Plan so that this Plan qualifies as an "employee stock purchase plan" within the meaning of Section 423 or any successor provision of the Code and the related regulations. Any provision of this Plan which is inconsistent with Section 423 or any successor provision of the Code shall, without further act or amendment by the Company or the Board, be reformed to comply with the requirements of Section 423. This Section 19 shall take precedence over all other provisions in this Plan. 20. NOTICES. All notices or other communications by a participant to the Company under or in connection with this Plan shall be deemed to have been duly given when received in the form specified by the Company at the location, or by the person, designated by the Company for the receipt thereof. 21. TERM; STOCKHOLDER APPROVAL. After this Plan is adopted by the Board, this Plan will become effective on the date that is the First Offering Date (as defined above); provided, however, that if the First Offering Date does not occur on or before December 31, 1995, this Plan will terminate as of December 31, 1995 having never become effective. This Plan shall be approved by the stockholders of the Company, in any manner permitted by applicable corporate law, within twelve (12) months before or after the date this Plan is adopted by the Board. No purchase of shares pursuant to this Plan shall occur prior to such stockholder approval. Thereafter, no later than twelve (12) months after the Company becomes subject to Section 16(b) of the Exchange Act, the Company will comply with the requirements of Rule 16b-3 with respect to stockholder approval. This Plan shall continue until the earlier to occur of (a) termination of this Plan by the Board (which termination may be effected by the Board at any time), (b) issuance of all of the shares of Common Stock reserved for issuance under this Plan, or (c) ten (10) years from the adoption of this Plan by the Board. 22. DESIGNATION OF BENEFICIARY. -8- 9 (a) A participant may file a written designation of a beneficiary who is to receive any shares and cash, if any, from the participant's account under this Plan in the event of such participant's death subsequent to the end of an Purchase Period but prior to delivery to him of such shares and cash. In addition, a participant may file a written designation of a beneficiary who is to receive any cash from the participant's account under this Plan in the event of such participant's death prior to a Purchase Date. (b) Such designation of beneficiary may be changed by the participant at any time by written notice. In the event of the death of a participant and in the absence of a beneficiary validly designated under this Plan who is living at the time of such participant's death, the Company shall deliver such shares or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such shares or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate. 23. CONDITIONS UPON ISSUANCE OF SHARES; LIMITATION ON SALE OF SHARES. Shares shall not be issued with respect to an option unless the exercise of such option and the issuance and delivery of such shares pursuant thereto shall comply with all applicable provisions of law, domestic or foreign, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange or automated quotation system upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. 24. APPLICABLE LAW. The Plan shall be governed by the substantive laws (excluding the conflict of laws rules) of the State of California. 25. AMENDMENT OR TERMINATION OF THIS PLAN. The Board may at any time amend, terminate or the extend the term of this Plan, except that any such termination cannot affect options previously granted under this Plan, nor may any amendment make any change in an option previously granted which would adversely affect the right of any participant, nor may any amendment be made without approval of the stockholders of the Company obtained in accordance with Section 21 hereof within twelve (12) months of the adoption of such amendment (or earlier if required by Section 21) if such amendment would: (a) increase the number of shares that may be issued under this Plan; (b) change the designation of the employees (or class of employees) eligible for participation in this Plan; or (c) constitute an amendment for which stockholder approval is required in order to comply with Rule 16b-3 (or any successor rule) of the Exchange Act. -9- 10 ESS TECHNOLOGY, INC. 1995 EMPLOYEE STOCK PURCHASE PLAN ENROLLMENT FORM Check One: Complete: [ ] New Enrollment Social Security No._________________________ [ ] Change Social Security No._________________________ 1. Name of Participant ____________________________________________________________ 2. Stock purchased under the Plan should be held in account with the Plan Broker in my name or in my name together with the names(s) indicated below: Name _____________________ Social Security No._________________________ Name _____________________ Social Security No._________________________ If spouse (circle one): Joint Tenants/Community Property PLEASE NOTIFY THE PLAN BROKER DIRECTLY TO TRANSFER OR SELL YOUR STOCK. 3. Payroll Deduction Level (from 2% to 10% in whole percentages): (deductions will be made from your total compensation which equals base salary, bonuses, overtime pay and commissions) 4. I confirm my spouse's interest (if married) in the community property herein, and I hereby designate the following person(s) as my beneficiary(ies) to receive all payments and/or stock attributable to my interest under the Plan: NAME *To be ADDRESS divided as follows: _____________________________________ _______________ _________________________________ Last First M.I. Number Street _____________________________________ _________________________________ Social Security No. Relationship City State Zip _____________________________________ _______________ _________________________________ Last First M.I. Number Street _____________________________________ _________________________________ Social Security No. Relationship City State Zip
