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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended March 31, 1998
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required).
For the transition period from ________________ to ________________
COMMISSION FILE NUMBER 0-28472
DIGITAL VIDEO SYSTEMS, INC.
(Name of small business issuer in its charter)
DELAWARE 77-0333728
(State of incorporation) (I.R.S. Employer Identification No.)
160 Knowles Drive, Los Gatos, CA 95032
(Address of principal executive offices) (zip code)
Issuer's telephone number: (408) 874-8200
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK
CLASS A WARRANTS
CLASS B WARRANTS
UNITS, EACH
CONSISTING OF ONE
SHARE OF COMMON
STOCK, ONE CLASS A
WARRANT AND ONE
CLASS B WARRANT
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to filing requirements for the past 90
days. YES X NO
Check mark indicates that disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [_]
The aggregate market value of the voting stock held by non-affiliates of
registrant as of June 12, 1998 was approximately $13,678,000.
There were 20,993,230 shares of registrant's common stock outstanding as of
June 12, 1998.
The following documents are incorporated by reference into this report:
Portions of registrant's Proxy Statement for its 1998 Annual Meeting of
Shareholders, to be filed with the Securities and Exchange Commission within
120 days after the close of registrant's fiscal year, are incorporated herein
by reference in Part III of this Annual Report.
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<PAGE>
Forward-Looking Statements
This document contains forward-looking statements within the meaning
of the "safe-harbor" provisions of the Private Securities Litigation
Act of 1995 that involve risks and uncertainties, including, without
limitation, statements with respect to the Company's strategy, proposed
sales of the Company's products, markets, and the development of the
Company's products. The Company's actual results may differ materially
from those described in these forward-looking statements due to a
number of factors, including, but not limited to, the uncertainty of
market acceptance of Video CD and DVD players and sub-assemblies and
other Company products, including DVD-ROM products and network video,
planned growth of the Company's operations, including potential
acquisitions of other businesses or technologies, dependence on a
limited number of suppliers of certain components used in the Company's
operations, risks associated with rapid technological change and
obsolescence and product development, conducting business in foreign
countries, such as China, South Korea and Taiwan, and the competitive
market for the Company's products, and other factors described in
Exhibit 99.1 to this Form 10-KSB, or in other documents the Company
files from time-to-time with the Securities and Exchange Commission.
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included herein the
Company's Annual Report on Form 10-KSB for the fiscal year ended March
31, 1998.
PART I
Item 1. Description of Business.
Overview
The Company was founded in 1992 to develop, manufacture, and market
digital video compression and decompression hardware and software for
entertainment, business and educational uses. The Company's current
product offering includes Video CD players for the Chinese consumer
market and for the commercial video market ("video engines"); video
servers for the cable ad insertion and video-on-demand markets; and,
CD-R, CD-RW products for the computer peripheral market. The Company
has also developed a DVD player for the home entertainment market and
expects to commence the marketing of this product and DVD-ROM products
during the first half of the current fiscal year.
During fiscal 1997, the Company completed its initial public
offering (the "IPO") and a follow-on public offering, which together
generated aggregate net proceeds of approximately $43.7 million. These
proceeds have been used principally to repay $7 million of bridge
notes, make business acquisitions and fund the growth in the Company's
operations and the losses generated to date by those operations. The
Company currently does not have any agreements, understanding, or
commitments with respect to any proposed material acquisitions, joint
ventures or other strategic alliances but may seek to enter into such
transactions in the future to acquire complementary businesses or
technologies or to create strategic alliances. However, the Company
can give no assurances that any such transactions will be consummated
in the future.
In October 1996, the Company acquired ViComp Technology Inc.
("ViComp"), a development stage company that designs MPEG-1 integrated
circuits for use in Video CD players and components. Pursuant to the
acquisition, the Company issued 491,253 shares of its Common Stock for
all the outstanding ViComp capital stock and granted options to certain
ViComp shareholders exercisable for 189,557 shares of the Company's
Common Stock. The transaction has been accounted for as a purchase and,
accordingly, the initial purchase price and acquisition costs have been
allocated to the identifiable assets and liabilities, including in-
process research and development of $1.8 million that was immediately
expensed.
While DVS retains the intellectual property developed by ViComp, the
Company has ceased the research and development program of this
subsidiary effective March 31, 1998, since market conditions have made
further development of an MPEG-1 decoder chip financially unattractive.
The Company has expensed a significant portion of assets, primarily
fixed assets, associated with this development in fiscal 1998 as they
have no alternate use (See Note 1 to the financial statements).
In August 1997, the Company completed the acquisition of the
business and certain assets and liabilities of the Digital Video
division (the "DV Business") of Arris Interactive L.L.C. ("Arris") in a
transaction accounted for as a purchase. The total purchase price of
approximately $3.5 million included cash of $1.5 million, the issuance
of 600,000 shares of common stock and related acquisition costs of
$141,000. Under the original purchase agreement, Arris was not
entitled to transfer or sell any of the shares of the Company's common
stock acquired in the transaction until certain periods had elapsed and
none of such shares were registered under any state or federal securities
laws. In addition, the Company also initially agreed to pay Arris
additional contingent consideration of up to $5 million if the DV
Business achieves certain revenue milestones. In March 1998, the
Company and Arris agreed to remove the restriction on sale of the
Company's common stock by Arris and cancel the provision for the payment of
contingent consideration to Arris set forth in the agreement.
In August 1997, the Company acquired substantially all of the assets
of Synchrome Technologies, Inc., ("Synchrome") a privately held
developer and manufacturer of multimedia and computer storage PC
products. The purchase price of $1.0 million (including acquisition
costs) was paid in cash and accounted for using the purchase method.
In August 1997 the Company, through its wholly-owned subsidiary,
D.V.S. H.K., and Panyu Tian Le Electrical Appliance Manufacturing Co.,
Ltd. ("Panyu") formed a joint venture (the "Panyu Joint Venture") in
China to manufacture and distribute Video CD players and DVD players.
As initially formed, the Panyu Joint Venture was owned 51% by the
Company, through D.V.S.H.K., and 49% by Panyu.
In December 1997, the Company, and Panyu entered into an Ownership
Shares Transfer Agreement ("the Transfer Agreement"). Pursuant to the
Transfer Agreement, which is subject to local government approval, the
Company purchased from Panyu its entire 49% interest in the
Panyu Joint Venture for a nominal amount, thereby increasing the
Company's interest in the venture to 100%. In January 1998, the
Company sold a 10% interest in the Panyu Joint Venture for a nominal
amount to Panyu Kembo Electrical Manufacturing Co; Ltd. ("Kembo") which
is owned by Dr. An Yueh Zehan, a member of the law firm representing
the Company in China. Kembo holds the interest as a nominee of the
Company.
In June 1998, the Company completed the acquisition of a perpetual,
worldwide, royalty-free license to DVD-ROM technology owned by Hyundai
Electronics Industries, Co., Ltd. ("Hyundai") in exchange for 2,000,000
shares of the Company's common stock. In addition, the Company,
through a newly-formed, wholly-owned subsidiary, DVS-Korea, completed
the acquisition of DVD-ROM manufacturing capabilities, a related
research and development team and management from Hyundai for
$1,000,000 in cash.
The principal executive offices of the Company are located at 160
Knowles Drive, Los Gatos, California 95032. The Company's telephone
number is (408) 874-8200.
Industry Background
Digital Video
Since the 1930's, video images have been transmitted and stored
almost exclusively using analog formats such as video tape. Digital
video, unlike analog video, can be compressed, which allows for
increased storage capability and transmission efficiencies as well as
the ability to reproduce and transmit video images without perceptible
image degradation. Digital video also permits superior editing
capabilities because of its greater compatibility with computers.
Because a standard for video compression is required for compressed
video to be shared among various products, a number of industry leaders
in consumer electronics, computers, and communications joined together
through the International Standards Organization (the "ISO") to define
a standard for compression of audio and video to CD-ROM called MPEG
(Motion Picture Experts Group) -1. MPEG-1 was adopted by the ISO in
1991. In 1994, the ISO adopted a standard for compression of audio and
video to broadcast systems called MPEG-2. MPEG-2 permits better picture
resolution than MPEG-1, but requires about four times as much data.
Video CDs store information in MPEG format. Video CDs are the same
size as audio CDs, about 120 millimeters in diameter and 1.2
millimeters in thickness, but allow up to 74 minutes of video and audio
storage. Although the picture quality of Video CDs produced in
accordance with MPEG-1 standards is not as good as that of laser discs
(and is about comparable to that of video cassettes tapes), the smaller
discs (i) allow superior interactive multimedia features through random
access to specific audio and video track; and (ii) can be produced more
cost effectively than laser discs or video cassettes. Further, the
Company has developed a technology that is incorporated into its
products known as "Video Perfect," which the Company believes provides
video quality for Video CDs that is equivalent to that of laser disc.
The Video Perfect technique decompresses video at a higher bit-rate
than MPEG-1, thus producing a better quality image.
In December 1995, the new DVD video disc format was agreed to by
those manufacturers and entertainment companies aligned with Sony
Electronics, Inc. and Philips Electronics NV on the one side and
Toshiba Corporation and Time Warner, Inc. on the other. This new disc
is the same size as a Video CD, but uses MPEG-2 compression technology.
As such, the current DVD disc can hold seven times as much information
as a Video CD. This data storage capacity represents approximately 133
minutes of video and audio.
Consumer electronics manufacturers, together with motion picture
studios, computer hardware companies and software developers, have
produced the DVD standard, which the Company believes has the
potential, over time, to supplant the VCR, computer CD-ROM, laser disc,
Video CD and other platforms. DVD offers improvements over CD in terms
of storage (per disc) and data transfer rates, leading to enhanced
interactive, multimedia and game applications. Moreover, the Company
believes that DVD offers several advantages over VCR, including
increased picture resolution and audio quality, user enhancements such
as quick random access and increased capacity, a more durable medium
(CD compared to VHS tape), and enhanced copyright protection of titles.
Further, DVD supports Dolby Digital with six separate audio channels
and includes features such as the ability to play existing audio, video
and computer CDs. The greater data capacity of DVD also gives it the
potential to display some combination of a soundtrack with up to eight
language options, video options that can offer up to nine camera
angles, up to 32 subtitle selections and a parental control system.
The Company believes a number of factors, such as movie industry's
endorsement and the computer industry's demand, should contribute to
the long-term success of the DVD player.
However, even though, the DVD player was launched in the United
States in the first quarter of calendar 1997 by several consumer
electronics companies, the commercial viability of the DVD player has
not yet been established as a high demand consumer electronics product.
The Consumer Electronics Manufacturers Association has stated that
about 346,000 DVD players were shipped to US consumer electronics
retailers in 1997, and another 149,000 units were shipped through April
1998.
Ad-Insertion
Traditionally, video content in the cable television industry was
recorded and transmitted as an analog signal, using video tapes and
video tape recorders. Storing this content in digital form makes the
video easy to retrieve and to manipulate. Combining this digital video
content with the processing power of a server provided cable operators
the opportunity to insert video content (advertisements) at precise
times in an incoming cable program signal. This ability to insert ads
in cable programming gave cable systems a revenue stream to supplement
subscription revenue, which was long the traditional source of revenue.
Prior to 1995, ad insertion products were typically based on
proprietary server platforms that were not cost-effective for cable
operators. At about that time, SeaChange International introduced an ad
insertion platform that used standard Intel processors and Microsoft
operating systems. Over the next two years, this single product
offering allowed SeaChange to capture most of the market for ad
insertion.
Computer Peripherals
CD-R (write-once) drives and media were originally developed by
Philips and Sony, as the next step in a progression from CD audio to
CD-ROM to video CD. CD-R was developed to provide consumers with the
ability to record music, videos, images or data for playback on their
PC. The CD-R drive uses a laser to create a digital pattern in an
organic dye present in the CD-R media, irreversibly changing the
optical characteristics of the disc. This digital pattern or data can
then be read in by a current CD-ROM drive as well as some CD audio
players. The limitation of this product is that data can be written to
the disk once only.
To address the shortcoming of CD-R, Philips developed an extension
of this product that was rewriteable, the CD-RW. This latter product
uses phase-change technology to give the laser the ability to write
multiple data patterns in the same media.
Products and Markets
The Company's current product offering includes Video CD players for
the Chinese consumer market and for the commercial video market ("video
engines"); video servers for the video-on-demand and cable ad
insertion markets; and CD-R and CD-RW products for the computer
peripheral market. The Company has also developed a DVD player for the
home entertainment market.
Video CD Player
The majority of the Company's product revenues during this fiscal
year were generated by sales of consumer Video CD players and sub-
assemblies in China and Hong Kong and commercial video CD players in
the United States.
A Video CD player looks like an audio CD player except that it plays
both video and audio. Like a video cassette recorder ("VCR") and laser
disc player, a Video CD player (in addition to the basic play feature)
generally has slow motion, fast forward and reverse capabilities. For
markets in Asia, Video CD players are also often equipped with karaoke
features such as digital echo and the ability to change the key in
which the music is played. As with a laser disc player, a Video CD
player can access tracks randomly, but unlike a VCR, currently marketed
Video CD players do not have recording capabilities.
The Video CD player consumer market has grown rapidly over the last
three years in China, and the Company believes that consumer markets
may emerge in other developing countries such as India, Vietnam, Russia
and the Philippines. Since its introduction to the Chinese market, the
price of the Video CD player has declined as manufacturing capacity and
competition have increased. The Company believes that manufacturing
capacity for Video CD players substantially exceeds demand in this
market. As a result, prices and margins for players have eroded to such
an extent that the Company is not currently able to sell video CD
players in this market at an adequate margin.
The Company has decided no longer sell video CD players in China.
The Company will sell its existing inventory of video CD players and is
looking to move the production of video engine products and DVD players
from Taiwan to China.
The consumer market for Video CD players in the United States,
Europe and other developed countries is generally not significant. The
Company believes that this is due to the fact that few motion picture
titles are available in a Video CD format in the United States and
other developed countries and, consequently, few consumers in these
markets have an incentive to purchase a Video CD player. Moreover, the
VCR is firmly entrenched, with most households with sufficient income
owning one. Because the image quality of Video CD and VHS tape are
similar, the Video CD player offers no qualitative advantage over the
VCR (which can also record material) to the consumer, even though both
players are comparably priced. Because a large consumer entertainment
market for Video CD players does not exist in the United States, Europe
and other developed countries and in light of the intense price
competition for Video CD players in China, the Company recently has
focused on commercial applications for Video CD ("video engines") in
these markets.
Within this video engine market, the Company addresses several
niches, with products for information kiosks, as well as for the
hospitality, education, and entertainment markets. These products are
marketed to retail stores, hotels, hospitals, museums, and educational
institutions to deliver advertisements, movies and technical data, as
well as training and educational material. The Company sells these
products to kiosk integrators, who integrate the product as part of a
complete solution, including software titles.
The current product, the Video Engine 100, is similar to a consumer
Video CD player, but has been adapted for commercial applications. It
is currently being sold to those customers who require a continuous
loop playback mode with minimal interactive requirements. This product
contains an RS232 port that allows the player to interface with a
computer.
The Video Engine 200, which the Company intends to introduce in July
1998, is a CD-I player intended for the secondary and elementary
education market. This is an interactive video CD player that has
applications in several markets, including education, medical and
corporate presentations. These players are manufactured for the Company
by LG Electronics in South Korea.
The Company intends to shift its video engine product line during
fiscal year 1999 to a DVD video engine, which will be a modification of
the consumer DVD player that has been developed. Additionally, during
fiscal year 1999, the Company plans to introduce a more compact version
of the Video Engine 100. The latter product will meet a need of certain
of the Company's customers for a compact replacement of the VCR in
retail stores.
This family of products provide information display and kiosk
suppliers with a range of choices for information delivery that are
tailored to their unique requirements and which, the Company believes,
are cost effective.
MX Server
The MX server, which the Company began shipping to customers in
March 1998, provides video on demand ("VOD") over RF (coaxial cable)
networks. Video-on-demand gives each user the ability to call up
video content as needed, without affecting any other user's
requirements on the system, and without requiring any other system user
to view the same content.
The core of the video on demand system is a low-cost, real-time
video server, the MX server. In addition to supporting a library of
immediately accessible video items on the server, the system supports
one or more Video CD jukebox systems, which allows for large amounts of
additional video material to be stored and accessed as required. The
MX server has a flexible design. By changing the video content and
modifying the user interface, these systems can be easily changed for
different applications such as movies and karaoke for entertainment
purposes; video training materials, research materials and interactive
testing for educational purposes; and archiving for business purposes.
The MX server may be controlled through the use of a browser
interface on an ordinary networked PC. The use of a standard World Wide
Web ("WWW") browser provides the ability to create and maintain
databases using a standard graphical user interface. Menus and other
user pages are displayed on a television or a PC monitor. The existing
system is designed to operate over local area networks using Ethernet,
coax or twisted pair wires. The Company's video server is functionally
compatible with Internet WWW servers and browsers and uses HTML (the
most commonly used language on the Internet) as the basis for all
control and management functions. The Company has adapted its system to
permit system navigation, video selection, loading, scheduling, and
video library maintenance through the use of industry standard
browsers.
The MX server addresses several markets, including education,
hospitality, entertainment, and medical applications. Typically, VOD
products provide instructional video titles, movie entertainment on a
pay-per-view basis, advertising at the point of sale and delivery of
technical medical information when needed.
In particular, the MX server fills a niche that larger competitors
seem to have ignored. For the corporate market, where video is used for
training purposes, the ability of the MX server to deliver video over
coaxial cable is a significant advantage. To date, most competitors,
deliver video over an Ethernet infrastructure. For most corporate
networks, delivering video over Ethernet means that other traffic on
the network must wait until video transmission is complete which
introduces intolerable delays in network transmission. In addition,
the Company's market data suggests that corporations do not want to
deliver video to the desktop but to a television at a small number of
fixed locations.
In the education market, the attraction of the MX server is its low
price and ease of use for streaming videos. In addition, the ability of
DVS to package a low-cost encoder with the MX server allows customers
in this market to make their own videos for distribution to the
classroom or library, which the Company believes is a significant
competitive advantage.
In other markets, such as point of purchase advertising and sports
arena venues, the MX server system is priced lower than the competing
products. An advantage that the MX server offers is that it is bundled
with a DVS load station to encode videos directly to the MX server.
This product takes full advantage of the Company's expertise in
developing systems for decoding and encoding MPEG video.
The MX server product will continue to evolve to meet customer needs
by enhancing functionality while maintaining a price advantage over
potential competitors. The MX server competes with other computer-
based video server products. The Company believes that its product is
more solutions-oriented and user-friendly than competing products.
The Company is building a distribution network of professional
video dealers, value-added resellers and system integrators to
supplement the efforts of an internal sales force. The video dealer
network established by the Company sells MX servers and video engines
directly to end users such as educational institutions, libraries,
retail chains, hospitals, and museums.
DVD Player
The Company has developed DVD players and is continuing to enhance
DVD players for the consumer markets. It is anticipated that this
product will be marketed to original equipment manufacturers ("OEMs")
and on a proprietary basis and will be available in both consumer and
commercial products.
However, there can be no assurances that the DVD player market will
become a significant one. Further, the competition for DVD players is
expected to be intense. Among the factors that may limit widespread
adoption of the current DVD player are the inability of current models
to record, the introduction of a competing standard, and the relatively
high retail price.
On June 24, 1998, the Company completed the acquisition of a
perpetual, worldwide, royalty-free license to DVD-ROM technology owned
by Hyundai Electronics Industries, Co., Ltd. ("Hyundai") in exchange
for 2,000,000 shares of the Company's common stock. In addition, the
Company, through a newly-formed, wholly-owned subsidiary, DVS-Korea,
completed the acquisition of DVD-ROM manufacturing capabilities, a
related research and development team and management from Hyundai for
$1,000,000 in cash.
Server Systems for Cable Ad Insertion
With the acquisition of Digital Video from Arris, the Company
entered the market for cable television ad insertion and near video on
demand (NVOD) servers. This division, which the Company renamed the New
Media Division, designs and manufactures servers that deliver MPEG-2
video to analog cable television set top boxes.
Overview of New Media Division Product Architecture
The New Media Division server solution is designed to be adaptable
from the existing analog network to the developing digital network. The
server architecture, consists of three levels: 1) video or networking
switching, 2) local video storage, schedule management, and playback,
and 3) central management and control. Configurations are designed
around the needs of the broadband customer; whether it is a single
cable headend or a large regional advertising interconnect.
A summary of the products follows:
Interconnect Server. This server controls the entire network,
interfacing with multiple Headend Servers and content providers.
Located at the central distribution point of a regional video network,
it acts as the library storage and control center for the overall
system. The Interconnect Server stores thousands of hours of program
information and is able to control and interface with many Headend
Servers. In addition, it provides transaction, traffic and billing
interfaces, network arbitration and real-time video scheduling. Network
performance, monitoring and maintenance functions are resident in all
servers, but are controlled and monitored by the Interconnect Server.
Headend Server. The Headend Server comes in two configurations: one
scalable for up to 24 MPEG-2 channels and another scalable for up to 85
MPEG-2 channels. The Headend Server is located at the headend of a
broadband or video distribution system. It stores advertisements,
movies, infomercials and other media services and inserts content on
schedule for viewing by subscribers. The Headend Server can operate in
a stand-alone, or in a networked configuration with the Interconnect
Server, both utilizing the EndZoneT software. The server supports
MPEG-2 data rates ranging from 1.5 to 9.5 megabits per second per
channel.
EndZoneT Software. An intuitive, end-to-end, server based management
software solution that is designed to provide operators with a
powerful, yet easy to manage software front-end for their content
insertion systems.
MPEG-2 Channel Decoder/Switch. This decoder is the bridge between
the analog world and the digital system. Each Decoder chassis provides
up to eight channels of real-time, studio-quality MPEG-2 decoding.
Each Channel Decoder is configured and monitored via the operator's
terminal connected to the Server using EndZone software. The Channel
Decoder is used for analog ad insertion and NVOD applications.
Windows NT Ad Insertion Platform ("Catapult"). Within its digital-
to-analog strategy, the New Media Division is presently developing a
cost-reduced digital video platform based upon Microsoft Windows NT
operating system, Pentium and PCI technologies. Catapult is been
developed to deliver an ad insertion platform to cable systems with
fewer than 20,000 subscribers, for whom the Company's current ad
insertion system is not cost-effective.
While the Company and its competitors have delivered a few systems
in Europe, Latin America and Asia, the principal market for ad
insertion is in the United States. Based upon reported revenues of all
competitors, the market for ad insertion is less than $100 million.