*If more than one beneficiary: (1) insert "in equal shares," or (2) insert percentage to be paid to each beneficiary. 5. The information provided on this Enrollment Form will remain in effect unless and until I complete and submit to the Human Resources Department a new enrollment form. ESS TECHNOLOGY, INC. OFFICE USE: Signature: ________________________ Date received by the Human Resource Dept.: ___________________ Name: _____________________________ Date entered into system: ___________________________ Date: _____________________________ PLEASE RETURN THIS FORM TO THE HUMAN RESOURCES DEPARTMENT. 11 ESS TECHNOLOGY, INC. 1995 EMPLOYEE STOCK PURCHASE PLAN SUBSCRIPTION AGREEMENT 1. I elect to participate in the ESS Technology, Inc. (the "Company") 1995 Employee Stock Purchase Plan (the "Plan") and to subscribe to purchase shares of the Company's Common Stock (the "Shares") in accordance with this Subscription Agreement and the Plan. 2. I authorize payroll deductions from each of my paychecks in that percentage of my gross compensation as shown on my Enrollment Form, in accordance with the Plan. 3. I understand that such payroll deductions shall be accumulated for the purchase of Shares under the Plan at the applicable purchase price determined in accordance with the Plan. I further understand that except as otherwise set forth in the Plan, Shares will be purchased for me automatically at the end of each Purchase Period unless I withdraw from the Plan or otherwise become ineligible to participate in the Plan. 4. I understand that this Subscription Agreement will automatically re-enroll me in all subsequent Offering Periods unless I withdraw from the Plan or I become ineligible to participate in the Plan. 5. I acknowledge that I have a copy of and am familiar with the Plan. I understand that a Prospectus describing the securities issuable under the Plan will be distributed to me upon the filing by the Company of a Registration Statement with the Securities and Exchange Commission with respect to the Plan. 6. I understand that Shares purchased for me under the Plan will be held in a personal account with the Plan Broker unless I request otherwise. 7. I hereby agree to be bound by the terms of the Plan. The effectiveness of this Subscription Agreement is dependent upon my eligibility to participate in the Plan. 8. I have read and understood this Subscription Agreement. Signature:______________________________ Name:___________________________________ Date:___________________________________ 12 PLEASE RETURN THIS FORM TO THE HUMAN RESOURCES DEPARTMENT. EX-10.30 5 1997 EQUITY INCENTIVE PLAN 1 EXHIBIT 10.30 ESS TECHNOLOGY, INC. 1997 EQUITY INCENTIVE PLAN (AS AMENDED ON JULY 18, 1998) 1. PURPOSES OF THE PLAN. The purposes of this Equity Incentive Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to the Employees and Consultants of the Company and to promote the success of the Company's business. Options granted hereunder may be either Incentive Stock Options (as defined under Section 422 of the Code) or Nonstatutory Stock Options, at the discretion of the Board and as reflected in the terms of the written option agreement. 2. DEFINITIONS. As used herein, the following definitions shall apply: (a) "Administrator" shall mean the Board or any of its Committees appointed pursuant to Section 4 of the Plan. (b) "Affiliate" shall mean an entity other than a Subsidiary (as defined below) in which the Company owns an equity interest. (c) "Applicable Laws" shall have the meaning set forth in Section 4(a) below. (d) "Board" shall mean the Board of Directors of the Company. (e) "Code" shall mean the Internal Revenue Code of 1986, as amended. (f) "Committee" shall mean the Committee appointed by the Board of Directors in accordance with Section 4(a) of the Plan, if one is appointed. (g) "Common Stock" shall mean the Common Stock of the Company. (h) "Company" shall mean ESS Technology, Inc., a California corporation. (i) "Consultant" means any person, including an advisor, who is engaged by the Company or any Parent or Subsidiary to render services and is compensated for such services, and any director of the Company whether compensated for such services or not. (j) "Continuous Status as an Employee or Consultant" shall mean the absence of any interruption or termination of service as an Employee or Consultant. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of sick leave, military leave, or any other leave of absence approved by the Administrator; provided that such leave is for a period of not more than 90 days or reemployment upon the expiration of such leave is guaranteed by contract or statute. For purposes of this Plan, a change in status from an 2 Employee to a Consultant or from a Consultant to an Employee will not constitute a termination of employment. (k) "Director" shall mean a member of the Board. (l) "Employee" shall mean any person (including any Named Executive, Officer or Director) employed by the Company or any Parent, Subsidiary or Affiliate of the Company. The payment by the Company of a director's fee to a Director shall not be sufficient to constitute "employment" of such Director by the Company. (m) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (n) "Fair Market Value" means, as of any date, the value of Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system including without limitation the National Market of the National Association of Securities Dealers, Inc. Automated Quotation ("Nasdaq") System, its Fair Market Value shall be the closing sales price for such stock as quoted on such system on the date of determination (as defined in paragraph (iv) below) (if for a given day no sales were reported, the closing bid on that day shall be used), as such price is reported in The Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is quoted on the Nasdaq System (but not on the National Market thereof) or regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the bid and asked prices for the Common Stock; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator. (iv) For purposes of this Plan, the date of determination shall mean the last trading date prior to the date of grant (as determined pursuant to Section 15 of this Plan). (o) "Incentive Stock Option" shall mean an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code, as designated in the applicable written option agreement. (p) "Named Executive" shall mean any individual who, on the last day of the Company's fiscal year, is the chief executive officer of the Company (or is acting in such capacity) or among the four highest compensated officers of the Company (other than the chief executive officer). Such officer status shall be determined pursuant to the executive compensation disclosure rules under the Exchange Act. -2- 3 (q) "Nonstatutory Stock Option" shall mean an Option not intended to qualify as an Incentive Stock Option, as designated in the applicable written option agreement. (r) "Officer" shall mean a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (s) "Option" shall mean a stock option granted pursuant to the Plan. (t) "Optioned Stock" shall mean the Common Stock subject to an Option. (u) "Optionee" shall mean an Employee or Consultant who receives an Option. (v) "Parent" shall mean a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (w) "Plan" shall mean this 1997 Equity Incentive Plan. (x) "Rule 16b-3" shall mean Rule 16b-3 promulgated under the Exchange Act as the same may be amended from time to time, or any successor provision. (y) "Share" shall mean a share of the Common Stock, as adjusted in accordance with Section 14 of the Plan. (z) "Subsidiary" shall mean a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. STOCK SUBJECT TO THE PLAN. Subject to the provisions of Section 14 of the Plan, the maximum aggregate number of shares that may be optioned and sold under the Plan is 5,000,000 shares of Common Stock. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option should expire or become unexercisable for any reason without having been exercised in full, the unpurchased Shares that were subject thereto shall, unless the Plan shall have been terminated, become available for future grant under the Plan. Notwithstanding any other provision of the Plan, shares issued under the Plan and later repurchased by the Company shall not become available for future grant under the Plan. 4. ADMINISTRATION OF THE PLAN. (a) COMPOSITION OF ADMINISTRATOR. (i) MULTIPLE ADMINISTRATIVE BODIES. If permitted by Rule 16b-3, and by the legal requirements relating to the administration of incentive stock option plans, if any, of applicable securities laws and the Code (collectively, the "Applicable Laws"), grants under the -3- 4 Plan may (but need not) be made by different administrative bodies with respect to Directors, Officers who are not directors and Employees who are neither Directors nor Officers. (ii) ADMINISTRATION WITH RESPECT TO DIRECTORS AND OFFICERS. With respect to grants of Options to Employees or Consultants who are also Officers or Directors of the Company, grants under the Plan shall be made by (A) the Board, if the Board may make grants under the Plan in compliance with Rule 16b-3 and Section 162(m) of the Code as it applies so as to qualify grants of Options to Named Executives as performance-based compensation, or (B) a Committee designated by the Board to make grants under the Plan, which Committee shall be constituted in such a manner as to permit grants under the Plan to comply with Rule 16b-3, to qualify grants of Options to Named Executives as performance-based compensation under Section 162(m) of the Code and otherwise so as to satisfy the Applicable Laws. (iii) ADMINISTRATION WITH RESPECT TO OTHER PERSONS. With respect to grants of Options to Employees or Consultants who are neither Directors nor Officers of the Company, the Plan shall be administered by (A) the Board or (B) a Committee designated by the Board, which Committee shall be constituted in such a manner as to satisfy the Applicable