This market is dominated by SeaChange International, which has captured
an estimated 70% of the cable ad insertion market. The remaining market
is divided among a number of competitors, including SkyConnect,
CML/Limt, DVS and others. Due to the dominance of the industry by a
single supplier and the number of competitors, the Company has decided
to no longer sell its "Enterprise" product offering in May 1998 and is
in the process of re-evaluating its overall business opportunities for
both the "Catapult" product line, Window NT ad insertion platform, and
the New Media Division.
Computer Peripheral Products
The acquisition of Synchrome added a computer peripheral product
line and retail distribution channel within the United States. In
addition, the acquisition gives the Company the opportunity to
establish a sales channel for future computer peripheral products, such
as DVD-ROM drives.
The Company purchases CD-R(write-once compact disk) and CD-
RW(rewritable compact disk) optical drives from a variety of
manufacturers and assembles them into an external or internal drive.
The drive is then bundled with industry-standard software and packaged
for sale to retailers. The Company is currently developing its own CD-
RW optical drives.
When connected to a PC, CD-R and CD-RW drives allow the user to copy
data, sound, images, or video to a CD disk that can be read by a CD-ROM
drive, an audio CD player, a video CD player, or a DVD-ROM drive
depending on the type of data recorded.
The market for CD-R and CD-RW is projected to grow to about 5
million units in 1998 calendar year from about 3 million units in 1997,
according to Freeman and Associates, Inc.
Video Encoding Products
The Company's encoding systems are PC-based MPEG compression systems
designed to provide turnkey solutions to encode MPEG-1 and MPEG-2 video
streams. Two products, which the Company sells in small numbers, are
described below.
MPEG Solo/Duo. The Company has developed a video encoding board that
provides the user with the capability to encode MPEG-1 or MPEG-2
videos. The Model 240 encoding board provides MPEG-1 compression, while
the Model 480 encoding board upgrades the Model 240 to MPEG-2
compression at half D1(encoding rate). The Model 100 upgrades the Model
240 or Model 480 with a digital input interface. These encoding board
sets are bundled with a PC and sold as an encoding load station with
the MX server.
ENC50 Authoring and Compression System. The ENC50 authoring and
compression system is a turnkey system that features digital video and
audio inputs, advanced video preprocessing and compression, real-time
video/audio MPEG-1 compression and multiplexing (linking together video
and audio), Video CD track composition, disc pre-mastering and master
disc writing. This system is targeted at quality conscious video
producers who are converting large quantities of video material to
Video CD. These customers include movie studios, karaoke producers,
educational institutions, and corporate and other video production
studios.
The Company believes that the market for these products is limited.
ViComp Technology
While DVS retains the intellectual property developed by ViComp, the
Company has ceased the research and development program of this
subsidiary effective March 31, 1998, since market conditions have made
further development of an MPEG-1 decoder chip financially unattractive.
The Company has expensed a significant portion of assets, primarily
fixed assets, associated with this development in fiscal 1998 as they
have no alternate use (See Note 1 to the financial statements).
Manufacturing
Most of the Company's current manufacturing efforts consist of
producing Video CD players and Video Engines. The Company utilizes
subcontractors in China and Taiwan to produce Video CD sub-assemblies
for Video CD players and video engines. The Video CD players for the
consumer market are assembled in the Panyu facility, while the video
engine 100 is burned and tested in the Taiwan facility.
The Company manufactures and assembles servers for ad insertion at
its facility in Suwanee, Georgia.
The Company assembles the MX server and computer peripheral products
at its facility in Los Gatos, California. As most of these products
have a short production cycle relative to a customer's need for such
products, the Company manufactures them as orders are received.
The Company will initially manufacture its DVD-ROM products in South
Korea. The Company is in the process of setting up manufacturing
arrangements, including subcontracting arrangements.
Marketing and Distribution
The Company's representatives attend trade and industry shows to
increase awareness and interest in digital video technology and the
Company's products. The Company employs twenty-six full-time sales
representatives who are based in Los Gatos, California, Suwanee,
Georgia, Tokyo, Japan, China and Hong Kong to sell its products and
anticipates that it will hire additional sales personnel as required.
The Company has begun to establish a network of video dealers in the
United States, who will resell the MX server and the video engine
product line. As of June 1, 1998, the Company has signed agreements
with 19 dealers.
Suppliers
The Company obtains video CD components and subassemblies for video
engines, consumer players and MX server and ad insertion servers from
a variety of suppliers.
The Company obtains its CD-R, CD-ROM and CD-RW drives from a variety
of suppliers. The Company anticipates that its DVD products will
incorporate optical components produced by a leading manufacturer.
The Company has no contractual right to obtain any specified number of
optical components from Matsushita and there can be no assurance that the
Company will be able to meet all of its future needs for such components
through Matsushita. Should the Company's ability to obtain the requisite
number of such components be limited for any lengthy period of time or if
the cost of such Matsushita components increases, or if such components
are only available to the Company at prices substantially higher than
those paid by the Company's competitors for these optical components or
other functionally equivalent optical components, the Company's ability
to supply products to its customers on a competitive basis or at all
could be materially and adversely affected. The Company is currently
evaluating alternative sources of supply and anticipates that it will
begin the process of qualifying optical components made by other
suppliers to work with the Company's DVD products. However, the
qualification process may take from six to twelve months to complete.
Agreements With Hyundai
On June 23, 1998, the Company completed a purchase transaction to
acquire an exclusive, perpetual, royalty-free license for certain
intellectual property relating to DVD-ROM technology from Hyundai
Electronics Industries, Co., Ltd. for 2,000,000 shares of the Company's
common stock. The transaction also included the acquisition of
certain fixed assets for manufacturing and research and development, as
well as inventory for $1 million cash.
In January 1994 and April 1995, respectively, Hyundai purchased from
the Company 3,247,473 shares of the Company's Series A Preferred Stock
for approximately $5,000,000 and 649,526 shares of the Company's Series
B Preferred Stock for approximately $1,000,000. In connection with
such purchases, Hyundai was given the right to designate a director, a
right of first refusal relating to sales of the Company's securities
and certain registration rights. Such public offering ("IPO") and
Hyundai waived its registration rights for 13 months following the
closing of the IPO in May 1996. Hyundai's Series A Preferred Stock and
the Series B Preferred Stock were converted into 3,896,999 shares of
Common Stock upon the closing of the IPO in May 1996.
In 1993, Hyundai and the Company entered into agreements relating to
the Company's development of a consumer karaoke player, a karaoke
jukebox, encoding machines and a karaoke network system. These
agreements were subsequently amended in 1994 in connection with the
Company and Hyundai agreeing to a manufacturing relationship for
karaoke jukebox players. The Company and Hyundai subsequently entered
into the 1995 Hyundai Technical Assistance and License Agreement ( the
" Technical Agreement") which subsumed part of the agreements entered
into in 1993 and obligated the Company to develop MPEG-2 compressor
products. The Technical Agreement is still in force.
Intellectual Property and Proprietary Rights
The Company uses confidentiality and non-disclosure agreements with
its employees, suppliers and distributors to protect its proprietary
products and has integrated a majority of its intellectual property
into complex devices to protect against reverse engineering. The
Company has filed patent applications in the United States and other
countries covering certain of the technologies that relate to its MX
server, video engine, and ad insertion products. There can be no
assurance, however, that patents will be granted for any of these
technologies or that any patent claims allowed will be sufficiently
broad so as to provide meaningful patent protection for the Company or
that even if obtained, that such patent claims will be enforced,
especially in foreign jurisdictions. There are few barriers to entry
into the market for the many of the Company's products. There can be no
assurance, therefore, that any of the Company's competitors, many of
whom have far greater resources than the Company, will not
independently develop technologies that are substantially equivalent or
superior to the Company's technologies. Further, the Company
distributes its products in countries where intellectual property laws
are not well-developed or are poorly enforced. Legal protections of the
Company's rights may be ineffective in such countries. Software piracy
and ineffective legal protection of the Company's software in foreign
jurisdictions, such as China, may cause substantial losses of sales by
the Company, which could have a material adverse effect on the
Company's operating results and financial condition.
Although the Company has taken and will continue to take steps that
it considers appropriate to protect its proprietary products, the
Company believes its future success will depend primarily on its
ability to rapidly bring to market products incorporating technological
advances and then reducing the cost of these products rather than on
establishing patent protection for them.
Research and Development
Since its inception, the Company has devoted a substantial portion
of its resources to research and product development, focusing on
digital video compression as well as decompression hardware and
software systems. Since the acquisition of the New Media Division, the
Company has also spent much effort in developing products for the
division. During the fiscal year ended March 31, 1997, the Company
incurred research and development expenses of $2.8 million. For the
fiscal year ended March 31, 1998, the Company incurred research and
development expenses of $8.1 million, which includes $1.9 million of
asset write-offs related to ViComp and the Company's New Media Division
(see Management's Discussion and Analysis of Gross Margin and Research
and Development).
The Company currently anticipates that during the next twelve months
its research and development efforts will focus on enhancing its DVD
player, developing the next generation of DVD-ROM products, reducing
the costs of its CD-RW and DVD-ROM products, adding features to its MX
server, and extending the video engine product line. The Company
anticipates that some of its research and product development personnel
will be utilized to support the sales and marketing efforts of the
Company in connection with customizing product applications for
specific customers. There can be no assurance, however, that research
and development efforts with respect to such products will progress as
anticipated, that the Company will be able to reduce costs sufficiently
to be able to compete with others marketing similar products or that
new markets for these products will develop on a timely basis, if at
all.
Competition
The Company's products compete or will compete with those marketed
by other manufacturers of Video CD players, DVD players, DVD-ROM
products and CD-RW drives. Most of the Company's competitors and
potential competitors, such as Sony, Matsushita, Philips, Hewlett
Packard, and Toshiba, are substantially larger in size and have far
greater financial, technical, marketing, customer service and other
resources than the Company.
Certain of the Company's potential competitors may have
technological capabilities or other resources that would allow them to
develop alternative products that could compete with the Company's
products. Potential competitors may begin operations or expand their
existing operations into the Company's proposed markets before the
Company is able to successfully market its products. There can be no
assurance that future technological advances by competitors will not
result in improved products or services that could adversely affect the
Company's business. Competition in the electronics industry also
extends to attracting and retaining qualified technical and marketing
personnel, and there can be no assurance that the Company will be
successful in attracting and retaining such qualified personnel.
With respect to the sale of Video CD players, the Company competes
with numerous Chinese companies, many of which have strong brand-name
recognition in the region, such as Chang Hong and Idall. In addition,
many of these competitors can manufacture Video CD players on a larger
scale than the Company and, accordingly, may be able to take advantage
of economies of scale. Competition in the Video CD market generally
occurs on the basis of price and features. There can be no assurance
that the Company can offer its customers products that are as
competitively priced or as feature rich as these larger competitors.
Most of the Japanese and Korean manufacturers of video CD players, who
had a significant share of the market in fiscal 1997, have been
displaced by Chinese manufacturers in fiscal 1998.
In the area of VOD systems, the Company competes with Starlight
Networks, Inc., Concurrent Computer, Tektronix, and Network Connection
as well as other sources for networked systems. The Company competes
with these companies based on cost, quality, reliability and speed of
video delivered. There can be no assurance that the Company will be
able to compete favorably against products offered by its competitors
in the future.
As a reseller of CD-R and CD-RW products, the Company competes with
Smart & Friendly, Hi-Val, Hewlett Packard and others. There can be no
assurance that the Company will be able to compete favorably against
products offered by its competitors in the future.
For cable ad insertion systems, the Company competes with SeaChange
International, SkyConnect and Channelmatic, among others. There can be
no assurance that the Company will be able to compete favorably against
products offered by its competitors in the future.
Employees
As of March 31, 1998, the Company had 563 full-time employees, of
whom 75 were research, development and engineering personnel, 65 were
sales and marketing representatives, 316 were production personnel and
107 were operations and administrative personnel. The Company believes
that its relations with its employees are good. The Company is not a
party to any collective bargaining agreement. Competition for employees
in the Company's industry is intense, and there can be, no assurance
that the Company will be able to attract or retain other highly
qualified personnel in the future.
Item 2. Properties
Facilities
The following is a description of the Company's facilities, all of
which but Panyu, China are leased from unaffiliated third parties.
Panyu, China is leased from Panyu, the former joint venture partner of
the Panyu Joint Venture.
Square Lease
Facility Location Feet Expiration
- ----------------------------------- --------------- --------- --------------
Corporate offices, sales and
marketing and research and
development...................... Los Gatos, CA 23,516 September 2000
Offices, sales and marketing and
research and development......... Suwanee, GA 16,500 December 2002
Research and development,
manufacturing.................... Taipei, Taiwan 2,107 September 1998
Sales and marketing, laboratory,
apartment, warehouse............. Hong Kong 4,492 May 1999
Manufacturing plant, office and
dormitory........................ Panyu, China 206,196 November 1999
Item 3. Legal Proceedings.
The Company is not a party to any pending material legal proceeding.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted during the fourth quarter of the fiscal
year covered by this report to a vote of the security holders.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
The Company's Common Stock has traded on the Nasdaq National Market
under the symbol DVID since May 9, 1996. The following table sets forth
the high and low last sale or bid prices for these securities for the
periods set forth below, as reported by Nasdaq. These prices do not
reflect retail mark-ups, markdowns or commissions.
High Low
--------- ---------
Fiscal 1998:
First quarter ended June 30, 1997................ $5.50 $2.88
Second quarter ended September 30, 1997.......... 5.50 3.00
Third quarter ended December 31, 1997............ 4.88 1.50
Fourth quarter ended March 31, 1998.............. 2.75 1.50
Fiscal 1997:
First quarter ended June 30, 1996................ $12.00 $8.00
Second quarter ended September 30, 1996.......... 9.50 5.75
Third quarter ended December 31, 1996............ 9.25 5.75
Fourth quarter ended March 31, 1997.............. 9.13 3.50
As of March 31, 1998, there were 126 record holders of the Common
Stock.
To date, the Company has not declared or paid any cash dividends
with respect to its Common Stock, and the current policy of the Board
of Directors is to retain earnings, if any, to provide for the growth
of the Company. Consequently, no cash dividends are expected to be paid
on the Common Stock in the foreseeable future. Further, there can be no
assurance that the proposed operations of the Company will generate the
revenues and cash flow needed to declare a cash dividend or that the
Company will have legally available funds to pay dividends.
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This document contains forward-looking statements within the meaning
of the "safe-harbor" provisions of the Private Securities Litigation
Act of 1995 that involve risks and uncertainties, including, without
limitation, statements with respect to the Company's strategy, proposed
sales of the Company's products, markets, and the development of the
Company's products. The Company's actual results may differ materially
from those described in these forward-looking statements due to a
number of factors, including, but not limited to, the uncertainty of
market acceptance of Video CD and DVD players and sub-assemblies and
other Company products, including DVD-ROM products and network video,
planned growth of the Company's operations, including potential
acquisitions of other businesses or technologies, dependence on a
limited number of suppliers of certain components used in the Company's
operations, risks associated with rapid technological change and
obsolescence and product development, conducting business in foreign
countries, such as China, South Korea and Taiwan, and the competitive
market for the Company's products, and other factors described in
Exhibit 99.1 to this Form 10-KSB, or in other documents the Company
files from time-to-time with the Securities and Exchange Commission.
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included herein the
Company's Annual Report on Form 10-KSB for the fiscal year ended March
31, 1998.
Overview
Digital Video Systems, Inc. (the "Company") develops, manufactures
and markets digital video compression and decompression hardware and
software for entertainment, business and educational uses. The
Company's current product offering includes Video CD players,
subassemblies and components for the consumer market and for the
commercial video market ("video engines"), and interactive video
engines and video-on-demand systems for the hospitality, entertainment,
and education and kiosk markets, and to a lesser extent, digital MPEG
compression systems, and sub-assemblies. The Company also offers
digital advertisement insertion systems for the cable television market
and CD-R and CD-RW for the computer peripheral market. The Company has
also developed a DVD player for the home entertainment market and
expects to commence the marketing of this product and DVD-ROM products
during the first half of the current fiscal year.
During fiscal 1997, the Company completed its initial public
offering (the "IPO") and a follow-on public offering, which generated
aggregate net proceeds of approximately $43.7 million. These proceeds
were used principally to repay $7 million of bridge notes, to fund the
growth in the Company's operations and the losses generated to date by
those operations and business acquisitions.
In October 1996, the Company acquired ViComp, a development stage
company that designs MPEG-1 integrated circuits for use in Video CD
players and components. Pursuant to the acquisition, the Company issued
491,253 shares of its Common Stock for all the outstanding ViComp
capital stock and granted options to certain ViComp shareholders
exercisable for 189,557 shares of the Company's Common Stock. The
transaction has been accounted for as a purchase and, accordingly, the
initial purchase price and acquisition costs have been allocated to the
identifiable assets and liabilities, including in-process research and
development of $1.8 million that was immediately expensed.
While DVS retains the intellectual property developed by ViComp, the
Company has ceased the research and development program of this
subsidiary effective March 31, 1998, since market conditions have made
further development of an MPEG-1 decoder chip financially unattractive.
The Company has expensed a significant portion of assets, primarily
fixed assets, associated with this development in fiscal 1998 as they
have no alternate use (See Note 1 to the financial statements).
In August 1997, the Company completed the acquisition of the
business and certain assets and liabilities of the Digital Video
division (the "DV Business") of Arris Interactive L.L.C. ("Arris") in a
transaction accounted for as a purchase. The total purchase price of
approximately $3.5 million included cash of $1.5 million, the issuance
of 600,000 shares of common stock and related acquisition costs of
$141,000. In-process research and development of $0.6 million was
immediately expensed during the fiscal year ended March 31, 1998 ("
Fiscal 1998"). Under the original purchase agreement, Arris was not
entitled to transfer or sell any of the shares of common stock until
certain periods had elapsed and none of such shares are registered under
any state or federal securities laws and any sales or transfers of such
shares must be made in compliance with such laws. In addition, the
Company also initially agreed to pay Arris additional contingent
consideration of up to $5 million if the DV Business achieves certain
revenue milestones.
In March 1998, the Company and Arris agreed to remove the restriction
on sale of the Company's common stock by Arris and provisions for the
payment of contingent consideration to Arris set forth in the initial
agreement.
In August 1997, the Company acquired substantially all of the assets
of Synchrome Technologies, Inc., ("Synchrome"), a privately held
developer and manufacturer of multimedia and computer storage PC
products. The purchase price of $1.0 million (including acquisition
costs) was paid in cash and accounted for using the purchase method.
Also in August 1997, the Company, through its wholly-owned
subsidiary, D.V.S. H.K., and the Panyu Tian Le Electrical Appliance
Manufacturing Co., Ltd. formed a joint venture in China to manufacture
and distribute Video CD and DVD players. As initially formed, the Panyu
Joint Venture was owned 51% by the Company, through D.V.S.H.K., and 49%
by Panyu.
In December 1997, the Company, and Panyu entered into an Ownership
Shares Transfer Agreement ("Transfer Agreement"). Pursuant to which,
the Company agreed to purchase from Panyu its entire 49% interest in
the Panyu Joint Venture for a nominal amount, thereby increasing the
Company's interest in the Venture to 100%. In January 1998, the
Company sold a 10% interest in the Panyu Joint Venture to Panyu Kembo
Electrical Manufacturing Co; Ltd.,("Kembo"), which is owned by Dr. An
Yueh Zehan, a member of the law firm representing the Company in China,
for a nominal amount. Kembo holds the interest as a nominee of the Company.
Results of operations for fiscal year ended March 31, 1998 (fiscal
1998) compared to year ended March 31, 1997 (fiscal 1997)
The following table sets forth for the periods indicated certain
income and expense items expressed as a percentage of the Company's
total revenues for the years ended March 31, 1998 and 1997. See
Consolidated Financial Statements and Notes thereto include elsewhere
herein.
<TABLE>
<CAPTION>
Percent Of Revenue
----------------------
Year Ended March 31,
----------------------
1998 1997
---------- -----------
<S> <C> <C>
Revenues................................. 100.0% 100.0%
Gross margin............................. -16.4% -5.1%
Research and development................. 45.8% 19.6%
Sales and marketing...................... 32.7% 12.6%
General and administrative............... 53.6% 36.3%
Purchased in-process research and
development............................. 3.5% 12.9%
Operating (loss)......................... -152.0% -86.4%
Net (loss)............................... -145.8% -91.4%
</TABLE>
<TABLE>
<CAPTION>
March 31, March 31, %
Consolidated revenue 1998 1997 Change
(in thousands)
- ---------------------------------------- ---------- -----------
<S> <C> <C> <C>
Product revenue............... $14,524 $7,903 83.8%
Development and services reven 671 208 222.6%
Component revenue............. 2,443 6,010 -59.4%
---------- ----------
Total revenue.............. $17,638 $14,121 24.9%
========== ========== ===========
</TABLE>
Total revenue increased $3.5 million, or 24.9% for fiscal 1998
compared with fiscal 1997 as a result of increasing product revenue,
which was partially offset by decreasing component revenue.
Product revenue consists of revenue from sale of Video CD players,
digital advertisement insertion systems, computer peripheral products,
and sub-assemblies. Product revenue increased $6.6 million, or 83.8%,
for fiscal 1998 compared with fiscal 1997. The increase was due to
newly acquired product lines in digital advertisement insertion systems
and computer peripheral products. The increase was also attributed to
the expansion of the Company's operations in Asia, including the Panyu
Joint Venture formed during fiscal 1998.
For the year ended March 31, 1998, development and service revenue
increased $0.5 million, or 222.6%, compared to the same period in the
prior year as a result of the formation of the Panyu Joint Venture in
fiscal 1998. Prior to the sale by Panyu of its 49% interest in the
Panyu Joint Venture, the Joint Venture assembled product on behalf of
Panyu and held no ownership rights with respect to the manufacturing
inventory; therefore, revenue generated by the Panyu Joint Venture was
considered service revenue. Panyu also acted as a distributor for the
Company's finished goods.
Component revenue decreased $3.6 million, or 59.4%, in fiscal 1998
compared to the same period in fiscal 1997. The decrease resulted from
the Company's decision to sell finished goods and sub-assemblies rather
than component parts. Component revenue is primarily derived from the
sale of certain inventory parts in excess of current manufacturing
needs of the Company and was used to generate working capital and
strengthen customer relationships. It is anticipated that component
revenue will continue to decrease in absolute dollars and as a
percentage of total revenue in the future. There were $1.4 million and
$0 component sales to related parties or affiliates in fiscal 1998 and
1997, respectively.