Laws. (iv) GENERAL. If a Committee has been appointed pursuant to subsection (ii) or (iii) of this Section 4(a), such Committee shall continue to serve in its designated capacity until otherwise directed by the Board. From time to time the Board may increase the size of any Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies (however caused) and remove all members of a Committee and thereafter directly administer the Plan, all to the extent permitted by the Applicable Laws and, in the case of a Committee appointed under subsection (ii), to the extent permitted by Rule 16b-3 and to the extent required under Section 162(m) of the Code to qualify grants of Options to Named Executives as performance-based compensation. (b) POWERS OF THE ADMINISTRATOR. Subject to the provisions of the Plan and in the case of a Committee, the specific duties delegated by the Board to such Committee, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(n) of the Plan; (ii) to select the Employees and Consultants to whom Options may from time to time be granted hereunder; (iii) to determine whether and to what extent Options are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; -4- 5 (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, the share price and any restriction or limitation, or any vesting acceleration or waiver of forfeiture restrictions regarding any Option and/or the shares of Common Stock relating thereto, based in each case on such factors as the Administrator shall determine, in its sole discretion); (vii) to reduce the exercise price of any Option to the then current Fair Market Value if the Fair Market Value of the Common Stock covered by such Option shall have declined since the date the Option was granted. (c) EFFECT OF ADMINISTRATOR'S DECISION. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options. 5. ELIGIBILITY. (a) RECIPIENTS OF GRANTS. Nonstatutory Stock Options may be granted to Employees and Consultants. Incentive Stock Options may be granted only to Employees, provided, however, that Employees of an Affiliate shall not be eligible to receive Incentive Stock Options. An Employee or Consultant who has been granted an Option may, if he or she is otherwise eligible, be granted an additional Option or Options. (b) TYPE OF OPTION. Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designations, to the extent that the aggregate Fair Market Value of Shares with respect to which Incentive Stock Options are exercisable for the first time by an Optionee during any calendar year (under all plans of the Company or any Parent or Subsidiary) exceeds $100,000, such excess Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 5(b), Incentive Stock Options shall be taken into account in the order in which they were granted, and the Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. (c) NO EMPLOYMENT RIGHTS. The Plan shall not confer upon any Optionee any right with respect to continuation of employment or consulting relationship with the Company, nor shall it interfere in any way with his or her right or the Company's right to terminate his or her employment or consulting relationship at any time, with or without cause. 6. TERM OF PLAN. The Plan shall become effective upon the earlier to occur of its adoption by the Board or its approval by the shareholders of the Company as described in Section 20 of the Plan. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 16 of the Plan. 7. TERM OF OPTION. The term of each Option shall be no more than ten (10) years from the date of grant thereof or such shorter term as may be provided in the Option Agreement. -5- 6 However, in the case of an Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant thereof or such shorter term as may be provided in the Option Agreement. 8. LIMITATION ON GRANTS TO EMPLOYEES. Subject to adjustment as provided in this Plan, the maximum number of Shares which may be subject to options granted to any one Employee under this Plan for any fiscal year of the Company shall be 375,000, except that new employees of the Company or of a Parent or Subsidiary of the Company (including new employees who are also officers and directors of the Company or any Parent or Subsidiary of the Company) are eligible to receive up to a maximum of 750,000 Shares in the calendar year in which they commence their employment. 9. OPTION EXERCISE PRICE AND CONSIDERATION. (a) EXERCISE PRICE. The per Share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Administrator, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of the grant of such Incentive Stock Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of determination; or (B) granted to any other Employee, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of determination. (ii) In the case of a Nonstatutory Stock Option, the per share Exercise Price shall be no less than 100% of the Fair Market Value on the date of determination. (iii) Notwithstanding anything to the contrary in subsections 9(a)(i) or 9(a)(ii) above, in the case of an Option granted on or after the effective date of registration of any class of equity security of the Company pursuant to Section 12 of the Exchange Act and prior to six months after the termination of such registration, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of determination. (b) PERMISSIBLE CONSIDERATION. The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant) and