International revenue represented approximately 71.9% and 91.2% of
total revenue for the years ended March 31, 1998 and 1997,
respectively. The Company expects international revenue to continue to
be a significant part of total revenue.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
Gross margin(loss)............ ($2,890) ($719) -301.9%
as a percentage of revenue.. -16.4% -5.1%
</TABLE>
Gross margin decreased $2.2 million, or 301.9%, in fiscal 1998
compared to fiscal 1997. Gross margin percentage decreased to negative
16.4 % in fiscal 1998 from negative 5.1% in fiscal 1997.
Gross margin for product revenue decreased $2.9 million, or 451.5%
to a negative gross margin of $3.6 million in fiscal 1998 from a
negative gross margin of $0.6 million in fiscal 1997. Product gross
margin as a percentage of product revenues decreased to negative 24.6%
in fiscal 1998 from negative 8.2% in fiscal 1997. The decrease in the
gross margin and gross margin percentage for fiscal 1998 was primarily
due to the recognition of the cost of all shipments made by the Panyu
Joint Venture while the Company deferred recognition of the associated
revenue until such time as cash is received and the downward effect
that intense competition had on the margin of receivables that were
collected. In addition, the Company recognized write-downs of
inventory totaling $1.6 million as a result of excess inventory and net
realizable value (see Note 1 to the financial statements). This
decrease was partly offset by a change in the mix of product shipped
during the year.
Gross margin for development and service revenue increased by $0.7
million in fiscal 1998 compared to fiscal 1997. The increase was
primarily a result of revenue associated with sub-contracted assembly
performed by the Panyu Joint Venture. Accordingly, gross margin
percentage for fiscal 1998 has increased compared to fiscal 1997.
Gross margin for components revenue was minimal for fiscal 1998 and
1997 and is expected to remain minimal as a result of the Company's
decision to sell finished goods and sub-assemblies rather than
component parts.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
Research and development...... $8,082 $2,761 192.7%
as a percentage of revenue.. 45.8% 19.6%
</TABLE>
Research and development expenses consist primarily of personnel and
equipment prototype costs required to conduct the Company's development
efforts.
Research and development expenses increased $5.3 million, or 192.7%,
during fiscal 1998 compared with the same period in fiscal 1997.
Research and development expenses as a percentage of net revenues in
fiscal 1998 increased to 45.8% from 19.6% in fiscal 1997. The increase
in these expenses and as a percentage of net revenues is primarily
attributable to an increase in headcount by 45 employees related to the
continued expansion of the Company's worldwide operations, including
the New Media Division acquired in August 1997. In addition, during
fiscal 1998, the Company wrote off approximately $1.9 million in
intangible assets associated with and equipment used for research and
development projects undertaken by ViComp and the New Media Divison.
Further, the Company increased its funding of the development of its
DVD player. The Company expects that research and development expenses
in dollar terms will continue to increase as the Company expands its
development efforts, including the development of DVD products.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
Sales and marketing........... $5,771 $1,785 223.3%
as a percentage of revenue.. 32.7% 12.6%
</TABLE>
Sales and marketing expenses consist primarily of personnel and
consulting costs involved in the selling process and in the marketing
of the Company's products, sales commissions, and expenses associated
with trade shows and advertising.
Sales and marketing expenses increased $4.0 million, or 223.3%,
during fiscal 1998 compared with the same period in fiscal 1997. Sales
and marketing expenses as a percentage of net revenues in fiscal 1998
increased to 32.7% in fiscal 1998 from 12.6% in fiscal 1997. The
increase in these expenses in aggregate dollar spending and as a
percentage of net revenues for fiscal 1998 was primarily due to
business acquisitions that occurred during the year which contributed
to the headcount increase of 53 employees. In addition, consulting
fees and trade show expenses increased as a result of Company's
commitment to improve worldwide revenue growth. The Company expects
that sales and marketing expenses in dollar terms will continue to
increase as the Company continues to expand its sales and marketing
efforts worldwide.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
General and administrative.... $9,447 $5,122 84.4%
as a percentage of revenue.. 53.6% 36.3%
</TABLE>
General and administrative expenses consist primarily of
administrative salaries and benefits, insurance, facility, legal,
accounting, investor relations and other business support costs.
General and administrative expenses increased $4.3 million, or
84.4%, during fiscal 1998 compared with fiscal 1997. General and
administrative expenses as a percentage of net revenues in fiscal 1998
increased to 53.6% in fiscal 1998 from 36.3% in fiscal 1997. The
increase in these expenses and as a percentage of net revenues for the
year ended March 31, 1998 resulted from additional administrative
personnel associated with the business acquisitions made during the
year. During fiscal 1998, the Company increased its general &
administrative personnel from 18 to 107 employees. Higher legal,
consulting and accounting fees incurred due to expansion of the
Company's operation have also contributed to the increase in general
and administrative expenses. The Company expects that general and
administrative costs will increase in dollar terms to the extent the
Company continues to expand its businesses.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
Purchased in-process research $617 $1,819 -66.1%
development..................
as a percentage of revenue.. 3.5% 12.9%
</TABLE>
Purchased in-process research and development expenses were $0.6
million and $1.8 million in fiscal 1998 and 1997, respectively.
Purchased in-process research and development expenses were incurred as
a result of the acquisition of the DV Business in August 1997 and
ViComp in October 1996.
<TABLE>
<CAPTION>
March 31, March 31, %
1998 1997 Change
(in thousands) ---------- ---------- -----------
<S> <C> <C> <C>
Other income and expense, net. $1,089 $559 94.8%
as a percentage of revenue.. 6.2% 4.0%
</TABLE>
The increase in other income during fiscal 1998 resulted primarily
from earning interest from funds raised in the Company's public
offerings for a full year in fiscal 1998 compared to a partial year's
earning in fiscal 1997.
Extraordinary item. In fiscal 1997, the Company recorded an
extraordinary item of $1.3 million for the early extinguishment of
bridge notes. The bridge notes were issued in January and March 1996
and were repaid in May 1996 from the proceeds of the Initial Public
Offering.
Income taxes. The Company incurred net losses and consequently paid
no federal or state income taxes in fiscal 1998 or 1997. For federal
and state tax purposes, the Company has net operating loss
carryforwards as of March 31, 1998 of approximately $31 million and
$4.0 million, respectively, which will expire in various years
beginning with 1999 if not utilized.
Due to the "change in ownership" provisions of the Internal Revenue
Code, the availability of the Company's net operating loss and credit
carryforwards may be subject to an annual limitation in future periods.
Such a limitation could substantially limit the eventual tax
utilization of these carryforwards.
The Company has established a valuation allowance against its
deferred tax assets of $13.2 million due to uncertainty surrounding the
realization of such assets. Management evaluates on a quarterly basis
the recoverability of the deferred tax assets and the level of the
valuation allowance. If it is determined that it is more likely than
not that the deferred tax assets are realizable, then the valuation
allowance will be appropriately reduced.
Liquidity and Capital Resources
As a result of the Company's significant operating losses and the
cost of acquiring and funding recent acquisitions, the Company's
working capital has been substantially reduced. The Company ended
fiscal 1998 with working capital of $8.3 million and cash, cash
equivalents and short-term investments of $6.9 million compared with
$32.7 million of working capital and $32.2 million of cash and cash
equivalents at the end of fiscal 1997. The Company's accumulated
deficit was $46 million at March 31, 1998. The Company's available
working capital is inadequate to fund the DVD-ROM operation and the
planned launch of its recently acquired DVD-ROM products, while
maintaining the Company's other activities.
To provide additional working capital, in June 1998 the Company
borrowed $1,000,000 from Dr. Edmund Y. Sun, the Company's Chairman and
Chief Technology Officer. The loan from Dr. Sun will be converted into
shares of the Company's common stock in July 1998 (at a price equal to
100% of the average closing price of the Company's common stock over
the five trading days preceding the conversion) and with Dr. Sun to
receive registration rights to cover these shares. Notwithstanding the
financing provided by Dr. Sun, the Company will need to generate
additional liquidity to meet its current obligations and maintain its
current level of operations or to fund any significant future increase
in revenues. The Company is actively seeking additional financing to
meet those needs. Management's plan in continuing their operations
include raising additional funds from new and existing investors and
financial institutions, evaluating its operating costs for potential
consolidation and future cost savings and generating revenues from
product sales.
The Company's goal will be to bring to market higher-margin products
based on the Company's engineering capabilities, such as the DVD player
and DVD-ROM product lines, and to provide adequate technical and
marketing support for currently marketed products. In addition, the
Company intends to convert its commercial Video CD product lines to
DVD-based product lines. To meet the Company's objectives, operations
will be streamlined and lower-margin product lines or other operations
that are likely to generate significant negative cash flow for the
foreseeable future will be eliminated. As part of this plan the
Company will no longer produce consumer Video CD players in China and will
no longer produce the New Media Division's current product line while
completing development of its Catapult ad insertion product for sale or
license to a third party.
There can be no assurance that the Company will obtain additional
financing or product revenue necessary to continue operations. The
financial statements do not include any adjustments that may result from
the outcome of this uncertainty.
Net cash used in operating activities totaled $21.2 million in
fiscal 1998 compared to $8.5 million in fiscal 1997. Substantially all
of the net cash used in operating activities in fiscal 1998 represented
the net loss of $25.7 million adjusted for non cash charges to
operations of $1.9 million for depreciation and amortization, $2.5
million for the write off of operating and intangible assets and $0.6
million for purchased in-process research and development.
Substantially all of the net cash used in operating activities in
fiscal 1997 represented the net loss of $12.9 million adjusted for non-
cash charges to operations of $0.4 million for depreciation and
amortization, $1.5 million for the write off of deferred financing
charges and accretion related to bridge notes, and $1.8 million for
purchased in-process research and development.
Net cash used in investing activities totaled $5.2 million in fiscal
1998 compared to $1.3 million in fiscal 1997. Substantially all of the
net cash used in investing activities in fiscal 1998 was for the
acquisition of the DV Business of $1.6 million and Synchrome of $1.0
million, acquisition of property and equipment and licenses of $1.3
million and the purchase of short-term investments of $1.0 million.
Substantially all of the net cash used in investing activities in
fiscal 1997 was for the acquisition of property and equipment of $1.1
million. The Company has no material capital expenditure commitments.
Net cash provided by financing activities was minimal in fiscal 1998
compared to $37.3 million in fiscal 1997. In fiscal 1997, net proceeds
from the Company's initial public offering ("IPO") and follow-on
offering totaled $44.3 million. This amount was offset by $7.0 million
used to repay bridge notes.
The above activities resulted in decreases in cash and cash
equivalents of $26.3 million in fiscal 1998 compared to an aggregate
increase of $27.6 million in fiscal 1997.
The Company has an inventory purchase commitment with Siemens Energy
& Automation, Inc. of approximately $0.7 million as of March 31, 1998.
Charge to income in the event of release of escrow securities
In the event the Company attains any of the earning or stock price
thresholds required for the release of all or a portion of the
securities placed in escrow in connection with the IPO, the release of
such securities will result, for financial reporting purposes, in
compensation expense to the Company. Accordingly, the Company will, in
the event of the release of the securities escrowed in connection with
the IPO, recognize, during the period that the conditions for such
release are met, a substantial non-cash charge to earnings for
financial reporting purposes for the period or periods during which
such securities are, or become probable of, being released from escrow.
The amount of this charge will be equal to the fair market value of
such securities on the date of release from escrow.
Seasonality
The Company's business in China and Taiwan is somewhat seasonal,
with demand for consumer products generally being higher in the fourth
calendar quarter and lower in January and February due to the Chinese
New Year.
Year 2000
Product Liability. While the Company believes that most of its
currently developed and actively marketed products are Year 2000
compliant for significantly all functionality, these products could
contain errors or defects related to the Year 2000. Product lines that may be
affected by the Year 2000 issue are the MX Server and Server Systems for
Cable AD Insertion. The Company did not ship the MX Server until March 1998
and has decided to discontinue its current Cable Ad Insertion product
offering, "Enterprise", in May 1998. The Company believes that the impact
from the Year 2000 will not be significant to its product lines as a whole.
Corporate Systems. The Company will start an assessment of its
computer systems and software and will modify or replace portions of
its software so that its operating systems will function properly with
respect to dates in the Year 2000 and thereafter. The Company will
evaluate system interfaces with third-party systems, such as those of
key suppliers, distributors and financial institutions, for Year 2000
functionality. The Year 2000 project cost is not expected to be
material. The Company believes that, with modifications to existing
software and conversions to new software, the Year 2000 issue will not
pose significant operational problems for its computer systems.
However, if such modifications and conversions are not made, or are not
completed timely, the Year 2000 issue could have a material adverse
impact on the operations of the Company. Additionally, the systems of
other companies with which the Company does business may not address
any Year 2000 problems on a timely basis, which could have an adverse
affect on the Company's systems or business transactions. As testing
of Year 2000 functionality of the Company's systems must occur in a
simulated environment, the Company will not be able to test full system
Year 2000 interfaces and capabilities prior to Year 2000. The Company
believes that its exposure on Year 2000 issues is not material to its
business as a whole.
Item 7. Financial Statements.
The following financial statements of the Company are included in
this report:
- -- Consolidated Balance Sheets-March 31, 1998
- -- Consolidated Statements of Operations-Years ended March 31, 1998
and 1997
- -- Consolidated Statements of Stockholders' Equity-Years ended March
31, 1998 and 1997
- -- Consolidated Statements of Cash Flows-Years ended March 31, 1998
and 1997
- -- Notes to Consolidated Financial Statements
Item 8. Changes In and Disagreement With Accountants on Accounting and
Financial Disclosure.
Not Applicable
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Digital Video Systems, Inc.
We have audited the accompanying consolidated balance sheet of
Digital Video Systems, Inc. as of March 31, 1998, and the related
consolidated statements of operations, stockholders equity, and cash
flows for each of the two years in the period ended March 31, 1998.
The 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 in accordance with generally accepted
auditing standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of Digital Video Systems, Inc. at March 31,1998, and
the consolidated results of its operations and its cash flows for each of
the two years in the period ended March 31, 1998 in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming
Digital Video Systems, Inc. will continue as a going concern. As more
fully described in Note 1 to the financial statements, the Company has
incurred recurring operating losses. This condition raises substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or on
the amounts and classification of liabilities that may result from the
outcome of this uncertainty.
ERNST & YOUNG LLP
San Jose, California
July 9, 1998
DIGITAL VIDEO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
March 31, 1998
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $5,915
Short-term investments............................. 1,033
Accounts receivable, less allowance for doubtful 1,139
accounts of $1,562 ...............................
Inventories........................................ 5,002
Prepaid expenses and other current assets.......... 792
----------
Total current assets............................. 13,881
Property and equipment, net.......................... 1,117
Intangibles.......................................... 645
Other assets......................................... 85
----------
$15,728
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $2,151
Accrued liabilities................................ 3,401
----------
Total current liabilities........................ 5,552
Stockholders' equity:
Preferred stock, $0.0001 par value:
5,000,000 shares authorized; no shares issued
or outstanding at March 31, 1998.................. --
Common stock, $0.0001 par value:
80,000,000 shares authorized; 20,970,164
shares issued and outstanding at March 31, 1998... 3
Additional paid-in capital......................... 56,510
Accumulated deficit................................ (46,015)
Cumulative translation adjustments................ (249)
Deferred compensation.............................. (73)
----------
Total stockholders' equity....................... 10,176
----------
$15,728
==========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
DIGITAL VIDEO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------
1998 1997
---------- -----------
<S> <C> <C>
Revenue:
Product revenue........................ $14,524 $7,903
Development and services revenue
(including $641 and $150 from related
parties and affiliates for the years
ended March 31, 1998 and 1997,
respectively)......................... 671 208
Component revenue......................
(including $1,357 and $0 from related
parties and affiliates for the years
ended March 31, 1998 and 1997,
respectively)......................... 2,443 6,010
---------- -----------
Total revenue........................ 17,638 14,121
---------- -----------
Cost of product revenue.................. 18,103 8,552
Cost of development and services revenue. 25 254
Cost of component revenue................ 2,400 6,034
---------- -----------
Gross margin(loss)................... (2,890) (719)
Operating expenses:
Research and development............... 8,082 2,761
Sales and marketing.................... 5,771 1,785
General and administrative............. 9,447 5,122
Purchased in-process research and
development........................... 617 1,819
---------- -----------
Total operating expenses............. 23,917 11,487
---------- -----------
Loss from operations................. (26,807) (12,206)
Interest expense......................... -- (316)
Interest and other income................ 1,089 875
---------- -----------
Loss before extraordinary item........... (25,718) (11,647)
Extraordinary item-loss from early
extinguishment of bridge notes.......... -- (1,264)
---------- -----------
Net loss................................. ($25,718) ($12,911)
========== ===========
Basic and Diluted net loss per share before
extraordinary item (pro forma 1997)..... ($2.09) ($1.27)
Basic and Diluted net loss per share
(pro forma 1997)........................ ($2.09) ($1.40)
========== ===========
Shares used in the calculation
of Basic and Diluted net loss per share. 12,276 9,194
========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
DIGITAL VIDEO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
Cumula-
tive
Convertible Addi- Transla-
Preferred Stock Common Stock tional Accumu- tion Deferred
------------------- ------------------- Paid-in lated Adjust- Compen-
Shares Amount Shares Amount Capital Deficit ments sation Total
----------- ------- ----------- ------- --------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT MARCH 31, 1996..... 5,232,948 $1 6,725,624 $1 $9,154 ($7,386) ($31) (151) $1,588
Exercise of common stock
options..................... -- -- 330,357 -- 46 -- -- -- 46
Sale of IPO Units, net of
issuance costs.............. -- -- 4,830,000 -- 20,714 -- -- -- 20,714
Conversion of preferred
stock to common stock....... (5,232,948) (1) 5,232,948 1 -- -- -- -- --
Reduction of deferred
compensation for options
placed in escrow............ -- -- -- -- (97) -- -- 97 --
Follow-on sale of Units,
net of issuance costs....... -- -- 2,645,000 -- 23,032 -- -- -- 23,032
Issuance of common stock
to acquire ViComp........... -- -- 491,253 -- 1,756 -- -- (48) 1,708
Shares and warrants issued
to a consultant............. -- -- 4,397 -- 23 -- -- -- 23
Amortization of deferred
compensation................ -- -- -- -- -- -- -- 16 16
Translation adjustment....... -- -- -- -- -- -- (41) -- (41)
Net loss........ -- -- -- -- -- (12,911) -- -- (12,911)
----------- ------- ----------- ------- --------- ---------- -------- --------- ---------
BALANCE AT MARCH 31, 1997..... -- -- 20,259,579 2 54,628 (20,297) (72) (86) 34,175
Exercise of common stock
options..................... -- -- 247,130 -- 36 -- -- -- 36
Shares and warrants issued
to a consultant............. -- -- 4,215 -- 11 -- -- -- 11
Cancellation of ViComp
escrowed shares............ -- -- (140,760) -- -- -- -- -- --
Issuance of common stock
to acquire Digial Video
Division from Arris......... -- -- 600,000 1 1,835 -- -- -- 1,836
Amortization of deferred
compensation................ -- -- -- -- -- -- -- 13 13
Translation adjustment....... -- -- -- -- -- -- (177) -- (177)
Net loss........ -- -- -- -- -- (25,718) -- -- (25,718)
----------- ------- ----------- ------- --------- ---------- -------- --------- ---------
BALANCE AT MARCH 31, 1998..... -- $ -- 20,970,164 $3 $56,510 ($46,015) ($249) ($73) $10,176
=========== ======= =========== ======= ========= ========== ======== ========= =========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DIGITAL VIDEO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended
March 31,
-------------------
1998 1997
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.............................. ($25,718) ($12,911)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation........................ 1,200 415
Amortization........................ 696 16
Deferred financing charges and
accretion related to bridge notes.. -- 1,491
Shares and warrants issued to a
consultant......................... 11 23
Purchased in-process research and
development........................ 617 1,819
Write-off of operating and
intangible assets ................. 2,524 --
Loss on disposal of fixed assets.... 121 --
Changes in operating assets and
liabilities:
Accounts receivable............... 1,803 (2,340)
Inventories....................... (3,538) 910
Prepaid expenses and other
current assets................... (331) (202)
Accounts payable.................. (864) 1,856
Accrued liabilities............... 2,313 441
--------- ---------
Net cash used in operating
activities..................... (21,166) (8,482)
--------- ---------
INVESTING ACTIVITIES
Acquisition of property and equipment. (954) (1,139)
Business combinations, net of cash
acquired............................. (2,670) (147)
Purchase of short-term cash
investments.......................... (3,366) --
Maturities of short-term investments.. 2,333 --
Purchases of intangibles.............. (320) --
Other investing activities............ (199) --
--------- ---------
Net cash used in investing
activities..................... (5,176) (1,286)
--------- ---------
FINANCING ACTIVITIES
Net proceeds from public offerings
of Units............................. -- 44,284
Proceeds from exercise of stock
options.............................. 36 46
Repayment of bridge notes............. -- (7,000)
--------- ---------
Net cash provided by financing
activities..................... 36 37,330
--------- ---------
Net increase/(decrease) in cash and cash
equivalents.......................... (26,306) 27,562
Cash and cash equivalents at beginning
of year.............................. 32,221 4,659
--------- ---------
Cash and cash equivalents at end of
year.................................. $5,915 $32,221
========= =========
Supplemental disclosure of cash flow
information:
Interest paid....................... $ -- $173
Supplemental disclosure of non-cash
Common stock issued in acquisitions. $1,836 $1,756
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
DIGITAL VIDEO SYSTEMS, INC.
Notes to Consolidated Financial Statements
Note 1 - The Company and its Significant Accounting Policies
The Company
Digital Video Systems, Inc. (the "Company") develops,
manufactures and markets digital video compression and decompression
hardware and software for entertainment, business and educational uses.
The Company's current product offering includes Video CD players,
subassemblies and components for the consumer and for the commercial
video markets ("video engines"), and interactive video engines and
video-on-demand systems for the hospitality, entertainment, education
and kiosk markets, and to a lesser extent, digital MPEG compression
systems, and sub-assemblies. The Company also offers digital
advertisement insertion systems for the cable television market and CD-
R and CD-RW for the computer peripheral market. The Company has also
developed a DVD player for the home entertainment market.
Basis of Presentation
The accompanying consolidated financial statements include the
accounts of the Company and all subsidiaries. All significant
intercompany balances and transactions have been eliminated.
As a result of the Company's significant operating losses and the
cost of acquiring and funding its recent acquisitions, the Company's
working capital has been substantially reduced. The Company ended
fiscal 1998 with working capital of $8.3 million and cash, cash
equivalents and short-term investments of $6.9 million compared with
$32.7 million of working capital and $32.2 million of cash and cash
equivalents at the end of fiscal 1997. The Company's accumulated
deficit was $46 million at March 31, 1998. The Company's available
working capital is not sufficient to fund the DVD-ROM operations and
the planned launch of its recently acquired DVD-ROM products, while
maintaining the Company's other activities.
To provide additional working capital, in June 1998 the Company
borrowed $1,000,000 from Dr. Edmund Y. Sun, the Company's Chairman and
Chief Technology Officer. The loan from Dr. Sun will be converted into
shares of the Company's common stock in July 1998 (at a price equal to
100% of the average closing price of the Company's common stock over
the five trading days preceding the conversion) and with Dr. Sun to
receive registration rights to cover these shares. Notwithstanding the
financing provided by Dr. Sun, the Company will need to generate
additional liquidity to meet its current obligations and maintain its
current level of operations or to fund any significant future increase
in revenues. The Company is actively seeking additional financing to
meet those needs. Management's plan in continuing their operations
include raising additional funds from new and existing investors and
financial institutions, evaluating its operating costs for potential
consolidation and future cost savings and generating revenues from
product sales.
The Company's goal will be to bring to market higher-margin products
based on the Company's engineering capabilities, such as the DVD player
and DVD-ROM product lines, and to provide adequate technical and
marketing support for currently marketed products. In addition, the
Company intends to convert its commercial Video CD product lines to
DVD-based product lines. To meet the Company's objectives, operations
will be streamlined and lower-margin product lines or other operations
that are likely to generate significant negative cash flow for the
foreseeable future will be eliminated. As part of this plan the
Company will no longer produce consumer Video CD players in China and will
no longer produce the New Media Division's current product line while
completing development of its Catapult ad insertion product for sale or
license to a third party.
There can be no assurance that the Company will obtain additional
financing or product revenue necessary to continue operations. The
financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result
from the outcome of this uncertainty.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Significant estimates include
impairment write-downs of fixed assets and intangibles and the level of
accounts receivable and inventory reserves. Actual results could differ
from those estimates.
Cash and Equivalents and Short-term Investments
Cash and cash equivalents include money market accounts and highly
liquid debt instruments with a remaining maturity of three months or
less at the date of purchase. Short-term investments consist of money
market instruments, investments in municipal bonds and mutual funds
with carrying values which approximate their market values.
In accordance with Statement of Financial Accounting Standard (SFAS)
No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", the Company has classified its debt securities as
available-for-sale. Available-for-sale securities are carried at fair
value, with unrealized gains and losses reported as a separate
component of stockholders' equity when material. Unrealized gains and
losses and realized gains and losses for each period presented have not
been material. The cost of securities sold is based on the specific
identification method.
Revenue Recognition
Revenue from product and component sales are recognized upon the
later of shipment, acceptance of the product by the customer, or when
payment from the customer is assured. Product revenue from the
Company's Panyu Joint Venture is recognized when cash is received
although the related cost of sale is recognized as product is shipped.
The Company offers limited stock rotation and price protection under
certain programs. The Company estimates and maintains a reserve for
product returns and price protection.
Development revenue is recognized based upon the completion of
specified milestones in accordance with the agreement terms, typically
as costs are incurred. Costs related to development revenues are
included in cost of development and service revenues in accompanying
statements of operations. Service revenues, including sub-contract
revenue earned by the Panyu Joint Venture, are recognized as cash is
received for services performed.
Advertising Expense
Advertising expenditures are charged to operations as incurred and
total $313,000 and $100,000 in fiscal 1998 and 1997, respectively.
Inventories
Inventories are stated at the lower of actual cost (first-in, first-
out method) or market. The Company has recorded a write-down of
inventory and a charge to cost of product revenue of $0.4 million to
reflect net realizable value as of March 31, 1998. Additionally,
management determined that inventory of certain products was in excess
of the Company's current requirements based on past levels of sales and
sales forecasted in fiscal 1999. Management has developed a program to
reduce inventories to levels that are consistent with forecasted sales
and has expensed to cost of product revenue, $1.2 million, related to
excess and obsolete inventory.
Property and Equipment
Property and equipment are stated at cost net of accumulated
depreciation and amortization or at their impaired value. Depreciation
and amortization are computed using the straight-line method over the
assets estimated useful lives of two to five years.
The Company has adopted FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long Lived Assets to be
Disposed of". As a result of the existance of certain impairment
indicators, the Company has determined that the value of certain assets
are impaired and has recorded impairment write-downs of $0.5 million in
relation to those assets which has been included in research and
development expenses. Those impairment indicators include: recurring
operating losses, further development of an MPEG-1 decoder chip
becoming financially unattractive and the dominance of the Cable Ad
Insertion market by a single supplier.
Intangibles
Intangible assets consist of acquired technology and purchased
goodwill and are stated at cost net of accumulated amortization or at
their impaired value. Amortization is computed using the straight line
method over the assets estimated useful lives of 5 months to 7 years.
As a result of the existence of certain impairment indicators, the
Company has determined that the value of certain assets are impaired
and has recorded impairment write-downs of $1.4 million in relation to
certain intangible assets and which has been expensed to research and
development in fiscal 1998. Those impairment indicators include:
recurring operating losses and the dominance of the Cable Ad Insertion
market by a single supplier. Due to the dominance of the industry by a
single supplier and the number of competitors, the Company has
discontinued its "Enterprise" product offering in May 1998 and is in
the process of re-evaluating its overall business opportunities for
both the "Catapult" product line and the New Media Division.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiaries is the
local currency. Translation adjustments, which result from the process
of translating foreign currency financial statements into U.S. dollars,
are included as a separate component of stockholders' equity.
Transactional gains and losses, which have not been material to date,
are included in interest and other income in the accompanying statement
of operations.
Certain Concentrations
Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash equivalents,
short-term investments, and receivables from customers. The Company
primarily invests its cash equivalents and short-term investments in
time deposits with high-credit quality institutions and corporate bonds
and notes. The Company is exposed to credit risk in the event of
default by these institutions and corporate entities to the extent of
the amount recorded in the balance sheet. With respect to receivables
from customers, the Company primarily sells its products worldwide to
original equipment manufacturers and product distribution companies in
Asia. The Company generally does not require collateral, and maintains
reserves for potential credit losses.
Foreign Operations
A significant proportion of the Company's operations are based
outside of the United States, principally in China, Hong Kong and
Taiwan. As a result, the Company will be subject to the need to comply
with a wide variety of foreign laws and regulations. In particular,
the Company may be materially adversely affected by changes in the
political, social and economic conditions in these countries, and by
changes in government policies with respect to such matters as laws and
regulations, methods to address inflation, currency conversion and
restrictions and rates and methods of taxation.
Revenue
A significant portion of the Company's revenue and net income is
derived from international sales, particularly from customers based in
Asia. Fluctuation of the U.S. dollar against foreign currencies,
charges in local regulatory or economic condition could adversely
affect operating results.
During the year ended March 31, 1998, one customer accounted for
31% of total revenue. During the year ended March 31, 1997, four customers
accounted for 25%, 20%, 16% and 12% of total revenue respectively.
Net Loss Per Share
In 1997 the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share ("FAS 128"). FAS 128 replaced the
calculation of primary and fully diluted net income (loss) per share
with basic and diluted net income (loss) per share. Unlike primary net
income (loss) per share, basic net income (loss) per share excludes any
dilutive effects of options, warrants and convertible securities.
Diluted net income (loss) per share is very similar to the previously
reported net loss per share. Net loss per share amounts for all
periods have been presented and, where appropriate, restated to conform
to the FAS 128 requirements.
Basic net loss per share is computed using the weighted average
number of common shares outstanding during the periods. Diluted net
loss per share is computed using the weighted average number of common
and potentially dilutive common shares during the periods, except those
that are antidilutive.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS
No.130, "Reporting Comprehensive Income", which establishes standards
for reporting and displaying comprehensive income and its components in
a full set of general-purpose financial statements and is required to
be adopted by the Company beginning in fiscal 1999. The Company is
evaluating the potential impact of this accounting pronouncement on
required disclosures. The Company anticipates that its unrealized gain
and loss on investments and cumulative translation adjustment balances
will be included as components of comprehensive income.
Additionally, the Financial Accounting Standards Board issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information", which establishes standards for the way that public
business enterprises report information in annual statements and
interim financial reports regarding operating segments, products and
services, geographic areas and major customers. SFAS 131 will be
effective be for the Company for fiscal 1999 year-end and will apply to
both annual and interim financial reporting subsequent to this date.
SFAS 131 is not expected to have a material impact on the financial
condition or results of operations of the Company.
Note 2 - Balance Sheet Components
Inventories, property and equipment, and accrued liabilities
consisted of the following at March 31, 1998 (in thousands):
<TABLE>
<S> <C>
Inventories:
Raw materials................................... $2,271
Work in progress................................ 875
Finished goods.................................. 1,856
----------
$5,002
==========
Property and equipment:
Machinery and computer equipment................ $2,251
Furniture and fixtures.......................... 537
----------
2,788
Accumulated depreciation........................ (1,671)
----------
$1,117
==========
Accrued liabilities:
Accrued warranty and related expenses........... $173
Payroll and related expenses.................... 956
Accrued taxes................................... 363
Other accrued expenses.......................... 1,909
----------
$3,401
==========
Intangible assets:
Goodwill........................................ 508
Intangible assets of business acquired.......... 1,935
Purchased licenses.............................. 320
----------
2,763
Accumulated amortization........................ (2,118)
----------
$645
==========
</TABLE>
Note 3 - Business Combinations
Acquisition of Digital Video Division-
On August 1, 1997, the Company completed the acquisition of the
business and certain assets and liabilities of the Digital Video
division (the "DV Business") of Arris Interactive L.L.C. ("Arris") in a
transaction accounted for as a purchase, and the results of the DV
Business have been included in the Company's operations since the date
of acquisition.
The total purchase price of approximately $3.5 million included cash
of $1.5 million, the issuance of 600,000 shares of common stock and
related acquisition costs of $141,000. As part of the Asset Purchase
Agreement, 50% of the Common Stock included in the consideration was
deposited into an escrow account. Under the original purchase
agreement, Arris was not entitled to transfer or sell any of the shares
of common stock until certain periods had elapsed and none of such
shares are registered under any state or federal securities laws and any
sales or transfers of such shares must be made in compliance with such
laws. In addition, the Company also initially agreed to pay Arris
additional contingent consideration of up to $5 million if the DV
Business achieves certain revenue milestones.
In March 1998, the Company and Arris agreed to remove the restriction
on sale of the Company's common stock by Arris and cancelled the
provisions for the payment of contingent consideration to Arris set forth
in the agreement.
The purchase price has been allocated based upon discounted cash
flow valuation method as follows (in thousands):
<TABLE>
<S> <C>
Current assets........................ $585
Equipment............................. 511
Intangibles........................... 1,935
Liabilities assumed................... (170)
In-process research and development... 617
------------
$3,478
============
</TABLE>
In accordance with generally accepted accounting principles, in-
process research and development has been expensed. At March 31, 1998,
the Company determined that the remaining intangible assets, consisting
of developed technology, had become fully impaired. This resulted in a
charge to operations of $1.4 million.
The following unaudited pro forma combined results of the Company
and the DV Business for the fiscal year ended March 31, 1998 and 1997
have been prepared assuming that the acquisition had occurred at the
beginning of the period presented. The following pro forma results are
not necessarily indicative of the results that would have occurred had
the transaction been completed at the beginning of the period
indicated, nor is it indicative of future operating results.
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------
1998 1997
(in thousands) ------------ ------------
<S> <C> <C>
Pro forma net revenue.............. $18,699 $17,412
Pro forma net loss before
extraordinary items............ ($26,364) ($19,235)
Pro forma net loss................. ($26,364) ($20,499)
Pro forma net loss per share before
extraordinary items............ ($2.08) ($1.85)
Pro forma net loss per share....... ($2.08) ($1.98)
</TABLE>
For the fiscal year ended March 31, 1998 and 1997 the pro forma net
loss excludes the non-recurring charge for purchased in-process
research and development.
Acquisition of Synchrome Technologies, Inc.
On August 25, 1997, the Company acquired substantially all of the
assets of Synchrome Technologies, Inc., ("Synchrome") a developer and
manufacturer of multimedia and computer storage PC products. The
purchase price of $1 million (including acquisition costs) was paid in
cash and accounted for the acquisition using the purchase method. The
results of operations of Synchrome have been included in the Company's
operations since acquisition.
The purchase price has been allocated based upon discounted cash
flow method as follows (in thousands):
<TABLE>
<S> <C>
Current assets........................ $521
Equipment............................. 52
Goodwill.............................. 508
Liabilities assumed................... (53)
------------
$1,028
============
</TABLE>
Panyu Joint Venture-
In August 1997 the Company, through its wholly-owned subsidiary,
D.V.S. H.K., and the Panyu Tian Le Electrical Appliance Manufacturing
Co., Ltd. ("Panyu") formed a joint venture (the "Panyu Joint Venture")
in China to manufacture and distribute Video CD and DVD players. As
initially formed, the Panyu Joint Venture was owned 51% by the Company,
through D.V.S.H.K., and 49% by Panyu.
During October 1997, the Company contributed approximately $600,000
in cash in accordance with the Joint Venture Agreement. Additional
contributions of cash $200,000 was made in February 1998 in addition to
inventory and other non cash working capital that has been contributed since
the Joint Venture's inception. In December 1997, the Company, and Panyu
entered into an Ownership Shares Transfer Agreement ("the Transfer Agreement").
Pursuant to the Transfer Agreement, which is subject to local government
approval, the Company purchased from Panyu their entire 49% interest in the
Panyu Joint Venture for a nominal amount, increasing the Company's interest
in the venture to 100%.
In connection with the Transfer Agreement, Panyu and the Panyu Joint
Venture entered into a two-year lease agreement pursuant to which Panyu
will lease to the Panyu Joint Venture certain land, buildings and
equipment ("Lease Assets") for a monthly fee of approximately $78,000.
The Lease provides that during its term, the Panyu Joint Venture may,
at its sole option, purchase the Lease Assets for a price equal to the
appraised value of such assets. The Panyu Joint Venture has also agreed
to purchase Video CD materials, parts and finished goods inventory from
Panyu valued at approximately $3.0 million.
In January 1998, the Company sold a 10% interest in the Panyu Joint
Venture for a nominal amount to Panyu Kembo Electrical Manufacturing
Co; Ltd. ("Kembo") which is owned by Dr. An Yueh Zehan, a member of the
law firm representing the Company in China for a nominal amount. Kembo
holds the interest as a nominee of the Company.
In the fourth quarter of fiscal 1998, the Company consolidated 100%
of the assets and liabilities of the Joint Venture as of March 31, 1998.
During the quarter ended December 31, 1997, the Company consolidated the
balance sheet and results of operations of the Panyu Joint Venture as of
September 1997 and the three months then ended.
Since the inception of the Panyu Joint Venture, the Company has
experienced severe problems with its former local Chinese partner,
Panyu, who has transferred its 49% interest to the Company in December
1997. Until the transfer, Panyu acted as a distributor for the
Company's finished goods manufactured by the Panyu Joint Venture.
Based upon a recent audit of the Panyu Joint Venture, the Company
believes that Panyu has misappropriated certain funds of the Panyu
Joint Venture primarily through its distributor relationship whereby
cash proceeds received by Panyu were retained and not remitted to the Joint
Venture. In addition, the Company believes that Panyu removed
inventory from the Panyu Joint Venture's premises without authorization
or payment and charged the Panyu Joint Venture for expenses without
proper supporting documentation.
The Company, on behalf of the Panyu Joint Venture has retained a
local CPA firm in the People's Repulic of China ("PRC") to perform an
investigative audit on transactions with Panyu and retained PRC counsel
to provide advice on how to recover such losses and is currently investigating
all available legal remedies. During fiscal 1998, the Company recognized
$0.6 million of service revenue from Panyu and recorded a receivable of $2.9
million, which was fully reserved at March 31, 1998, as there can be no
assurance that any amounts will be recovered from Panyu.
Vicomp Technology, Inc.-
In October 1996, the Company acquired a related party, ViComp
Technology, Inc. ("ViComp"), a development stage company that designs
integrated circuits for use in video CD players. Pursuant to the
acquisition, the Company issued 491,253 shares of its Common Stock for
all the outstanding ViComp capital stock and granted options to certain
ViComp shareholders exercisable for 189,557 shares of the Company's
Common Stock. The Company's Chairman and Chief Technology Officer
("Chairman") owned approximately 57% of the outstanding capital stock
of ViComp at the time of its acquisition by the Company. Of the 281,520
shares of the Company's common stock to be received by the Chairman,
140,760 shares are subject to an escrow having substantially identical
terms to the escrow agreement described in Note 8. These shares have
not been included in the purchase price as they are subject to
forfeiture in the event specified levels of pretax income or market
price are not achieved. The remaining 140,760 shares issued to the
Chairman were held in a separate performance escrow and have been
cancelled as certain performance milestones were not reached by July
1997. These shares also were not included in the purchase price. The
transaction has been accounted for as a purchase and, accordingly, the
initial purchase price and acquisition costs have been allocated to the
identifiable assets and liabilities, including in-process research and
development of $1,819,000 which was immediately expensed. Additional
consideration paid upon the achievement of the performance milestones
(equal to the fair market value of the 140,760 shares released from the
performance escrow), if any, will be recorded as additional purchase
price at such time. The results of operations of ViComp have been
included in the Company's operations since acquisition.
Note 4 - Cash Equivalents, Short-term Investments and Fair Value of
Financial Instruments
As of March 31, 1998, the estimated fair value of the cash
equivalents and short-term investments consisted of the following (in
thousands):
Cash and money market funds....................... $1,944
Corporate securities.............................. 4,392
US Government and government sponsored securites.. 611
----------
Total available-for-sale and trading
investments.............................. $6,947
==========
The estimated fair value of marketable securities by contractual maturity as of
March 31, 1998 are as follows:
Cash equivalents and short-term investments: (in thousands)
Due in one year or less........................... $5,914
Due after one year................................ 1,033
----------
$6,947
==========
Fair values of cash equivalents and short-term investments and
trading assets approximate cost due to one or more of the following:
the short term maturities of the investments, absence of changes in
underlying interest rates or the absence of changes in security credit
ratings.
Note 5 - Commitments
Lease Commitments
The Company leases its facilities and certain office equipment under
noncancelable leases which require the Company to pay operating costs,
including property taxes, insurance and maintenance. Future minimum
lease payments under these operating leases at March 31, 1998 are as
follows (in thousands):
1999............................................ $1,782
2000............................................ 1,422
2001............................................ 447
2002............................................ 200
2003 & thereafter............................... 171
----------
$4,022
==========
Rent expense charged to operations was approximately $975,000 and
$274,000 for the years ended March 31, 1998 and 1997, respectively.
Purchase Commitments
The Company has an outstanding purchase commitment for raw materials
of approximately $678,000 as of March 31, 1998. The Company is due to
take delivery of the inventory in August 1998.
NOTE 6--INCOME TAXES
For financial reporting purposes, the net loss includes the following
components:
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------
1998 1997
(in thousands) ---------- ----------
<S> <C> <C>
United States.................. ($17,290) ($11,011)
Foreign........................ (8,428) (1,900)
---------- ----------
Total.......................... ($25,718) ($12,911)
========== ==========
</TABLE>
The differences between the benefit for income taxes and the amount computed
at the U.S. statutory income tax rate are as follows:
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------
1998 1997
(in thousands) ---------- ----------
<S> <C> <C>
Tax at U.S. statutory rate..... ($8,826) ($4,390)
Purchased in-process research
and development............... -- 618
Losses for which no tax
benefit was recognized........ 8,809 3,661
Other, net..................... 17 111
---------- ----------
Benefit for income taxes....... $ -- $ --
========== ==========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets at March 31, 1998 are as follows
(in thousands):
<TABLE>
<CAPTION>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards......... $11,200
Inventory valuation accounts............. 590
Reserves and other accrued expenses not
yet deductible for taxes................ 550
Other.................................... 940
----------
Total deferred tax assets................ 13,280
Valuation allowance for deferred tax
assets.................................. (13,280)
----------
Net deferred tax assets.................. $ --
==========
</TABLE>
For federal and state tax purposes, the Company has net operating
loss carryforwards as of March 31, 1998 of approximately $31 million
and $4.0 million, respectively, which will expire in various years
beginning with 1999 if not utilized.
Due to the "change in ownership" provisions of the Internal Revenue
Code, the availability of the Company's net operating loss and credit
carryforwards may be subject to an annual limitation in future periods.
Such a change could substantially limit the eventual tax utilization of
these carryforwards.
Note 7 - Net Loss Per Share
In February 1997, the Financial Accounting Standards Board issued
FAS 128, which was required to be adopted on December 31, 1997. As a
result, the Company has changed the method used and restated prior
periods.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------
1998 1997
---------- ----------
(in thousands except per share amounts)
<S> <C> <C>
Net loss before extraordinary item.......... ($25,718) ($11,647)
Net loss.................................... ($25,718) ($12,911)
========== ==========
Weighted average common shares
outstanding during the period(1).......... 12,276 8,741
Convertible perferred stock
(pro forma 1997).......................... -- 453
---------- ----------
Shares used in computing Basic and
Diluted net loss per share
(pro forma 1997).......................... 12,276 9,194
========== ==========
Basic and Diluted net loss per share
before extraordinary item
(pro forma 1997).......................... ($2.09) ($1.27)
Basic and Diluted net loss per share
(pro forma 1997).......................... ($2.09) ($1.40)
========== ==========
</TABLE>
(1) Does not include 8,311,598 and 8,388,814 shares of escrow common and
preferred stock for fiscal 1998 and 1997, respectively.
Pro forma basic and diluted net loss per share for 1997 have been
computed as described in Note 1 and also gives effect (using the if-
converted method) to the conversion of convertible preferred shares
that automatically converted upon completion of the Company's initial
public offering from the date of issuance.
For fiscal 1998 and 1997, respectively, 3,358,283 and 2,788,489
options and 18,489,955 and 18,480,970 of warrants were excluded from the
calculation of diluted loss per share because their effect is anti-dilutive.
Note 8 - Stockholder's Equity
Common Stock Offering
In May 1996, the Company completed an initial public offering, ("IPO"),
of 4,830,000 units, each unit consisting of one share of Common Stock, one
Class A Warrant and one Class B Warrant, priced at $5.00 per Unit. In
November 1996, the Company closed a follow-on offering of 26,450 units.
Each Unit consisted of 100 units which are identical to the units
issued in the Company's initial public offering of units as described
above. In connection with the IPO, all of the then outstanding shares
of convertible preferred stock of 5,232,948 were converted to common
stock on a one-for-one basis. The proceeds, net of commissions and
certain expenses, to the Company from the offerings were approximately
$43.7 million.