may consist entirely of (1) cash, (2) check, (3) promissory note, (4) other Shares that (x) in the case of Shares acquired upon exercise of an Option either have been owned by the Optionee for more than six months on the date of surrender or were not acquired, directly or indirectly, from the Company, and (y) have a Fair Market Value on the date of surrender equal -6- 7 to the aggregate exercise price of the Shares as to which said Option shall be exercised, (5) authorization from the Company to retain from the total number of Shares as to which the Option is exercised that number of Shares having a Fair Market Value on the date of exercise equal to the exercise price for the total number of Shares as to which the Option is exercised, (6) delivery of a properly executed exercise notice together with irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds required to pay the exercise price, (7) any combination of the foregoing methods of payment, or (8) such other consideration and method of payment for the issuance of Shares to the extent permitted under Applicable Laws. In making its determination as to the type of consideration to accept, the Administrator shall consider if acceptance of such consideration may be reasonably expected to benefit the Company. 10. EXERCISE OF OPTION. (a) PROCEDURE FOR EXERCISE; RIGHTS AS A SHAREHOLDER. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Administrator, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Administrator, consist of any consideration and method of payment allowable under Section 9(b) of the Plan. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a shareholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such stock certificate promptly upon exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 14 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) TERMINATION OF STATUS AS AN EMPLOYEE OR CONSULTANT. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant, such Optionee may, but only within thirty (30) days (or such other period of time, not exceeding three (3) months in the case of an Incentive Stock Option or six (6) months in the case of a Nonstatutory Stock Option, as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option) after the date of such termination (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), exercise his or her Option to the extent that he or she was -7- 8 entitled to exercise it at the date of such termination. To the extent that the Optionee was not entitled to exercise the Option at the date of such termination, or if the optionee does not exercise such Option (which he or she was entitled to exercise) within the time specified herein, the Option shall terminate. (c) DISABILITY OF OPTIONEE. Notwithstanding Section 10(b) above, in the event of termination of an Optionee's Continuous Status as an Employee or Consultant as a result of his or her total and permanent disability (as defined in Section 22(e)(3) of the Code), he or she may, but only within six (6) months (or such other period of time not exceeding twelve (12) months as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option) from the date of such termination (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), exercise his or her Option to the extent he or she was entitled to exercise it at the date of such termination. To the extent that he or she was not entitled to exercise the Option at the date of termination, or if he does not exercise such Option (which he was entitled to exercise) within the time specified herein, the Option shall terminate. (d) DEATH OF OPTIONEE. In the event of the death of an Optionee: (i) during the term of the Option who is at the time of his death an Employee or Consultant of the Company and who shall have been in Continuous Status as an Employee or Consultant since the date of grant of the Option, the Option may be exercised, at any time within six (6) months (or such other period of time, not exceeding twelve (12) months, as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option) following the date of death (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance but only to the extent of the right to exercise that would have accrued had the Optionee continued living and remained in Continuous Status as an Employee or Consultant three (3) months (or such other period of time as is determined by the Administrator as provided above) after the date of death, subject to the limitation set forth in Section 5(b); or (ii) within thirty (30) days (or such other period of time not exceeding three (3) months as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option) after the termination of Continuous Status as an Employee or Consultant, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. (e) RULE 16B-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. -8- 9 11. WITHHOLDING TAXES. As a condition to the exercise of Options granted hereunder, the Optionee shall make such arrangements as the Administrator may require for the satisfaction of any federal, state, local or foreign withholding tax obligations that may arise in connection with the exercise, receipt or vesting of such Option. The Company shall not be required to issue any Shares under the Plan until such obligations are satisfied. 