Each Class A Warrant entitles the holder to purchase at an exercise
price of $6.50, subject to adjustment, one share of Common Stock and
one Class B Warrant. Each Class B Warrant entitles the holder to
purchase, at an exercise price of $8.75, subject to adjustment, one
share of Common Stock. The Class A Warrant and the Class B Warrants
included in the Units are exercisable at any time after issuance until
May 9, 2001. The Class A Warrants are subject to immediate redemption
and the Class B Warrants are subject to redemption commencing in May
1997, by the Company at $0.05 per Warrant, upon 30 days' written
notice, if the average closing bid price of the Company's Common Stock
has equaled or exceeded $9.10 per share with respect to the Class A
Warrants and $12.25 per share with respect to the Class B Warrants
(subject to adjustment in each case) for 30 consecutive trading days
ending within 15 days of the date the Warrants are called for
redemption.
Private Placement
In March 1996, the Company completed a $7 million private placement
of bridge notes. Each bridge note unit consisted of a $50,000 face
value promissory note bearing 10% interest and was due in January and
March 1997, and 25,000 warrants ("Bridge Warrants"). The $7 million was
allocated $0.9 million to the 3,500,000 Bridge Warrants issued and $6.1
million to the bridge notes payable. The debt discount and selling
commissions and expenses were expensed using the interest method over
the term of the notes through May 1996 at which time the bridge notes
were repaid using the proceeds from the initial public offering and the
remaining debt discount and selling commissions and expenses of $1.3
million were charged to operations as an extraordinary item in fiscal
year 1997. The Bridge Warrants included in the private placement
converted on a one-to-one basis into Class A Warrants upon the closing
of the Company's IPO of Units.
Escrowed Securities
In April 1996, the holders of the Company's common and preferred
stock, and holders of options to purchase common stock pursuant to the
Company's 1993 stock option plan, placed, on a pro rata basis,
7,812,948 of their shares and options to purchase 1,852,697 shares of
common stock, respectively, into escrow, and a holder of an option to
purchase 200,000 shares of Common Stock outside the Company's 1993
stock option plan placed all of such options into escrow. Additionally,
234,355 options reserved for future grant under the Company's 1993
Stock Option Plan were subject to escrow upon grant. The common stock
and options will be released to the stockholders on a pro rata basis,
in the event specified levels of pretax income of the Company for the
years ended March 31, 1999 to 2001 are achieved, or the market price of
the Company's common stock attains specified targets during a 36-month
period commencing from the effective date of the registration statement
relating to the Company's IPO. The pretax income levels are subject to
proportionate adjustment upon the issuance of certain securities
subsequent to the Company's IPO.
Any shares or options remaining in escrow on July 15, 2001 will be
forfeited, which shares and options will then be contributed to the
Company's capital.
In the event that the foregoing earnings or market price levels are
attained and the escrow securities released, the release of escrow
securities to officers, directors, employees and consultants of the
Company will result in compensation expense for financial reporting
purposes. The expense will equal the fair market value of the escrow
securities on the date of release and could result in a material charge
to operations.
As of March 31, 1998, 8,311,598 shares of the Company's common
stock, 1,486,238 outstanding options to purchase common stock and
443,532 options available for future grant were subject to escrow.
To date, no shares or options have been released from escrow.
Stock Option Plans
The Company's stock option plans provide for the granting of
incentive stock options and nonstatutory stock options to employees,
directors and consultants at prices ranging from 85% to 110% (depending
on the type of grant) of the fair value of the common stock on the
grant date as determined by the Board of Directors. Most options vest
ratably over a four-year period commencing as of the date of grant.
The Company has authorized 3,762,532 shares of common stock for
issuance under the 1993 Stock Option Plan (the "1993 Plan") and
1,500,000 shares of common stock for issuance under the 1996 Stock
Option Plan (the "1996 Plan"). The options granted under the 1993 Plan
and 1996 Plan are exercisable over a maximum term of ten years from the
date of grant, and are subject to various restrictions as to resale and
right of repurchase by the Company.
During fiscal 1995 the Company issued options to purchase shares of
common stock and recorded deferred compensation of approximately
$175,000 for financial reporting purposes with respect to such option
grants to reflect the difference between the exercise price and deemed
fair value, for financial statement presentation purposes, of the
Company's common shares. Deferred compensation is being amortized over
the vesting period of the stock options.
In January 1998, the Board of Directors offered non-officer
employees holding stock options with exercise prices over $2.16 per
share the opportunity of canceling those stock options (not subject to
Company's performance escrow) in exchange for new options issued with
exercise prices of $2.16 per share, the market price on January 14,
1998. Employees who were eligible were required to trade in 25% of
their outstanding non-escrowed options to reprice their shares.
Included in the table below are options for 651,293 shares that were
granted and options for 868,386 shares that were canceled under this
program during fiscal 1998.
Option activity under the 1993 Plan and 1996 Plan was as follows:
<TABLE>
<CAPTION>
Outstanding Options
----------------------
Available Weighted
for Number Average
Grant of Shares Exercise
Price
----------- ----------- ----------
<S> <C> <C> <C>
Balance at March 31, 1996....... 1,525,913 1,665,512 $0.14
Options authorized............ 1,000,000 -- --
Options granted............... (2,623,773) 2,623,773 $4.48
Options exercised............. -- (330,357) $0.14
Options canceled.............. 480,882 (480,882) $3.07
----------- -----------
Balance at March 31, 1997....... 383,022 3,478,046 $3.01
Increase in shares authorized. 500,000 -- --
Options granted............... (1,773,043) 1,773,043 $3.33
Options exercised............. -- (247,130) $0.14
Options canceled.............. 1,845,676 (1,845,676) $4.49
----------- -----------
Balance at March 31, 1998....... 955,655 3,158,283 $2.54
=========== =========== ==========
</TABLE>
<TABLE>
<CAPTION>
Options Oustanding Options Exercisable
----------------------------------- ----------------------
Number Weighted Number
Outstanding Average Weighted Exercisable Weighted
at Remaining Average at Average
Range of March 31, Contractual Exercise March 31, Exercise
Exercise Prices 1998 Life (Years) Price 1998 Price
- ----------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.14 832,783 6.84 $0.14 678,518 $0.14
1.44 135,500 9.96 1.44 -- --
2.13 - 2.19 757,095 9.78 2.15 106,367 2.15
3.50 - 5.00 1,225,936 8.79 3.75 264,546 3.75
7.25 206,969 8.89 7.25 80,090 7.25
- ----------------- ----------- -----------
$0.14 - $7.25 3,158,283 8.57 $2.54 1,129,521 $1.65
=========== ===========
</TABLE>
Employee Stock Purchase Plan
In September 1997, the shareholders approved 500,000 shares for
distribution under the Company's employee stock purchase plan which
employees may purchase shares, subject to certain limitations, at no
less than 85% of the lower of the fair market value of the shares at
the beginning or end of a three-month purchase period. The first
enrollment period for the stock purchase plan began on April 1, 1998.
Other Options and Warrants
On February 1, 1996, the Board of Directors authorized a grant of
200,000 common stock options to a consultant. The options, which are
not included in the 1993 Plan or 1996 Plan, have an exercise price of
$5.00 per share and were fully vested at March 31, 1998. None of these
options have been exercised to date.
In connection with the IPO and follow-on offering, the Company
granted an option to purchase 650,000 Units (each Unit is identical to
the ones issued in the IPO) to an underwriter. 420,000 Units are
exercisable at a price of $6.50 per Unit during a three year period
commencing in May 1998. 230,000 Units are exercisable at a price of
$16 per Unit over a period of two years commencing November 21, 1999.
As of March 31, 1998, there were warrants, issued to a consultant,
outstanding to purchase 30,970 shares of common stock at $8.375 per
share through 2002.
Accounting for Stock Based Compensation
The Company accounts for stock option plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employee," (APB No. 25). In accordance with APB No. 25, the
Company has generally not recognized compensation expense in connection
with such plans.
The Company has adopted the disclosure -only provisions of Statement
of Financial Accounting Standards No. 123, (SFAS 123), "Accounting for
Stock-Based Compensation". Had compensation cost for the 1996 and 1993
Plans been determined based on the fair value at the grant date for the
options granted in fiscal 1998 consistent with the provisions of SFAS
123, the Company's net loss for fiscal 1998 and 1997 would have been
increased to the pro forma amounts indicated below (amount in
thousands, except per share):
<TABLE>
<CAPTION>
Years Ended March 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Net loss before extraordinary item--
pro forma......................... ($27,367) ($11,846)
Net loss -- pro forma............... ($27,367) ($13,110)
Basic and Diluted net loss per share
before extraordinary item
-- pro forma...................... ($2.23) ($1.29)
Basic and Diluted net loss per share
-- pro forma...................... ($2.23) ($1.43)
</TABLE>
The weighted average estimated fair values of employee stock options
for fiscal year 1998 and 1997 were $1.78 and $1.51 per share,
respectively.
The fair value for these options was estimated at the date of grant
using the Black-Scholes option-pricing model with the following
weighted average assumptions for 1998 and 1997:
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------
1998 1997
---------- ----------
<S> <C> <C>
Risk-free interest rate.......... 5.50% 6.50%
Dividend yield................... 0.0% 0.0%
Volatility....................... 0.90 0.90
Average life..................... 1.19 3.83
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options, and because changes in these subjective input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable
single measure of the fair value of its employee stock options.
The pro forma effects of applying SFAS No. 123 are not likely to be
representative of the effects on pro forma disclosures in future year.
Because SFAS No. 123 is applicable only to options granted subsequent
to March 31, 1995, its pro forma effect will not be fully reflected
until approximately fiscal 2000.
Note 9 - Employee Benefit Plan
During fiscal 1998, the Company has implemented a 401(k) tax-
deferred savings plan under which all US employees may contribute up to
16% of their compensation, subject to certain Internal Revenue Service
limitations. The Company has not contributed to the plan to date.
Note 10 - Related Party Transactions
Since the inception of the Panyu Joint Venture, the Company has
experienced severe problems with its former local Chinese partner,
Panyu, who has transferred its 49% interest to the Company in December
1997. Until the transfer, Panyu acted as a distributor for the
Company's finished goods manufactured by the Panyu Joint Venture.
Based upon a recent audit of the Panyu Joint Venture, the Company
believes that Panyu has misappropriated certain funds of the Panyu
Joint Venture primarily through its distributor relationship whereby
cash proceeds received by Panyu have not been remitted to the Joint
Venture. In addition, the Company believes that Panyu removed
inventory from the Panyu Joint Venture's premises without authorization
or payment and charged the Panyu Joint Venture for expenses without
proper supporting documentation.
The Company, on behalf of the Panyu Joint Venture has retained a
local PRC CPA firm to perform an investigative audit on transactions
with Panyu and retained PRC counsel to provide advice on how to recover
such losses and is currently investigating all available legal
remedies. During fiscal 1998, the Company recognized $0.6 million of
service revenue from Panyu and recorded a receivable of $2.9 million,
which was fully reserved at March 31, 1998, as there can be no
assurance that any amounts will be recovered from Panyu.
In addition, during fiscal 1998, The Company recognized
approximately $1,357,000 of revenue from Anhui Wanyan Electronic
Systems, Co., Ltd. (Wyan), an affiliate of the Company, and the
receivable from Wyan of $542,000 as of March 31, 1998, which was fully
reserved for.
Note 11 - Segment Information
The Company operates in one business segment, which includes
developing, producing and marketing digital video systems and sub-
assemblies, digital ad insertion products and computer peripheral
products. The following table summarizes the Company's operations from
its headquarters located in Los Gatos, California and branch office in
Suwanee, Georgia ("United States") and its foreign operations in China,
Hong Kong and Taiwan ("Asia"):
<TABLE>
<CAPTION>
United
States Asia Total
--------- --------- ---------
<S> <C> <C> <C>
Year Ended March 31, 1998:
Revenue from unaffiliated customers......... $4,928 $12,039 $16,967
Revenue from related parties and affiliates. 29 642 671
--------- --------- ---------
Total revenue............................... $4,957 $12,681 $17,638
========= ========= =========
Loss from operations........................ ($18,483) ($8,324) ($26,807)
========= ========= =========
Identifiable assets......................... $10,020 $5,708 $15,728
========= ========= =========
Year Ended March 31, 1997:
Revenue from unaffiliated customers......... $1,090 $12,881 $13,971
Revenue from related parties and affiliates. 150 -- 150
--------- --------- ---------
Total revenue............................... $1,240 $12,881 $14,121
========= ========= =========
Loss from operations........................ ($9,583) ($2,623) ($12,206)
========= ========= =========
Identifiable assets......................... $31,115 $6,958 $38,073
========= ========= =========
</TABLE>
Export sales, representing sales from the United States to customers
in foreign countries, were $196,000 and $867,000, for the years ended
March 31, 1998 and 1997, respectively.
Note 12 - Subsequent Event with Related Party
In June 1998, the Company completed the acquisition of a perpetual,
worldwide, royalty-free license to DVD-ROM technology owned by Hyundai
Electronics Industries, Co., Ltd. ("Hyundai") in exchange for 2,000,000
shares of the Company's common stock. In addition, the Company,
through a newly-formed, wholly-owned subsidiary, DVS-Korea, completed
the acquisition of DVD-ROM manufacturing capabilities, a related
research and development team and management from Hyundai for
$1,000,000 in cash.
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance With Section 16(a) of the Exchange Act.
The Company intends to file with the Securities and Exchange
Commission a definitive proxy statement (the "Proxy Statement")
pursuant to Regulation 14A in connection with the Annual Meeting of
Shareholders expected to be held in September 1998, which will involve
the election of directors, within 120 days of the end of the fiscal
year covered by this Annual Report on Form 10-KSB. Information
regarding directors and executive officers of the Company will be in
the Proxy Statement and is incorporated herein by reference.
Item 10. Executive Compensation
Information regarding executive compensation will be in the Proxy
Statement and is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and
Management.
Information regarding security ownership of certain beneficial
owners and management will be in the Proxy Statement and is
incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions
will be included in the Proxy Statement and is incorporated herein by
reference.
Item 13. Exhibits and Reports on Form 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
- ------- ---------------------------------------------------------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of the Company.(1)
3.2 Bylaws of the Company.(1)
4.1 Specimen Common Stock Certificate.(3)
4.2 Form of Warrant Agreement (the "Warrant Agreement") by and among the
Company, American Stock Transfer & Trust Company and the Underwriter
(including forms of Class A and Class B Warrant certificates).(3)
4.3 Form of Underwriter's Unit Purchase Option (issued in connection with
the Company's initial public offering).(1)
4.4 Warrant Agreement.(1)
4.5 Escrow Agreement dated as of April 23, 1996 among American Stock
Transfer & Trust Company, the Company and Optionholders listed on
Exhibit B thereto.(3)
4.6 Form of Subscription Agreement from the Bridge Financing.(2)
4.7 Escrow Agreement dated as of October 17, 1996 made by and between the
Company and Dr. Edmund Y. Sun.(4)
4.8 Escrow Agreement dated as of October 17, 1996 made by and among the
Company, Dr. Edmund Sun and American Stock Transfer & Trust
Company.(4)
4.9 Escrow Agreement dated as of October 17, 1996 made by and among the
Company, the shareholders named on the signature pages thereto and
American Stock Transfer & Trust Company.(4)
4.10 Form of Amendment to the Warrant Agreement.(4)
4.11 Form of Underwriter's Unit Purchase Option.(4)
10.1 1993 Amended and Restated Stock Option Plan.(2)
10.2 Employment Agreement as of March 1, 1996 between the Company and Dr.
Edmund Sun.(2)
10.3 Product Agreement made March 16, 1993 between Hyundai and the
Company.(1)
10.4 Technical Assistance and License Agreement made March 16, 1993 between
Hyundai and the Company.(1)
10.5 1995 Hyundai Technical Assistance and License Agreement.(1)
10.6 Consulting Agreement made as of February 1, 1996 between the Company
and Intermarkt.(1)
10.7 Sublease Agreement, dated as of November 15, 1995, between the Company
and McAfee Associates, Inc. (along with consent to sublease and master
lease agreement).(1)
10.8 House Leasing Agreements dated August 31, 1994 and September 6, 1994
for facility in Taiwan (translated).(1)
10.9 Form of Indemnity Agreement with the Company's officers and directors.
(1)
10.10 Series A Preferred Stock Purchase Agreement made as of January 21,
1994 between the Company and Hyundai.(1)
10.11 Series B Preferred Stock Purchase Agreement made as of April 1995
between the Company and Hyundai.(1)
10.12 Consulting and Employment Agreement between the Company and Robert B.
Pfannkuch entered into as of March 15, 1996.(2)
10.13 Agreement and Plan of Merger dated as of October 17, 1996 by and
between the Company, ViComp Technology, Inc. and the shareholders of
ViComp Technology, Inc.(4)
10.14 Registration Rights Agreement dated as of October 17, 1996 by and
between the Company and the shareholders of ViComp Technology, Inc.
named therein.(4)
10.15 1996 Stock Option Plan.(4)
10.16 Consulting Agreement made as of September 27, 1996 between the Company
and Sitrick and Company Inc.(4)
10.17 Office Lease Agreement commencing on October 15, 1996 between the
Company and Paulsen Office Park.(4)
10.18 Lease, dated July 17, 1996, between the Company and Ken Yang Real
Estate (Shanghai) Co. Ltd.(4)
10.19 Letter dated April 10, 1997 from Robert B. Pfannkuch to the Company
regarding resignation as an Officer.(5)
10.20 Employment Agreement between the Company and Thomas R. Parkinson
entered into March 28, 1997.(5)
10.21 Settlement Agreement and General Release entered into January 30, 1997
between the Company and Janis P. Gemignani.(5)
10.22 Joint Venture Agreement dated as of August 5, 1997 by and between
D.V.S. H.K., a wholly-owned subsidiary of the Company, adn Panyu
Tian Le Electrical Appliance Manufacturing Co., Ltd. (6)
10.23 Asset Purchase Agreement dated as of July 25, 1997 by and between
the Company and Arris Interactive LLC. (7)
10.24 Amendment No. 1 to Asset Purchase Agreement by and between the
Company and Arris Interactive LLC dated as of August 1, 1997. (7)
10.25 Form of Escrow Agreement by and between the Company and Arris
Interactive LLC. (7)
10.26 1997 Employee Stock Purchase Plan. (8)
10.27 1993 Amended and Restated Stock Option Plan. (8)
10.28 1996 Amended and Restated Stock Option Plan. (8)
10.29 Employment Agreement dated as of August 1, 1997 by and between the
Company and Gary Franza. (9)
10.30 Ownership Shares Transfer Agreement by and between D.V.S. H.K.,
a wholly-owned subsidiary of the company, and Panyu.(10)
10.31 Lease Agreement by and between D.V.S. H.K., a wholly-owned
subsidiary of the Company, and Panyu.(10)
10.32 Form of Joint Venture Partner Substitution Agreement (superceded ).(10)
10.33 Employment Agreement dated as of January 12, 1998 by and
between the Company and Edward Miller.(10)
10.34 Lease Agreement by and between Digital Video Systems, Inc. and
Dell Enterprises. (10)
10.35 Asset Purchase Agreement dated as May 8, 1998 by and between
the Company and Hyundai Electronic Industries Company, Ltd.
10.36 Amendment to Asset Purchase Agreement dated June 23, 1998 by and
between the Company and Hyundai Electronic Industries Company, Ltd.
10.37 Joint Venture Partner Subsitution Agreement
10.38 Amendment to the Asset Purchase Agreement dated March 26, 1998
by and between the Company and Arris Interactive LLC.
21 List of Subsidiaries
23.1 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule
99.1 Certain Considerations
</TABLE>
- ---------
(1) Incorporated by reference from the Company's Registration Statement on
Form SB-2 (Registration No. 333-2228), as filed with the Commission on
March 8, 1996.
(2) Incorporated by reference from Amendment No. 1 to the Company's
Registration Statement on Form SB-2 (Registration No. 333-2228) as filed
with the Commission on April 23, 1996.
(3) Incorporated by reference from Amendment No. 2 to the Company's
Registration Statement on Form SB-2 (Registration No. 333-2228), as filed
with the Commission on May 8, 1996.
(4) Incorporated by reference from the Company's Registration Statement on
Form SB-2 (Registration Statement No. 333-15471), as filed with the
Commission on November 4, 1996.
(5) Incorporated by reference from the Company's Form 10KSB for the Fiscal
Year Ended March 31, 1997 as filed with the with the Commission on
June 30, 1997.
(6) Incorporated by reference to the Company's Current Report on Form 8-
K filed with the Commission on August 15, 1997.
(7) Incorporated by reference to the Company's Current Report on Form 8-
K filed with the Commission on September 26, 1997.
(8) Incorporated by reference to the Company's Definitive Proxy
Statement filed with the Commission on August 11, 1997.
(9) Incorporated by reference from the Company's Form 10QSB for the quarter
ended September 30, 1997 as filed with the with the Commission on
November 19, 1997.
(10)Incorporated by reference from the Company's Form 10QSB for the quarter
ended December 31, 1997 as filed with the Commission on
February 12, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
DIGITAL VIDEO SYSTEMS, INC.
July 9, 1998 By /s/ Edward M. Miller
-----------------------------------
Edward M. Miller
Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Signature Capacity Date
- -------------------------- ---------------------------------- -------------
/s/ Dr. Edmund Y. Sun Chairman of the Board and July 9, 1998
- --------------------------- Chief Technology Officer
Dr. Edmund Y. Sun
/s/ Philip B. Smith Director July 9, 1998
- ---------------------------
Philip B. Smith
/s/ Joseph F. Troy Director July 9, 1998
- ---------------------------
Joseph F. Troy
/s/ Sanford Sigoloff Director July 9, 1998
- ---------------------------
Sanford Sigoloff
/s/ Sung Hee Lee Director July 9, 1998
- ---------------------------
Sung Hee Lee
/s/ Tom Parkinson Director July 9, 1998
- ---------------------------
Tom Parkinson
/s/ John Smuda Chief Financial Officer July 9, 1998
- ---------------------------
John Smuda
EXHIBIT 10.35
ASSET PURCHASE AGREEMENT
ASSET PURCHASE AGREEMENT dated as of May 8, 1998, by and between
Digital Video Systems, Inc., a Delaware corporation ("DVS") and Hyundai
Electronics Industries Company, Ltd., a company organized under the laws
of Korea ("Hyundai").
W I T N E S S E T H:
WHEREAS, DVS desires to license from Hyundai and Hyundai desires to
license, directly to DVS, substantially all of the intangible assets (the
"Intangible Assets") of Hyundai used or useful in its DVD-ROM division
("DVD-ROM Business"), and to sell to a wholly-owned Korean subsidiary of
DVS ("DVS-Korea"), all of the tangible assets used or useful in the DVD-
ROM Business (the "Tangible Assets," and together with the Intangible
Assets, the "Assets") and in connection therewith grant to DVS certain
other rights, in exchange for, shares of common stock of DVS (the "Common
Stock") in the case of the Intangible Assets, and cash, in the case of
the Tangible Assets, as set forth herein (collectively, the
"Transaction");
WHEREAS, the parties desire to enter into this Asset Purchase
Agreement to set forth their mutual agreements concerning the above
matters;
NOW, THEREFORE, in consideration of the mutual promises of the
parties hereto, and of good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, it is mutually agreed by
and between the parties hereto as follows:
ARTICLE 1
LICENSE, SALE AND TRANSFER OF ASSETS AND SHARES; CLOSINGS
1.1 (a) Exclusive License of Intangible Assets. (i) Subject to the
terms and conditions of this Agreement, at the closing of the license of
the Intangible Assets (the "IP Closing"), Hyundai will grant to DVS a
perpetual, worldwide, royalty-free license to use the Intangible Assets,
and DVS will license the Intangible Assets from Hyundai for 2,000,000
shares of common stock of DVS (the "Common Stock"). Except as otherwise
noted on Schedule 1.1(a), the Intangible Assets shall be free and clear
of all liens, claims, and other liabilities, and shall include all of the
intangible personal property owned, licensed or otherwise held by Hyundai
in connection with the DVD-ROM Business, including, without limitation
all intellectual property associated with the development, ownership,
marketing and sale of Hyundai's DVD-ROM product, DVD licenses from the
DVD consortium and all of Hyundai's trademarks, patents, servicemarks,
copyrights, any pending applications for trademarks or patents or
servicemarks or copyrights (a complete schedule of all such property
shall be provided to DVS as soon as practicable after this Agreement is
signed by DVS and Hyundai, and shall be attached hereto as
Schedule 1.1(a)), trade secrets, design know-how, and engineering and
other plans, drawings and diagrams relating to the DVD-ROM Business (the
"Proprietary Technology"). With respect to any pending patent
applications included in the Proprietary Technology, DVS shall use its
best efforts to complete the application process and to obtain the patent
sought; provided, that Hyundai shall assist DVS in any manner, and take
any actions, required by law to ensure that the patent is obtained.
(ii) Notwithstanding Section 1.1(a)(i), DVS
acknowledges that in certain limited instances, Hyundai shall have the
right to cross-license the Intangible Assets to a third-party. Hyundai
shall not be permitted to cross-license any of the Intangible Assets
except where such cross-license is required by Hyundai in order for
Hyundai to obtain a counter party cross-license from a third-party who
asserts its intellectual property rights against Hyundai, or threatens to
initiate, or initiates a legal action against Hyundai. In all cases
where Hyundai grants such a third-party cross-license to the Intangible
Assets, Hyundai shall ensure that the grant of such license shall not in
any manner impair the rights of DVS under this Agreement. Further, in
connection with any such cross-license granted by Hyundai, Hyundai shall
obtain a written agreement from the cross-licensee that such cross-
licensee shall not use the licensed property to compete with DVS or its
subsidiaries, including, without limitation, DVS-Korea. Hyundai shall
provide both DVS and DVS-Korea with 30 days prior written notice of any
proprosed cross-license by Hyundai of any of the Intangible Assets.
(b) Sale of Tangible Assets; Assumption of Liabilities. Subject
to the terms and conditions of this Agreement, at the closing of the sale
of the Tangible Assets (the "Asset Closing"), Hyundai will sell, convey,
assign and transfer the Tangible Assets to DVS-Korea, and DVS-Korea will
purchase the Tangible Assets from Hyundai for $1,000,000 (United States
Dollars) in cash. The Tangible Assets shall be free and clear of all
liens, claims, and other liabilities, and shall include the following:
(i) all of the tangible personal property owned,
leased, operated or held by Hyundai in connection with the DVD-ROM
Business, including, but not limited to, fixed assets, equipment,
tooling, inventory, spare parts, manuals and other such tangible personal
property (a complete listing of such tangible assets shall be provided to
DVS as soon as practicable after this Agreement is signed by DVS and
Hyundai, and shall be attached hereto as Schedule 1.2(b)(i)) and all
books and records relating to the DVD-ROM Business.
(ii) all of the benefits and obligations of Hyundai's
supply contracts, pending sales, and customer database related to the
DVD-ROM Business, with a complete listing of the foregoing contracts,
including those with Shin Heung, Matshushita and Dong-Ah SMT (the
"Contracts") (a complete listing of such Contracts shall be provided to
DVS as soon as practicable after this Agreement is signed by DVS and
Hyundai, and shall be attached hereto as Schedule 1.2(b)(ii)); and
(iii) all of Hyundai's rights to operate the DVD-ROM
Business, including all licenses, consents, certificates, authorizations
and privileges (a complete listing of such material licenses, consents,
certificates, authorizations and privileges shall be provided to DVS as
soon as practicable after this Agreement is signed by DVS and Hyundai,
and shall be attached hereto as Schedule 1.2(b)(iii)).
(c) Other Transactions. In connection with the sale of the
Assets to DVS:
(i) Hyundai will grant to DVS-Korea the exclusive right
to use the Hyundai name and logo in connection with the marketing and
sale of DVD-ROM, DVD-RAM, CD-R and CD-RW products of DVS and DVS-Korea in
the United States, Canada, Europe and China for a period of one year from
the IP Closing Date (as defined below). DVS-Korea may use the Hyundai
name and logo alone only: (A) if required in order to satisfy the
requirements of certain suppliers and governmental regulatory agencies,
and (B) on the existing 450 units of product made by the DVD-ROM Business
and containing the Hyundai name and logo. In all other cases, DVS shall
only use the Hyundai name and logo in conjunction with the DVS name and
logo. Hyundai shall have the right to approve the manner in which the
Hyundai name and logo are applied to products, packaging and marketing
materials. DVS shall give Hyundai 30 days in which to review any new
application of the Hyundai name and logo and if Hyundai does not notify
DVS within such 30 day-period that a proposed use is not acceptable, then
DVS shall have the right to apply the Hyundai name and logo in the manner
proposed. Hyundai shall not unreasonably reject any proposed use of its
name and logo by DVS for the purpose described in this Section 1.2(c).
Notwithstanding any use of the Hyundai name and logo by DVS-Korea, DVS
and/or DVS-Korea shall be liable to their respective customers or end-
users for any defective products, customer service and support, and
damages or costs associated therewith.
(ii) grant to DVS the right to exclusively use, for a
rental fee of 2,000,000 Korean Won per month, the current 10,000 square-
foot Hyundai DVD-ROM facility (the "Facility") for a period of six months
from the later to occur of the IP Closing Date and the Asset Closing Date
(as defined below) for final assembly and testing of DVD ROM drives; and
(iii) grant to DVS a five-year worldwide license for
all Hyundai DVD-video intellectual property, including, without
limitation, navigator software based upon certain chip sets of C-Cube and
Matshushita, for a royalty fee to be negotiated in good faith.
(d) Taxes. Hyundai shall be responsible for all taxes and
fees related to the transfer of the Assets customary for a seller under
the laws of Korea, and each of DVS or DVS-Korea, as the case may be,
shall be responsible for all taxes and fees related to the transfer of
the Assets customary for a buyer under the laws of Korea.
(e) Liabilities. Except as otherwise expressly set forth
herein, DVS shall not assume any liabilities of or relating to Hyundai,
the Assets, or the DVD-ROM Business.
(f) Consents, Other Approvals, Etc.. Notwithstanding
anything in this Agreement to the contrary, DVS and Hyundai acknowledge
and agree that certain laboratory approvals will be required by DVS-Korea
in order to manufacture products. In addition, DVS and Hyundai
acknowledge and agree that in order for Matshushita to sell certain
components to DVS-Korea rather than to Hyundai, Matshushita will be
required to obtain an approval from the Japanese Ministry of Commerce.
During the time that such consents and approvals are being obtained (the
"Interim Period"), Hyundai agrees to take those actions and perform those
services necessary to ensure that: (i) DVS-Korea has a sufficient supply
of all components required from Matshushita in connection with the DVD-
ROM Business, and (ii) products sold by DVS-Korea contain necessary
certifications, whether governmental or otherwise. Hyundai agrees that
it shall enter into a subcontracting agreement pursuant to which it shall
take such actions and perform such services (the "Subcontracting
Agreement"), in form and substance to be negotiated in good faith by DVS
and Hyundai as soon as practicable after the signing of this Agreement.
1.2 Consideration.
(a) Payments at Closings.
(i) In consideration of the license by Hyundai of the
Intangible Assets to DVS, DVS at the IP Closing shall issue to Hyundai
2,000,000 shares of Common Stock.
(ii) In consideration of the transfer by Hyundai of
the Tangible Assets to DVS-Korea, DVS-Korea at the Asset Closing shall
pay to Hyundai $1,000,000 (United States Dollars) by wire transfer or
certified check, and DVS-Korea shall assume the liabilities under
Sections 1.4(c) and 1.5 hereof accrued through the Asset Closing Date (as
defined below).
(iii) The offer and sale of the Common Stock issued to
Hyundai hereunder has not been registered under the United States
Securities Act of 1933, as amended (the "Securities Act"). Such Common
Stock must be held by Hyundai until such Common Stock is registered
pursuant to an effective registration statement under the Securities Act
and all applicable state securities laws or any state of the United
States, as provided for in Section 8.5 hereof.
(iv) Hyundai agrees not to sell or otherwise transfer
the Common Stock for a period of 180 days from and after the Asset
Closing Date (as defined below). After the expiration of such 180 day
period and subject to Section 1.2(a)(iii) hereof, Hyundai shall be
entitled to transfer or sell all of such then existing shares of Common
Stock (as may be adjusted for stock splits or dividends).
1.3 Closings. (a) The IP Closing will take place at the offices
of Hyundai, Seoul, Korea, at 10:00 a.m. (local time) on the business day
following the date which is the last to occur of ten days following the
date all required consents and approvals, if any, have been received and
30 days following the signing of this Agreement, or at such other time
and place as the parties may agree (the "IP Closing Date"). Each party
shall use its best efforts to ensure that it obtains all required
consents and approvals, if any, in a timely manner.
(b) The Asset Closing will take place at the offices of
Hyundai, Seoul, Korea, at 10:00 a.m. (local time) on the business day
following the date which is the last to occur of ten days following the
date all required consents and approvals, if any, have been received and
30 days following the signing of this Agreement, or at such other time
and place as the parties may agree (the "Asset Closing Date," and
together with the IP Closing Date, the "Closing Dates"). Each party
shall use its best efforts to ensure that it obtains all required
consents and approvals, if any, in a timely manner.
Provided that all required consents and approvals have been obtained and
all applicable closing conditions have been met, the IP Closing and the
Asset Closing may occur concurrently, but nothing herein shall require
the Closings to occur concurrently. This Agreement shall be terminable
as provided in Section 12.1 hereof.
1.4 Closing Obligations. At each Closing, as applicable, DVS and
Hyundai shall take the following actions, in addition to such other
actions as may otherwise be required under this Agreement:
(a) Conveyance Instruments. Hyundai shall deliver to DVS
such warranty deeds, bills of sale, assignments, and other instruments of
conveyance and transfer as DVS may reasonably request to effect the
assignment to DVS of the Assets.
(b) Delivery of Stock. DVS shall deliver to Hyundai share
certificates duly endorsed for transfer to Hyundai representing 2,000,000
shares of DVS's issued and outstanding Common Stock.
(c) Assumption Agreement and Bill of Sale. Each party
shall execute and deliver an Assumption Agreement and Bill of Sale in the
form of Exhibit A hereto.
(d) Certificates. Each party shall deliver the certifi-
cates as to the accuracy of the representations and warranties contained
herein, the compliance with the covenants and agreements contained
herein, and the satisfaction of the conditions to the applicable Closing
contained herein.
1.5 Post-Closing Obligations To Be Assumed By DVS. DVS agrees
that it will assume and will pay, perform and discharge all obligations
of the DVD-ROM Business that are specifically assumed by DVS in
connection with each Closing as provided herein or that arise from the
conduct of the DVD-ROM Business after the applicable Closing Date when
the same become due or are required to be performed or discharged.
1.6 Post-Closing Obligations To Be Paid By Hyundai. Hyundai
agrees that it will be solely liable for and shall pay, perform and
discharge all obligations of the DVD-ROM Business (including any
contingent liabilities relating to the conduct of the DVD-ROM Business
prior to the applicable Closing) that are not specifically assumed by DVS
as provided herein that relate to the conduct of the DVD-ROM Business
prior to the applicable Closing Date when the same become due or are
required to be performed or discharged.
ARTICLE 2
REPRESENTATIONS AND WARRANTIES OF HYUNDAI
Hyundai hereby represents and warrants to DVS as follows:
2.1 Organization. Hyundai is a company duly organized, validly
existing and in good standing under the laws of Korea with the power and
authority to conduct its business and to own and lease its properties and
assets (including the Assets) and, as to the conduct of the DVD-ROM
Business and the use and ownership of the Assets specifically, is duly
qualified or licensed to do business and is in good standing as a foreign
corporation in any jurisdictions in which it does business.
2.2 Power and Authority. Hyundai has the power and authority to
execute, deliver, and perform this Agreement and the other agreements and
instruments to be executed and delivered by it in connection with the
transactions contemplated hereby and thereby, has taken all necessary
company action (including obtaining the approval of its board of
directors) to authorize the execution and delivery of this Agreement and
such other agreements and instruments and the consummation of the
transactions contemplated hereby and thereby. This Agreement is, and the
other agreements and instruments to be executed and delivered by Hyundai
in connection with the transactions contemplated hereby when executed and
delivered shall be, the legal, valid, and binding obligations of Hyundai,
enforceable in accordance with their terms.
2.3 No Conflict. Neither the execution and delivery of this
Agreement and the other agreements and instruments to be executed and
delivered in connection with the transactions contemplated hereby or
thereby, nor the consummation, of the transactions contemplated hereby or
thereby, will violate or conflict with: (a) except insofar as required
consents are to be procured prior to the applicable Closing, any federal,
state, or local law, regulation, ordinance, zoning requirement,
governmental restriction, order, judgment or decree applicable to
Hyundai, the DVD-ROM Business, or the Assets; (b) any provision of any
charter, bylaw or other governing or organizational instruments of
Hyundai; or (c) except insofar as consents are to be procured prior to
the applicable Closing, any mortgage, indenture, license, instruments
trust, contract, agreement, or other commitment or arrangement to which
Hyundai is a party or by which Hyundai or any of the Assets is bound.
2.4 Required Government Consents. Except for the filing and/or
recording of deeds and other instruments of conveyance, transfer, or
assignment required by copyright, patent, or trademark laws or the laws
of the jurisdictions in which the Assets are located, to occur upon
applicable Closing and except as otherwise set forth herein, no approval,
authorization, certification, consent, variance, permission, license, or
permit to or from, or notice, filing, or recording to or with, federal,
state, or local governmental authorities is necessary for the execution
and delivery of this Agreement and other agreements and instruments to be
executed and delivered in connection with the transactions contemplated
hereby or thereby by Hyundai or the consummation by Hyundai of the
transactions contemplated hereby or thereby, or the ownership and use of
the Assets and the conduct of the related business (including by DVS or
DVS-Korea, as the case may be).
2.5 Required Contract Consents. Except as set forth in Schedule
2.5, (such scheduled items shall be referred to herein as the "Required
Contract Consents," and such schedule shall be provided to DVS as soon as
practicable after this Agreement is signed by DVS and Hyundai, and
attached hereto), no approval, authorization, consent, license,
permission, or waiver to or from, or notice, filing, or recording to or
with, any person is necessary for: (a) the execution and delivery of
this Agreement and the other agreements and instruments to be executed
and delivered in connection with the transactions contemplated hereby or
thereby by Hyundai or the consummation by Hyundai of the transactions
contemplated hereby; (b) the transfer and assignment to DVS at the Asset
Closing of the Contracts; or (c) the ownership and use of the Assets and
the conduct of the DVD-ROM Business (including by DVS or DVS-Korea, as
the case may be).
2.6 Title to Assets; Sufficiency, etc. Hyundai has good and
marketable title to, or a valid leasehold interest in, all of the Assets,
free and clear of all liens, claims, encumbrances, security interests or
other restrictions on transfer, except for properties and assets disposed
of in the ordinary course of business since the date of the most recent
balance sheet provided by Hyundai to DVS. The Assets are sufficient to
conduct the DVD-ROM Business as presently conducted and as presently
proposed to be conducted in the Hyundai Business Plan dated April 1998
which was provided to DVS by Hyundai (the "Business Plan"). Hyundai owns
or leases all buildings (including the Facility), machinery, equipment,
and other tangible assets necessary for the conduct of the DVD-ROM
Business as presently conducted and as presently proposed to be conducted
and the Facility has a current capacity of not less than 50,000 units per
month (approximately 600,000 units per year).
2.7 Title to Intellectual Property.
(a) Subject to Section 1.1(a)(ii), DVS shall receive an
exclusive license the Proprietary Technology at the IP Closing, free and
clear of all liens, encumbrances or licenses (except as set forth on
Schedule 1.1(a);
(b) Except as set forth on Schedule 1.1(a) hereto, Hyundai
owns or will own on the IP Closing Date all of the Proprietary
Technology. The Proprietary Technology is sufficient for the operation
of the DVD-ROM Business as presently conducted and as presently proposed
to be conducted in the Business Plan. Each item of Proprietary Technology
owned by Hyundai for or in connection with the DVD-ROM Business
immediately prior to the IP Closing Date will be subject to an exclusive
license by DVS immediately subsequent to the IP Closing Date. Hyundai
has taken all necessary and desirable action to maintain and protect each
item of Proprietary Technology that it owns in connection with the
DVD-ROM Business.
(c) The use of the Assets and conduct of the DVD-ROM
Business does not interfere with, infringe upon, misappropriate, or
otherwise come into conflict with any proprietary technology rights of
third parties, and Hyundai has never received any charge, complaint,
claim, demand, or notice alleging any such interference, infringement,
misappropriation, or violation (including any claim that Hyundai must
license or refrain from using any proprietary technology rights of any
third party) in connection with the conduct of the DVD-ROM Business. To
the knowledge of Hyundai, no third party has interfered with, infringed
upon, misappropriated, or otherwise come into conflict with any
Proprietary Technology rights of Hyundai.
(d) Hyundai has delivered to DVS correct and complete
copies of all items of Proprietary Technology listed in Schedule 1.1(a).
With respect to each item of Proprietary Technology required to be
identified in Schedule 1.1(a):
(i) Hyundai possesses all right, title, and interest
in and to the item, free and clear of any security interest, license, or
other restriction;
(ii) the item is not subject to any outstanding
injunction, judgment, order, decree, ruling, or charge;
(iii) no action, suit, proceeding, hearing,
investigation, charge, complaint, claim, or demand is pending or, to the
knowledge of Hyundai, is threatened, which challenges the legality,
validity, enforceability, use, or ownership of the item; and
(iv) Hyundai has never agreed to indemnify any person
(other than its customers) for or against any interference, infringement,
misappropriation, or other conflict with respect to the item.
2.8 Financial Statements. Hyundai shall provide DVS, no later
than three business days prior to the earlier to occur of the IP Closing
Date and the Asset Closing Date, a balance sheet as of April 30, 1998.
Such balance sheet, including the notes thereto, if any, will properly
reflect all assets and liabilities as then in existence.
2.9 Conduct of Business.
(a) Ordinary Course of Business: No Removal or Disposal of
Assets. Since April 30, 1998, Hyundai has operated the DVD-ROM Business
in an ordinary course consistent with past practices, and has not removed
or disposed of any assets that were assets of the DVD-ROM Business as of
April 30, 1998, except in the ordinary course.
(b) No Material Adverse Change. Since April 30, 1998,
there has been no material adverse change in the DVD-ROM Business or the
Assets or in the financial condition, operations, or prospects of the
DVD-ROM Business.
(c) Absence of Particular Events. Since April 30, 1998
Hyundai has not: (i) suffered any damage or destruction adversely
affecting the DVD-ROM Business or involving the Assets in the amount of
$15,000 (United States Dollars) in any one instance; (ii) incurred any
liability or obligation relating to the DVD-ROM Business other than in
the ordinary course consistent with past practice; (iii) made any change
in any method, practice, or principle of accounting involving the DVD-ROM
Business or the Assets; or (iv) paid, loaned, or advanced any material
monetary amount or other asset to, or sold, transferred, or leased any
asset to, any employee involved in the DVD-ROM Business except for normal
compensation involving salary and benefits.
(d) Absence of Joint Ventures, etc. Hyundai is not a party
to any joint venture or other similar agreement or arrangement that
involves any sharing of profits of the DVD-ROM Business or the Assets or
is similar to or competitive with the DVD-ROM Business.
2.10 Major Vendors and Strategic Relationships. Schedule 2.11
lists each licensor, developer, and supplier of property or services to,
and each licensee, end-user, or customer of, the DVD-ROM Business, to
whom Hyundai paid or billed in the aggregate $10,000 (United States
Dollars) or more during the twelve-month period ended April 30, 1998,
together with, in each case, the amount paid or billed during such
period. In addition Schedule 2.11 lists each strategic relationship
which the DVD-ROM Business maintains (Schedule 2.11 shall be provided to
DVS as soon as practicable after this Agreement is signed by DVS and
Hyundai, and attached hereto). To the best knowledge of Hyundai, there
is no reason why the relationship with any such person or entity might
not be continued by DVS, after its acquisition of the DVD-ROM Business,
indefinitely at least at substantially the same level of business and on
substantially the same terms as Hyundai experienced during the twelve-
month period preceding the later to occur of the IP Closing and the Asset
Closing.
2.11 Litigation. No claim, action, suit, proceeding, inquiry,
hearing, arbitration, administrative proceeding, or investigation
(collectively, "Litigation") is pending, or, to Hyundai's best knowledge
threatened against Hyundai, its present or former directors, officers, or
employees, or any party to any contract, affecting, involving, or
relating to the DVD-ROM Business or any of the Assets. Hyundai knows of
no facts that could reasonably be expected to serve as the basis for
litigation against itself (or DVS upon acquisition of the DVD-ROM
Business), its present or former directors, officers, or employees
affecting, involving, or relating to the DVD-ROM Business or the Assets.
2.12 Personnel and Compensation. Hyundai shall have delivered to
DVS prior to Asset Closing a due and complete list of the names and
current compensation levels of: (a) all salaried, annual or other
employees materially involved in the DVD-ROM Business; and (b) all
consultants involved in the DVD-ROM Business.