12. STOCK WITHHOLDING TO SATISFY WITHHOLDING TAX OBLIGATIONS. At the discretion of the Administrator, Optionees may satisfy withholding obligations as provided in this paragraph. When an Optionee incurs tax liability in connection with an Option which tax liability is subject to tax withholding under applicable tax laws, and the Optionee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the Optionee may satisfy the withholding tax obligation by one or some combination of the following methods: (a) by cash payment, or (b) out of Optionee's current compensation, or (c) if permitted by the Administrator, in its discretion, by surrendering to the Company Shares that (i) in the case of Shares previously acquired from the Company, have been owned by the Optionee for more than six months on the date of surrender, and (ii) have a fair market value on the date of surrender equal to or less than Optionee's marginal tax rate times the ordinary income recognized, or (d) by electing to have the Company withhold from the Shares to be issued upon exercise of the Option that number of Shares having a fair market value equal to the amount required to be withheld. For this purpose, the fair market value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). Any surrender by an Officer or Director of previously owned Shares to satisfy tax withholding obligations arising upon exercise of this Option must comply with the applicable provisions of Rule 16b-3. All elections by an Optionee to have Shares withheld to satisfy tax withholding obligations shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; (b) once made, the election shall be irrevocable as to the particular Shares of the Option as to which the election is made; and (c) all elections shall be subject to the consent or disapproval of the Administrator. In the event the election to have Shares withheld is made by an Optionee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the Optionee shall receive the full number of Shares with respect to which the Option is exercised but such Optionee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. -9- 10 13. NON-TRANSFERABILITY OF OPTIONS. The Option may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution. The designation of a beneficiary by an Optionee will not constitute a transfer. An Option may be exercised, during the lifetime of the Optionee, only by the Optionee or a transferee permitted by this Section 13. 14. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION; CORPORATE TRANSACTIONS. (a) ADJUSTMENT. Subject to any required action by the shareholders of the Company, the number of shares of Common Stock covered by each outstanding Option, the number of shares of Common Stock that have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, the maximum number of shares of Common Stock for which Options may be granted to any employee under Section 8 of the Plan, and the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Administrator, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. (b) CORPORATE TRANSACTIONS. In the event of the proposed dissolution or liquidation of the Company, the Option will terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Administrator. The Administrator may, in the exercise of its sole discretion in such instances, declare that any Option shall terminate as of a date fixed by the Administrator and give each Optionee the right to exercise his or her Option as to all or any part of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Administrator determines, in the exercise of its sole discretion and in lieu of such assumption or substitution, that the Optionee shall have the right to exercise the Option as to some or all of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. If the Administrator makes an Option exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Administrator shall notify the Optionee that the Option shall be exercisable for a period of fifteen (15) days from the date of such notice, and the Option will terminate upon the expiration of such period. -10- 11 15. TIME OF GRANTING OPTIONS. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option or such other date as is determined by the Administrator; provided however that the grant date shall be the later of the date on which the Administrator makes the determination granting such Option or the date of commencement of the Optionee's employment relationship with the Company. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. 16. AMENDMENT AND TERMINATION OF THE PLAN. (a) AMENDMENT AND TERMINATION. The Board may amend or terminate the Plan from time to time in such respects as the Board may deem advisable; provided that, the following revisions or amendments shall require approval of the shareholders of the Company in the manner described in Section 20 of the Plan: (i) any increase in the number of Shares subject to the Plan, other than an adjustment under Section 14 of the Plan; (ii) any change in the designation of the class of persons eligible to be granted Options; or (iii) any change in the limitation on grants to employees as described in Section 8 of the Plan or other changes which would require shareholder approval to qualify options granted hereunder as performance-based compensation under Section 162(m) of the Code. (b) SHAREHOLDER APPROVAL. If any amendment requiring shareholder approval under Section 16(a) of the Plan is made subsequent to the first registration of any class of equity securities by the Company under Section 12 of the Exchange Act, such shareholder approval shall be solicited as described in Section 20 of the Plan. (c) EFFECT OF AMENDMENT OR TERMINATION. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 17. CONDITIONS UPON ISSUANCE OF SHARES. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the Shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. -11- 12 As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 18. RESERVATION OF SHARES. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 19. OPTION AGREEMENT. Options shall be evidenced by written option agreements in such form as the Board shall approve. 20. SHAREHOLDER APPROVAL. (a) Continuance of the Plan shall be subject to approval by the shareholders of the Company within twelve (12) months before or after the date the Plan is adopted. Such shareholder approval shall be obtained in the manner and to the degree required under applicable federal and state law and the rules of any stock exchange upon which the Shares are listed. (b) In the event that the Company registers any class of equity securities pursuant to Section 12 of the Exchange Act, any required approval of the shareholders of the Company obtained after such registration shall be solicited substantially in accordance with Section 14(a) of the Exchange Act and the rules and regulations promulgated thereunder. (c) If any required approval by the shareholders of the Plan itself or of any amendment thereto is solicited at any time otherwise than in the manner described in Section 20(b) hereof, then the Company shall, at or prior to the first annual meeting of shareholders held subsequent to the later of (1) the first registration of any class of equity securities of the Company under Section 12 of the Exchange Act or (2) the granting of an Option hereunder to an officer or director after such registration, do the following: (i) furnish in writing to the holders entitled to vote for the Plan substantially the same information that would be required (if proxies to be voted with respect to approval or disapproval of the Plan or amendment were then being solicited) by the rules and regulations in effect under Section 14(a) of the Exchange Act at the time such information is furnished; and (ii) file with, or mail for filing to, the Securities and Exchange Commission four copies of the written information referred to in subsection (i) hereof not later than the date on which such information is first sent or given to shareholders. -12- EX-11.01 6 COMPUTATION OF NET INCOME PER SHARE 1 EXHIBIT 11.01 ESS TECHNOLOGY, INC. COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1997 1998 ------- -------- -------- Weighted average common shares.............................. 37,702 39,953 40,955 Weighted average incremental common equivalent shares: Common stock(2)........................................... 3,886 -- -- Cheap stock(2)............................................ -- -- -- ------- -------- -------- Total weighted average common and common equivalent shares.................................................... 41,588 39,593 40,955 ======= ======== ======== Net income (loss)........................................... $21,626 $(10,866) $(28,016) ======= ======== ======== Net income (loss) per share................................. $ 0.52 $ (0.27) $ (0.68) ======= ======== ========
- --------------- (1) This Exhibit should be read in conjunction with Note 1 of Notes to Consolidated Financial Statements. (2) Earnings per share is computed using the weighted average number of common and common equivalent shares ("weighted average shares") outstanding during the period. Common equivalent shares consist of the Company's common stock issuable upon exercise of stock options (using the treasury stock method), except when antidilutive. 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. EX-21.01 7 LIST OF REGISTRANT'S SUBSIDIARIES 1 EXHIBIT 21.01 LIST OF REGISTRANT'S SUBSIDIARIES
PERCENTAGE OWNED NAME JURISDICTION OF ORGANIZATION BY REGISTRANT ---- ---------------------------- ---------------- ESS (Far East) Ltd. .................................... Hong Kong 100% ESS Technology International, Inc. ..................... Cayman Islands 100% OSEE Technology, Inc. .................................. California 100% VideoCore Technology, Inc. ............................. California 100% Platform Technologies, Inc. ............................ California 100% ESS International, Inc. ................................ Cayman Island 100% Viva Media Corporation.................................. Hawaii 100% Wei Fhi Technology, Inc. ............................... Cayman Island 100% Vsystems International, Inc. ........................... Cayman Island 100%
EX-23.01 8 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23.01 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-97830) of ESS Technology, Inc. of our report dated January 21, 1999, which appears on page 26 of this Form 10-K. PRICEWATERHOUSECOOPERS LLP San Jose, California March 31, 1999 EX-27.01 9 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 65,752 16,719 41,758 3,928 22,882 153,697 54,977 16,977 214,645 72,573 0 0 0 137,312 0 214,645 218,252 218,252 182,417 182,417 66,818 0 (1,478) (29,505) (1,489) (28,016) 0 0 0 (28,016) (.68) (.68)
-----END PRIVACY-ENHANCED MESSAGE-----