2.13 No Liability for Terminated Employees. DVS shall not incur
any liability in connection with the termination by Hyundai of any
employees in connection with the sale of the Assets, including, without
limitation, any fees, costs or expenses described in Section 9.1(a)
hereof and those relating to or in connection with any threatened or
actual claims or litigation relating to such termination or to DVS's
determination, in its sole discretion, to not employ any such terminated
employees.
2.14 Inventory. The inventory of the DVD-ROM Business consists of
raw materials and supplies, manufactured and purchased parts, finished
goods and working prototypes.
2.15 Contracts. Hyundai has delivered to DVS a correct and
complete copy of each Contract (as amended to date) listed on Schedule
1.2(a)(iii). With respect to each Contract: (i) the Contract is legal,
valid, binding, enforceable, and in full force and effect; (ii) except as
otherwise expressly stated herein, the Contract will continue to be
legal, valid, binding, enforceable, and in full force and effect on
identical terms following the consummation of the transactions
contemplated hereby (subject to the assignments and assumptions provided
for in this Agreement); (iii) no party is in breach or default, and no
event has occurred which with notice or lapse of time would constitute a
breach or default, or permit termination, modification, or acceleration,
under the Contract; and (iv) no party has repudiated any provision of the
Contract.
2.16 Employees. With respect to the DVD-ROM Business, Hyundai:
(a) is not a party to or bound by any collective bargaining agreement,
nor has it experienced any strikes, grievances, claims of unfair labor
practices, or other collective bargaining disputes; and (b) is not a
party to any employment agreement with any officer, director or employee
(other than as set forth on Schedule 6.9) hereto).
2.17 Environmental, Health and Safety Matters. (a) Hyundai has
obtained and complied with, and is in compliance with, all material
permits, licenses and other authorizations that are required pursuant to
environmental, health, and safety laws, rules and regulations for the
occupation of its facilities and the operation of the DVD-ROM Business,
all of which are listed on Schedule 1.2(a)(ii) hereto.
(b) Hyundai has not received any written or oral
notice, report or other information regarding any actual or alleged
material violation of any environmental, health, and safety regulations,
or any liabilities or potential liabilities (whether accrued, absolute,
contingent, unliquidated or otherwise), including any investigatory,
remedial or corrective obligations, relating to any of them or its
facilities arising under environmental, health, and safety laws, rules
and regulations in connection with the DVD-ROM Business.
2.18 Investment. Hyundai understands that the Common Stock issued
to Hyundai pursuant to this Agreement has not been registered and will
not be registered for approximately 180 days following the later to occur
of the IP Closing and the Asset Closing. Until the registration of the
Common Stock has been effected, Hyundai agrees and acknowledges that it
will not, directly or indirectly, offer, transfer, sell, assign, pledge,
hypothecate or otherwise dispose of any shares of the Common Stock.
2.19 Broker's or Finder's Fees. Hyundai has not authorized any
person to act as broker or finder or in any other similar capacity in
connection with the transactions contemplated by this Agreement in any
manner that may or will impose liability on DVS.
2.20 Export and Sale of DVD Products. Hyundai knows of no facts
that would impair the ability of DVS or DVS-Korea to export substantially
all of the products of the DVD-ROM Business and to sell such products
outside of Korea. Hyundai has obtained all licenses and permits
necessary for the DVD-ROM Business to export and sell products outside of
Korea and has transferred all such licenses and permits to DVS pursuant
to this Agreement. All such licenses and permits are listed on Schedule
1.2(a)(iii).
2.21 Business Plan. The information contained in the Business
Plan is complete, current and accurate. The Business Plan does not any
untrue statement and does not omit to state any fact necessary to make
the statements therein not misleading.
2.22 Disclosure. No representation, warranty, or statement made
by Hyundai in this Agreement or in any document or certificate furnished
or to be furnished to DVS pursuant to this Agreement contains or will
contain any untrue statement or omits or will omit to state any fact
necessary to make the statements contained herein or therein not
misleading. Hyundai has disclosed to DVS all facts known or reasonably
available to Hyundai that are material to the financial condition,
operation, or prospects of the DVD-ROM Business and the Assets.
2.23 Truth at Closings. All of: (a) the representations,
warranties, and agreements of Hyundai contained in this Article 2 and (b)
the representations, warranties and agreements of Hyundai contained in
the Schedules and Exhibits attached hereto shall be true and correct and
in full force and effect on and as of each of the Closing Dates.
ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF DVS
DVS hereby represents and warrants to Hyundai as follows:
3.1 Organization. DVS is a corporation validly existing and in
good standing under the laws of the State of Delaware with the corporate
power and authority to conduct its business and to own and lease its
properties and assets. DVS is duly qualified or licensed to do business
and is in good standing as a foreign corporation in each state in which
the failure to be so qualified or licensed would have a material adverse
effect on its financial condition or operations.
3.2 Power and Authority. DVS has the power and authority to
execute, deliver, and perform this Agreement and the other agreements and
instruments to be executed and delivered by it in connection with the
transactions contemplated hereby and thereby, and, other than obtaining
the requisite shareholder approval, DVS has taken all necessary corporate
action to authorize the execution and delivery of this Agreement and such
other agreements and instruments and the consummation of the transactions
contemplated hereby and thereby. This Agreement is, and, when such other
agreements and instruments are executed and delivered, the other
agreements and instruments to be executed and delivered by DVS in
connection with the transactions contemplated hereby and thereby shall
be, the legal, valid, and binding obligation of DVS, enforceable in
accordance with their terms.
3.3 Broker's or Finder's Fees. DVS has not authorized any person
to act as broker, finder, or in any other similar capacity in connection
with the transactions contemplated by this Agreement.
3.4 No Conflict. Neither the execution and delivery by DVS of
this Agreement and of the other agreements and instruments to be executed
and delivered by DVS in connection with the transactions contemplated
hereby or thereby, nor the consummation by DVS of the transactions
contemplated hereby or thereby will violate or conflict with: (a) any
federal, state, or local law, regulation, ordinance, governmental
restriction, order, judgment or decree applicable to DVS; or (b) any
provision of any charter, bylaw, or other governing or organizational
instrument of DVS.
3.5 Required Contract Consents. No approval, authorization,
consent, permission, or waiver to or from, or notice, or recording to or
with, any person is necessary for the execution and delivery of this
Agreement and the other agreements and instruments to be executed and
delivered in connection with the transactions contemplated hereby or
thereby by DVS or the consummation by DVS of the transactions
contemplated hereby.
3.6 Disclosure. No representation, warranty, or statement made
by DVS in this Agreement or in any document or certificate furnished or
to be furnished to DVS pursuant to this Agreement contains or will
contain any untrue statement or omits or will omit to state any fact
necessary to make the statements contained herein or therein not
misleading. DVS has disclosed to Hyundai directly or through its filings
with the SEC pursuant to the Securities and Exchange Act of 1934, all
facts known or reasonably available to DVS that are material to the
financial condition, operation, or prospects of its business and assets.
3.7 Share Ownership. DVS warrants that the shares transferred to
Hyundai hereunder are duly authorized, fully paid and non assessable and
owned free and clear of any preemptive rights, liens, claims, charges or
encumbrances. DVS warrants that it has only one class of common stock,
there are no outstanding commitments to purchase, reacquire or redeem any
of its Capital Stock nor are there any declared but unpaid dividends on
such Capital Stock.
3.8 Truth at Closing. All of the representations, warranties,
and agreements of DVS contained in this Article 3 shall be true and
correct and in full force and effect on and as of each of the Closing
Dates.
ARTICLE 4
CONDUCT OF THE BUSINESS PRIOR TO CLOSINGS
4.1 Course of Business. Prior to each of the Closing Dates,
Hyundai shall conduct the DVD-ROM Business diligently and substantially
in the same manner heretofore conducted, and Hyundai shall not institute
any new methods of accounting or operation or engage in any transaction
or activity, enter into any agreement, or make any commitment, except in
the ordinary course of such business and consistent with past practice,
and except as would not reasonably be expected to have a material adverse
effect on the DVD-ROM Business.
4.2 Prohibited Actions. Until after both Closings, in no event,
without the prior written consent of the other party, shall Hyundai:
(a) Liens. Permit any of its assets to be subjected to any
mortgage, pledge, lien, or encumbrance.
(b) Disposition of Assets. Waive any claims or rights of
substantial value respecting their assets, or sell, transfer, or
otherwise dispose of any of their assets, except in the ordinary course
of business and consistent with past practice.
(c) Licenses. Other than in the ordinary course of its
licensing activities and consistent with past practice, dispose of,
license, or permit to lapse any rights in any intellectual property.
(d) Increases in Compensation. Increase the compensation
of officers, employees, or consultants with respect to the DVD-ROM
Business.
ARTICLE 5
COVENANTS OF HYUNDAI AND DVS PRIOR TO CLOSINGS
5.1 Access. From the date of this Agreement to each of the
Closing Dates, Hyundai shall: (a) provide DVS with such information as
DVS may from time to time reasonably request with respect to the DVD-ROM
Business and the transactions contemplated by this Agreement; (b) provide
DVS and its officers, counsel, and other authorized representatives
access during regular business hours and upon reasonable notice to its
books, records, and offices, as DVS may from time to time reasonably
request; and (c) permit DVS to make such inspections thereof as it may
reasonably request. Any investigation shall be conducted in such a
manner as not to interfere unreasonably with the operation of the DVD-ROM
Business.
5.2 Updating of Information. From the date of this Agreement to
each of the Closing Dates, Hyundai shall deliver revised or supplementary
Schedules to this Agreement, containing accurate information as of the
applicable Closing Date, in order to enable DVS to confirm the accuracy
of its representations and warranties and otherwise to give full effect
to the provisions of this Agreement. Delivery of revised Schedules by
Hyundai shall not reduce or impair any of the rights that any party may
have under Article 6 hereof.
5.3 Negotiations with Third Parties. Hyundai shall not, directly
or indirectly, engage in sale discussions with any potential third party
buyers for any of the Assets (whether or not solicited by Hyundai) unless
DVS and Hyundai mutually agree to terminate this Agreement.
5.4 Strategic Relationship. Hyundai shall use its best efforts
to facilitate the introduction of DVS to Matshushita prior to the earlier
to occur of the IP Closing and the Asset Closing, and to ensure the
continuity of Hyundai's current relationship with Matshushita with
respect to the DVD-ROM Business following its acquisition by DVS.
ARTICLE 6
CONDITIONS TO HYUNDAI'S OBLIGATIONS
Each of the obligations of Hyundai to be performed hereunder shall
be subject to the satisfaction (or waiver by Hyundai) at or prior to each
Closing Date of each of the following conditions:
6.1 Representations and Warranties True at Closing Date. DVS's
representations and warranties contained in this Agreement shall be true
on and as of the applicable Closing Date with the same force and effect
as though made on and as of such date; DVS shall have complied with the
covenants and agreements set forth herein to be performed by it on or
before such Closing Date; and DVS shall have delivered to Hyundai a
certificate dated at such Closing Date and signed by a duly authorized
officer of DVS to all such warrants.
6.2 Litigation. No Litigation shall be threatened or pending
against DVS or Hyundai before any court or governmental agency that, in
the reasonable opinion of counsel for Hyundai, could result in the
restraint or prohibition of any such party, or the obtaining of damages
or other relief from such party, in connection with this Agreement or the
consummation of the transactions contemplated hereby.
6.3 Documents Satisfactory in Form and Substance. All
agreements, certificates, and other documents delivered by DVS to Hyundai
hereunder shall be in form and substance satisfactory to counsel for
Hyundai, in the exercise of such counsel's reasonable judgment.
6.4 Consents. All required consents shall have been obtained.
6.5 Investigations. Neither any investigation of DVS by Hyundai,
nor the Schedules hereto, nor any other document delivered to Hyundai as
contemplated by this Agreement, shall have revealed any facts or
circumstances that, in the good faith judgment of Hyundai, reflect in a
material adverse way on the business, operations, or prospects of the DVS
and its business.
6.6 No Material Adverse Change. From the date of this Agreement
until each Closing Date, DVS shall not have suffered any material
adverse change (whether or not such change is referred to or described in
any supplement to the Schedules), or the financial condition, operations,
or prospects of DVS's business.
6.7 Opinion of Counsel. At the earlier to occur of the IP
Closing and the Asset Closing, Hyundai shall have received an opinion of
Troy & Gould, counsel to DVS, in form and substance reasonably
satisfactory to Hyundai and its counsel and covering the matters to be
agreed upon in good faith by DVS and its counsel and Hyundai as soon as
practicable after the signing of this Agreement.
6.8 Formation of DVS Korea. DVS shall have formed, or caused to be
formed, DVS-Korea to hold the Tangible Assets and to conduct the DVD-ROM
Business.
6.9 Hiring of DVD-ROM Product Development Team. DVS shall use its
reasonable best efforts to cause DVS-Korea to employ Hyundai's DVD-ROM
product development team, which consists of approximately 38 engineers
and managers whose names are set forth on Schedule 6.9 (such schedule
shall be provided to DVS as soon as practicable after this Agreement is
signed by DVS and Hyundai, and attached hereto) on terms no less
favorable to DVS-Korea than those currently enjoyed by Hyundai. However,
during the Interim Period, to the extent that certain employees directly
involved in the manufacture and testing of DVD-ROM products are required
to be employed by Hyundai to ensure that products sold by DVS-Korea
contain necessary certifications, such employees shall remain employees
of Hyundai and DVS-Korea shall reimburse Hyundai for their salaries.
Following the termination of the Interim Period, DVS shall use its
reasonable best efforts to cause such employees to become employees of
DVS-Korea.
ARTICLE 7
CONDITIONS TO DVS'S OBLIGATIONS
Each of the obligations of DVS to be performed hereunder shall be
subject to the satisfaction (or the waiver by DVS) at or prior to each
Closing Date of each of the following conditions:
7.1 Representations and Warranties True at Each Closing Date.
Hyundai's representations and warranties contained in this Agreement
shall be true on and as of the applicable Closing Date with the same
force and effect as though made on and as of such date; Hyundai shall
have complied with the covenants and agreements set forth herein to be
performed by it on or before such Closing Date; and Hyundai shall have
delivered to DVS a certificate dated at such Closing Date and signed by a
duly authorized officer of Hyundai to all such effects.
7.2 Performance. Hyundai, shall have performed and complied with
all agreements, obligations, and conditions required by this Agreement to
be performed or complied with by it on or prior to the applicable
Closing.
7.3 Investigations. Neither any investigation of Hyundai by DVS,
nor the Schedules hereto, nor any other document delivered to DVS as
contemplated by this Agreement, shall have revealed any facts or
circumstances that, in the good faith judgment of DVS, reflect in a
material adverse way on the Assets or the business, operations, or
prospects of the DVD-ROM Business.
7.4 Consents. All required consents (including all Required
Contract Consents and DVS shareholder approval) have been obtained.
7.5 No Litigation. No Litigation shall be threatened or pending
against DVS or Hyundai before any court or governmental agency that, in
the reasonable opinion of counsel for DVS, could result in the restraint
or prohibition of any such party, or the obtaining of damages or other
relief from such party, in connection with this Agreement or the
consummation of the transactions contemplated hereby.
7.6 No Material Adverse Change. From the date of this Agreement
until the applicable Closing Date, Hyundai shall not have suffered any
material adverse change (whether or not such change is referred to or
described in any supplement to the Schedules) in the financial condition,
operations, or prospects of the DVD-ROM Business.
7.7 Non-Compete Agreement. At or prior to the earlier to occur
of the IP Closing and the Asset Closing, Hyundai shall have entered into
a three-year Non-Compete Agreement in substantially the form attached
hereto as Exhibit B.
7.8 Opinion of Counsel. At each of of the IP Closing and the
Asset Closing, DVS shall have received an opinion of the general counsel
to Hyundai, in form and substance reasonably satisfactory to DVS and its
counsel and covering matters to be agreed upon by DVS and its counsel and
Hyundai as soon as practicable after the signing of this Agreement.
7.9 Condition of Tangible Assets. To the reasonable satisfaction
of DVS, each tangible asset shall be free from defects (patent and
latent), shall have been maintained in accordance with normal industry
practice, shall be in good operating condition and repair (subject to
normal wear and tear), and shall be suitable for the purposes for which
it presently is used and presently is proposed to be used in the Business
Plan.
7.10 Hiring of DVD-ROM Product Development Team. Hyundai shall
use its reasonable best efforts to enable DVS or DVS-Korea, as the case
may be, to retain the services of all or substantially all of Hyundai's
DVD-ROM product development team, which consists of approximately 38
engineers and managers whose names are set forth on Schedule 6.9, on
terms no less favorable to DVS-Korea than those currently enjoyed by
Hyundai (other than those employees who will remain with Hyundai during
the Interim Period).
7.11 Subcontracting Agreement. At or prior to the earlier to
occur of the IP Closing and the Asset Closing, Hyundai and DVS shall have
entered into the Subcontracting Agreement.
7.12 Fairness Opinion. At or prior to the IP Closing DVS shall
have entered obained a fairness opinion in form and substance reasonably
satisfactory to DVS and its counsel.
ARTICLE 8
COVENANTS OF HYUNDAI AND DVS FOLLOWING CLOSINGS
8.1 Tax Matters.
(a) Hyundai's Right and Responsibility for Preclosing Tax
Matters. Hyundai shall have the right and responsibility to direct the
handling of all tax matters affecting or relating to the conduct of the
DVD-ROM Business prior to the later to occur of the IP Closing Date and
the Asset Closing Date, including the prosecution of all administrative
and judicial remedies, the settlement of all issues, and the execution of
agreements, consents, or waivers, extending the statute of limitations,
provided that no such action, agreement, or stipulation shall have any
effect on the tax position or liability of DVS, including as successor to
the DVD-ROM Business.
(b) DVS's Cooperation. DVS shall use its reasonable
efforts to provide Hyundai such assistance as it may reasonably request
in connection with matters relating to taxes, including information with
respect to Hyundai's preparation of any returns of taxes, any audit or
other examination by any taxing authority, any judicial or administrative
proceeding relating to Hyundai's liability for taxes, or any claims
arising hereunder respecting the DVD-ROM Business. DVS shall retain and
provide Hyundai with records or information which may be relevant to any
such return, audit, examination, proceeding, or determination, and DVS
shall retain all such books and records for examination so long as
necessary in keeping with applicable statutes of limitations.
8.2 Allocation of Purchase Price. The purchase price shall be
allocated to the Assets in accordance with the requirements of Section
1060 of the Internal Revenue Code of 1986, as amended, based on mutual
agreement between Hyundai and DVS, and all tax returns and reports filed
or prepared by Hyundai and DVS with respect to the transactions
contemplated by this Agreement shall be consistent with that allocation.
8.3 Transfer Taxes. Subject to 1.1(d), all sales, transfer, and
similar taxes and fees (including all recording fees, if any) incurred in
connection with this Agreement and the transactions contemplated hereby
shall be borne by Hyundai, and Hyundai shall file all necessary
documentation with respect to such taxes.
8.4 Stock Options. DVS shall, subject to obtaining the approval of
DVS's shareholders, establish a pool of 1,000,000 shares of Common Stock
(including options to be granted to Sung Hee Lee) to be available for
option grants to employees of DVS-Korea.
8.5 Registration of Common Stock. DVS shall use its best efforts to
register the Common Stock under the United States Securities Act of 1933,
as amended, within 180 days following the later to occur of the IP
Closing and the Asset Closing. Hyundai shall provide all information and
assistance to DVS necessary to enable DVS to effect such registration of
the Common Stock.
8.6 Further Assurances. Subject to the terms and conditions of
this Agreement, each party agrees to use all of its reasonable efforts to
take, or cause to be taken, all actions and to do or cause to be done,
all things necessary and proper or advisable to consummate and make
effective the transactions contemplated by this Agreement (including the
execution and delivery of such further instruments and documents) as the
other party may reasonably request.
ARTICLE 9
CERTAIN TRANSACTION MATTERS
9.1 Transition Services Provided by Hyundai; Use of Facility.
(a) Commitment. Hyundai shall continue to provide the
Transition Services, as defined in Section 9.3(b) to DVS following the
Closings until June 30, 1998 or such earlier time as DVS-Korea is able to
secure services similar to the Transition Services provided by Hyundai.
(b) Definition of Transition Services. For purposes of
this Agreement, "Transition Services" shall mean administrative support
services of a nature previously rendered by the headquarters of Hyundai
to the DVD-ROM Business such as the processing of payroll and insurance
claims, accounting and billing, legal compliance work, clerical support,
maintenance of facilities, and similar services.
(c) Manner and Time of Performance. Hyundai shall perform
the Transition Services with the degree of care, skill, and diligence
with which it previously performed, or may continue to perform, similar
services for itself or others. Hyundai will make every reasonable effort
to maintain sufficient resources such that it may provide the Transition
Services. Hyundai reserves the right to determine staffing and
scheduling of Transition Services, and to engage contractors as needed,
provided that Hyundai shall make every reasonable effort to conform to
the priorities and timeframes given by DVS. Hyundai shall not be
required to devote substantial time of its executives to the Transition
Services such as would interfere with their other responsibilities to
Hyundai. To the extent possible, DVS shall advise Hyundai in advance of
its projected requirements, according to skill level of personnel and
estimated worktime, and provide priorities and timeframes with respect to
the urgency of completion.
(d) Funding and Reimbursement. As payment for the
Transition Services, DVS shall reimburse Hyundai according to the fee
schedule set forth in Schedule 9.3(e). Hyundai and DVS agree that the
rates noted on such fee schedule may change from time to time to take
into account variations in accordance with actual costs. Hyundai shall
invoice DVS on a monthly basis for fees accruing for Transition Services,
and DVS shall remit payment in full of the invoiced amount within 30 days
of receipt of Hyundai's invoice.
(e) Records. Hyundai shall maintain complete and accurate
accounting records, in a form consistent with prior practice and standard
accounting procedures, to substantiate its fees accruing for Transition
Services.
(f) Use of Facility. Hyundai shall grant to DVS the right
to exclusively use, for a rental fee of 2,000,000 Korean Won per month,
the Facility for a period of six months from the later to occur of the IP
Closing Date and the Asset Closing Date for final assembly and testing
of DVD-ROM drives.
ARTICLE 10
INDEMNITY
10.1 Indemnification by Hyundai. Hyundai shall indemnify, defend,
and hold harmless DVS and DVS-Korea and their respective successors and
assigns and the directors, officers, employees, and agents of each
(collectively, the "DVS Group"), at, and at any time after, the Closings,
from and against any and all demands, claim, actions, or causes of
action, assessments, losses, damages, liabilities, costs, and expenses,
including reasonable fees and expenses of counsel, other expenses of
investigation, handling, and litigation, and settlement amounts, together
with interest and penalties (collectively, a "Loss" or "Losses"),
asserted against, resulting to, imposed upon, or incurred by the DVS
Group, directly or indirectly, by reason of, resulting from, or arising
in connection with any of the following:
(a) Breach or Obligation. Any breach of any repre-
sentation, warranty, or agreement of Hyundai contained in or made
pursuant to this Agreement, including the agreements and other
instruments contemplated hereby.
(b) Excluded Liabilities. Any liabilities or obligations
of any kind or nature whatsoever, whether accrued, absolute, contingent
or otherwise, known or unknown, arising out of or in connection with the
conduct of the DVD-ROM Business or the ownership or use of the Assets
prior to the applicable Closing Date, except for the liabilities
specifically assumed by DVS hereunder.
(c) Termination of Employees. Any fees, costs or expenses
incurred by DVS in connection with the termination by Hyundai of any
employees in connection with the sale of the Assets and those relating to
or in connection with any threatened or actual claims or litigation
relating to such termination or to DVS's determination, in its sole
discretion, to not employ any such terminated employees.
(d) Incidental Matters. To the extent not covered by the
foregoing, any and all demands, claims, actions or causes of action,
assessments, losses, damages, liabilities, costs, and expenses, including
reasonable fees and expenses of counsel, other expenses of investigation,
handling, and litigation and settlement amounts, together with interest
and penalties, incident to the foregoing.
10.2 Indemnification by DVS. DVS shall indemnify, defend, and
hold harmless Hyundai and its successors and assigns and the directors,
officers, employees, and agents of each (collectively, the "Hyundai
Group"), at, and at any time after, the Closings, from and against any
and all demands, claims, actions or causes of action, assessments,
losses, damages, liabilities, costs, and expenses, including reasonable
fees and expenses of counsel, other expenses of investigation, handling,
and litigation, and settlement amounts and including any net income tax
amount associated with all such indemnification recoveries (collectively,
a "Loss" or "Losses"), asserted against, resulting to, imposed upon, or
incurred by the Hyundai Group, to the extent arising from any of the
following:
(a) Breach of Obligation. Any breach of any representa-
tion, warranty, or agreement of DVS contained in or made pursuant to this
Agreement, including the agreements and other instruments contemplated
hereby.
(b) Assumed Liabilities. Any of the liabilities assumed
hereunder by DVS.
(c) Misuse of Hyundai Name. Any liabilities arising from
misrepresentation by DVS in connection with DVS's use of the Hyundai name
on products and product packaging and in marketing materials of the DVD-
ROM Business.
(d) Incidental Matters. To the extent not covered by the
foregoing, any and all demands, claims, actions or causes of action,
assessments, losses, damages, liabilities, costs, and expenses, including
reasonable fees and expenses of counsel, other expenses of investigation,
handling, and litigation, and settlement amounts, together with interest
and penalties, incident to the foregoing.
10.3 Notice of Claim. The party entitled to indemnification
hereunder (the "Claimant") shall promptly deliver to the party liable for
such indemnification hereunder (the "Obligor") notice in writing (the
"Required Notice") of any claim for recovery under Section 10.1 or
Section 10.2, specifying in reasonable detail the nature of the Loss,
and, if known, the amount, or an estimate of the amount of the liability
arising therefrom (the "Claim"). The Claimant shall provide to the
Obligor as promptly as practicable thereafter information and
documentation reasonably requested by the Obligor to support and verify
the claim asserted, provided that, in so doing, it may restrict or
condition any disclosure in the interest of preserving privileges of
importance in any foreseeable litigation.
10.4 Defense. If the facts pertaining to the Loss arise out of
the claim of any third party (other than a member of the DVS Group or
Hyundai Group, whichever is entitled to indemnification for such matter)
available by virtue of the circumstances of the Loss, the Obligor may
assume the defense or the prosecution thereof, including the employment
of counsel or accountants, at its cost and expense. The Claimant shall
have the right to employ counsel separate from counsel employed by the
Obligor in any such action and to participate therein, but the fees and
expenses of such counsel employed by the Claimant shall be at its
expense. The Claimant shall have the right to determine and adopt (or,
in the case of a proposal by Obligor, to approve) a settlement of such
matter in its reasonable discretion, except that Claimant need not
consent to any settlement that: (a) imposes any nonmonetary obligation
or (b) Obligor does not agree to pay in full. The Obligor shall not be
liable for any settlement of any such claim effected without its prior
written consent, which shall not be unreasonably withheld. Whether or
not the Obligor chooses to so defend or prosecute such claim, all the
parties hereto shall cooperate in the defense or prosecution thereof and
shall furnish such records, information, and testimony, and attend such
conferences, discovery proceedings, hearings, trials, and appeals, as may
be reasonably requested in connection therewith.
10.5 Recovery of Attorney Fees For Frivolous Actions. The Obligor
shall be entitled to recover its reasonable out-of-pocket costs
(including court costs and actual attorney fees) incurred in defending
any Claim brought by the Claimant on frivolous grounds or pursued for the
purpose of delay or harassment. The Claimant shall be entitled to
recover its reasonable out-of-pocket costs (including court costs and
actual attorney fees) incurred in pursuing any Claim defended by the
Obligor on frivolous grounds or opposed for the purpose of delay or
harassment. A frivolous claim shall include any Claim that is not bona
fide and that is not brought in good faith after consultation with
counsel.
ARTICLE 11
CONFIDENTIALITY
11.1 Confidentiality Obligation of DVS Prior to Closings. Until
the later to occur of the IP Closing and the Asset Closing (and, if this
Agreement is terminated for any reason, for three years thereafter), DVS
shall, and shall use its best efforts to cause its personnel and agents
to, hold in strict confidence, not disclose to any person without the
prior written consent of Hyundai, and not use in any manner except in
connection with the transactions contemplated hereby, any confidential
business or technical information obtained from Hyundai in connection
with the transactions contemplated hereby concerning Hyundai, the DVD-ROM
Business or Assets that has been designated by Hyundai as confidential.
This obligation shall cease to apply to DVS upon the occurrence of later
to occur of the IP Closing and the Asset Closing, provided however that
confidential information concerning Hyundai's other businesses shall be
kept confidential. In the event this Agreement terminates for any
reason, DVS shall return to Hyundai or destroy all materials in its
possession containing any such confidential information, including all
copies, extracts, adaptations, and transcriptions thereof.
11.2 Confidentiality Obligation of Hyundai Following Closings.
For a period of three years from the date hereof, Hyundai shall, and
shall use its best efforts to cause its personnel and agents to, hold in
strict confidence, not disclose to any person without the prior written
consent of DVS, and not use in any manner whatsoever (except as otherwise
provided herein), any confidential business or technical information
retraining in its possession concerning DVS's business or assets. In the
event that this Agreement terminates for any reason, Hyundai shall
surrender to DVS or destroy all materials remaining in its possession
containing any such confidential information, including all copies,
extracts, adaptations, and transcriptions thereof.
11.3 Permitted Disclosures. Notwithstanding Sections 11.1 and
11.2, either party may disclose confidential information (a) where
necessary to any regulatory authorities or governmental agencies pursuant
to legal process, (b) if required by court order or decree or (c) if
required in the opinion of counsel to a party for that party to comply
with SEC disclosure requirements.
11.4 Scope of Confidential Information. For purposes of this
Agreement, information shall not be deemed confidential (a) if such
information is available in full from public sources; (b) if such
information is received from a third party not under an obligation to
keep such information confidential; or (c) if die recipient can
conclusively demonstrate that such information was independently
developed by the recipient.
ARTICLE 12
TERMINATION PRIOR TO CLOSINGS
12.1 Termination of Agreement. This Agreement may be terminated
at any time prior to the earlier to occur of the IP Closing and the Asset
Closing:
(a) Mutual Consent. By the mutual consent of DVS and
Hyundai;
(b) Deadline. By either DVS or Hyundai without liability,
if both Closings shall not have occurred on or before June 23, 1998
through no fault of the party seeking to terminate this Agreement; or
(c) Material Breach. By DVS or Hyundai in writing, without
liability, if the other party shall (i) fail to perform in any material
respect its agreements contained herein required to be performed by it on
or prior to the applicable Closing Date or (ii) materially breach any of
its representations, warranties, agreements, or covenants contained
herein, provided that such failure or breach is not cured within ten days
after such party has been notified of the other party's intent to
terminate this Agreement pursuant hereto.
12.2 Termination of Obligations. Termination of this Agreement
pursuant to this Article 12 shall terminate all obligations of the
parties hereunder, except for the obligations set forth in Article 11 and
except for any damages incurred by the non-defaulting party in the event
of a termination under Section 12.1(c) hereof.
ARTICLE 13
MISCELLANEOUS
13.1 Entire Agreement. This Agreement (including the Schedules
and Exhibits), and the other certificates, agreements, and other
instruments to be executed and delivered by the parties in connection
with the transactions contemplated hereby; constitute the sole
understanding of the parties with respect to the subject matter hereof.
No amendment, modification, or alteration of the terms or provisions of
this Agreement shall be binding unless the same shall be in writing and
duly executed by the parties hereto.
13.2 Parties Bound by Agreement; Successors and Assigns. The
terms, conditions, and obligations of this Agreement shall inure to the
benefit of and be binding upon the parties hereto and the respective
successors and assigns thereof.
13.3 Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall for all purposes be deemed to be an
original and all of which shall constitute the same instrument.
13.4 Headings. The headings of the Sections and paragraphs of
this Agreement are inserted for convenience only and shall not be deemed
to constitute part of this Agreement or to affect the construction
hereof.
13.5 Modification and Waiver. Any of the terms or conditions of
this Agreement may be waived in writing at any time by the party that is
entitled to the benefits thereof. No waiver of any of the provisions of
this Agreement shall he deemed to or shall constitute a waiver of any
other provision hereof (whether or not similar).
13.6 Expenses. Hyundai and DVS shall each pay all costs and
expenses incurred by it or on its behalf in connection with this
Agreement and the transactions contemplated hereby, including fees and
expenses of its own financial consultants, accountants, and counsel.
13.7 Notices. All notices, requests, demands, claims, and other
communications which are required or may be given under this Agreement
shall be in writing and shall be deemed to have been duly given: when
received, if personally delivered; when transmitted, if transmitted by
telecopy, electronic or digital transmission method; five business days
after such notice, request, demand claim or other communication is sent,
if sent by registered or certified mail, return receipt requested,
postage prepaid, and addressed to the intended recipient as set forth
below:
If to DVS to:
DIGITAL VIDEO SYSTEMS, INC.
160 Knowles Drive
Los Gatos, California USA 95032
Attention: Edward M. Miller, CEO
Fax: (408) 874-8222
Copy to:
TROY & GOULD
1801 Century Park East
Suite 1600
Los Angeles, California USA 90067
Attention: Sanford J. Hillsberg, Esq.
Fax: (310) 201-4746
If to Hyundai to:
HYUNDAI ELECTRONICS INDUSTRIES COMPANY, LTD.
12th Fl. Hyundai Jeonja Bldg.
66, Jeokseon-dong Jongro-ku
Seoul, Korea
Attention: Kyung H. Jee, Esq.
Fax: (02) 733-2145, or 2146 or 2147
Copy to:
HYUNDAI ELECTRONICS INDUSTRIES COMPANY, LTD.
International Finance Department, 12th Fl.
140-2 Kye-Dong Chongro-Ku
Seoul, Korea
Attention: K.H. Lee
Fax: (02) 746-8076
Any party may send any notice, request, demand, claim, or other
communication hereunder to the intended recipient at the address set
forth above using any other means, but no such notice, request, demand,
claim, or other communication shall be deemed to have been duly given
unless and until it actually is received by the intended recipient. Any
party may change the address to which notices, requests, demands, claims,
and other communications hereunder are to be delivered by giving the
other parties notice in the manner herein set forth.
13.8 Bulk Sales Law. The parties waive compliance with any bulk
sales laws or similar laws relating to notices to creditors.
13.9 Governing Law. This Agreement shall be construed in
accordance with and governed by the laws of the State of California
without giving effect to the principles of conflicts of law thereof.
13.10 Arbitration; Choice of Law. (a) Any dispute, controversy or
claim whether based on contract, tort, statute or other legal theory
(including, but not limited to, any claim of fraud or misrepresentation),
arising out of or related to this Agreement, or any subsequent agreement
between the parties, shall be fully and finally resolved by arbitration
pursuant to this Section 13.10 and the then-current commercial rules and
supervision of the American Arbitration Association (the "AAA"). The
duty to arbitrate shall extend to any officer, employee, shareholder,
principal, agent, trustee in bankruptcy or otherwise, affiliate,
subsidiary, or guarantor of a party hereto making or defending any claim
that would otherwise be arbitrable hereunder.
(b) Prior to demanding arbitration, the parties shall first
in good faith consult among appropriate officers of DVS and Hyundai,
which officers shall begin promptly after one party has delivered to the
other a written request for consultation in accordance with the notice
provisions contained in Section 13.7 hereof. At any time thereafter,
either party may request in writing, in accordance with the notice
provisions set forth in Section 13.7 hereof, that the dispute be referred
to appropriate senior officers of DVS and Hyundai. Within ten business
days after such request, such senior officers shall meet and attempt in
good faith to resolve the dispute. Neither DVS or Hyundai shall file a
demand for arbitration until 15 business days after a request is made for
such meeting.
(c) Any arbitration occurring pursuant to this Section 13.10
shall be held in San Jose, California, USA before three arbitrators, one
of which shall be selected by Hyundai, one of which shall be selected by
DVS and one of which shall be selected by the arbitrators selected by
Hyundai and DVS, respectively. The decision, and award, if any, of such
arbitrators shall be final and binding upon each of DVS and Hyundai. DVS
and Hyundai agree that the arbitrators shall not have the power to award
punitive damages. DVS and Hyundai agree that in order to prevent
irreparable harm to the party claiming harm, such arbitrators may grant
temporary or permanent injunctive or other equitable relief for in order
to protect the intellectual property rights of any party.
(d) Issues of arbitrability shall be determined in
accordance with any applicable federal substantive and procedural laws.
All other aspects of this Agreement shall be interpreted in accordance
with, and the arbitrators shall apply and be bound to follow the
substantive laws of the State of California. Each party shall bear its
own attorney's fees, associated with any arbitration, and the other costs
and expenses of any arbitration shall be borne by each party as provided
by the rules of the AAA.
(e) Each of DVS and Hyundai agrees not to submit a dispute
subject to this Section 13.10 to any federal, state, local or foreign
court or arbitration association except as may be necessary to enforce
the arbitration procedures of, or any award under, this Section 13.10.
If court proceedings to stay litigation or compel arbitration are
necessary, the party who unsuccessfully opposes such proceedings shall
pay all associated costs, expenses and attorneys' fees that are
reasonably incurred by the non-opposing party.
(f) Notwithstanding anything to the contrary in this Section
13.10, in the event of an alleged violation of a party's intellectual
property rights under this Agreement, such party may seek temporary
injunctive relief from any court of competent jurisdiction in the State
of California, pending the appointment of an arbitration panel. The
party requesting such relief shall simultaneously file a demand for
arbitration of the alleged dispute, and shall request the AAA to proceed
under its rules for an expedited hearing.
13.11 Severability. Any term or provision of this Agreement that
is invalid or unenforceable in any situation in any jurisdiction shall
not affect the validity or enforceability of the remaining terms and
provisions hereof or the validity or enforceability of the offending term
or provision in any other situation in any other jurisdiction.
13.12 Public Announcements. Hyundai and DVS shall consult with
each other before issuing any press releases or otherwise making any
public statements with respect to this Agreement and the transactions
contemplated hereby. Neither Hyundai nor DVS shall issue any such press
release or make any public statement without the agreement of the other
party, except as such party's counsel advises in writing and as may be
required by law.
13.13 Third-Party Beneficiaries. With the exception of: (a) the
parties to this Agreement and (b) the DVS Group and the Hyundai Group
with respect to the matters inuring to their benefit under Article 10,
there shall exist no right of any person to claim a beneficial interest
in this Agreement or any rights occurring by virtue of this Agreement.
13.14 "Including." Words of inclusion shall not be construed as
terms of limitation herein, so that references to "included" matters
shall be regarded as nonexclusive, noncharacterizing illustrations.
13.15 References. Whenever reference is made in this Agreement to
any Article, Section, Schedule, or Exhibit, such reference shall be
deemed to apply to the specified Article or Section of this Agreement or
the specified Schedule or Exhibit to this Agreement.
13.16 Survival of Agreements. All covenants, agreements,
representations, and warranties made herein shall survive the execution
and delivery of this Agreement and the Closings.
IN WITNESS WHEREOF, each of the parties hereto has caused this
Agreement to be executed on its behalf on the date indicated.
DIGITAL VIDEO SYSTEMS, INC.
By: /s/ Thomas R. Parkinson
Title: President and COO
Date: May 8, 1998
[Corporate seal]
HYUNDAI ELECTRONICS INDUSTRIES COMPANY, LTD.
By: /s/ Youn Huh
Title: Senior Vice President
Date: May 8, 1998
[Company seal]
INDEX
Schedules
Schedule 1.1(a) - Proprietary Technology
Schedule 1.2(b)(i) - Tangible Assets
Schedule 1.2(b)(ii) - Contracts
Schedule 1.2(b)(iii) - Licenses, Permits, etc.
Schedule 2.5 - Required Contract Consents
Schedule 2.11 - Major Vendors and Strategic
Relationships
Schedule 6.9 - Employees
Schedule 9.3(e) - Transition Services Fees
Exhibits
Exhibit A - Assumption Agreement and Bill of Sale
Exhibit B - Non-Compete Agreement
Exhibit 10.36
AMENDMENT TO ASSET PURCHASE AGREEMENT
This Amendment to the Asset Purchase Agreement (the "Amendment") is
entered into as of June 23, 1998 by and between Digital Video Systems,
Inc., a Delaware corporation ("DVS") and Hyundai Electronics Industries
Co., Ltd., a company organized under the laws of Korea ("Hyundai").
WHEREAS, DVS and Hyundai entered into a certain Asset Purchase
Agreement, dated as of May 8, 1998; and
WHEREAS, the parties now desire to attend the Agreement on the
terms provided in this Amendment.
NOW, THEREFORE, the parties hereto agree as follows:
1. The first sentence of Section 1.1(a) of the Agreement is
hereby amended and restated in its entirety as follows:
"1.1(a) Exclusive License of Intangible Assets. Subject
to the terms and conditions of this Agreement, at the closing of the
license of the Intangible Assets (the "IP Closing"), Hyundai will grant
to DVS a perpetual, worldwide, royalty-free license to use the Intangible
Assets other than the Three Patents as defined hereinbelow, and DVS will
license the Intangible Assets other than the Three Patents from Hyundai
for 2,000,000 shares of common stock of DVS (the "Common Stock"). The
Three Patents shall mean INFORMATION REPRODUCING APPARATUS FOR OPTICAL
DISK (Korea Patent No. 135598), TRACK/SEEK CONTROL APPARATUS AND METHOD
USING POSITION ERROM COMPENSATION (Korea Patent No. 085917) and HEAD SEEK
CONTROL APPARATUS FOR AN OPTICAL DISK (U.S. Patent No. 5,519,678), which
shall be transferred to DVS Korea as provided in Section 1.1(b) hereof."
2. The first sentence of Section 1.1(b) of the Agreement is
hereby amended and restated in its entirety as follows:
"(b) Sale of Tangible Assets and the Three Patents;
Assumption of Liabilities. Subject to the terms and conditions of this
Agreement, at the closing of the sale of the Tangible Assets (the "Asset
Closing"), Hyundai will sell, convey, assign and transfer the Tangible
Assets and the Three Patents to DVS Korea, and DVS Korea will purchase
the Tangible Assets and the Three Patents from Hyundai for $1,000,000
(United States Dollars) in cash. It is agreed that DVS shall make DVS
Korea grant back to Hyundai a perpetual, worldwide, non-exclusive,
royalty-free and fully paid-up license to use the Three Patents."
3. Continued Validity. Except as amended above, the terms and
conditions of the Agreement shall remain in full force and effect. Each
of the provisions of the Agreement which are not expressly amended by
this Agreement are hereby confirmed to the same extent as if each was
fully set forth herein.
This Amendment may be executed in two identical counterparts, each
of which shall be deemed to be an original and all of which taken
together shall be deemed to constitute the Amendment when a duly
authorized representative of each party has signed a counterpart. The
parties intend to sign and deliver this Amendment by facsimile
transmission. Each party agrees that the delivery of the Amendment by
facsimile shall have the same force and effect as delivery of original
signatures and that each party may use such facsimile signatures as
evidence of the execution and delivery of the Amendment by all parties to
the same extent that an original signature could be used.
IN WITNESS WHEREOF, the parties have caused this Amendment to be
executed by their duly authorized representatives as of the date first
set forth above.
Digital Video Systems, Inc. Hyundai Electronics Industries
Co., Ltd.
By: /s/ Edmund Sun By: /s/ Youn Huh
Name: Edmund Sun Name: Youn Huh
Title: Chairman Title: Senior Vice President
Exhibit 10.37
Majority Partner: D.V.S. H.K., Limited ("DVS")
Legal Address: Unit 22-23A, Level 18, Landmark, 39 Lung
Sum Avenue, Sheung Shui, New Territories,
Hong Kong
Legal Representative: Dr. Edmund Sun
New Minority Partner: Panyu Kembo Electrical Manufacturing Co; Ltd.
Legal Representative: Yu Ling Koo
WHEREAS, DVS and Panyu Tian Le Electrical Manufacturing Co.
("Tian Le") entered into a Joint Venture Contract in August 1997,
pursuant to which the Panyu D.V.S. Electrical Appliances Manufacturing
Co; Ltd. Was formed (the "Joint Venture"); and
WHEREAS, the Joint Venture was initially owned 51% by DVS and 49%
interest by Tian Le, and in December 1997, DVS purchased from Tian Le
its entire 49% interest in the Joint Venture, with the agreement that
Tian Le would hold a 10% interest in the Joint Venture for the benefit
of DVS's new Joint Venture Partner until DVS had identified a new Joint
Venture Partner; and
WHEREAS, Panyu Kembo Electrical Manufacturing Co; Ltd. Is a
company formed in Panyu, Guangdong Province, that is owned by Dr. An
Yueh Zehan and Yu Ling Koo; and
WHEREAS, DVS and Panyu Kembo have agreed that Panyu Kembo will
acquire the 10% interest in the Joint Venture currently held by Tian
Le, subject to the terms and conditions set forth below:
NOW, THEREFORE, the parties hereto agree as follows:
1. DVS and Panyu Kembo agree that Panyu Kembo shall acquire the 10%
interest in the Joint Venture previously held by Tian Le for full
consideration of 100 RMB.
2. Panyu Kembo's 10% interest in the Joint Venture shall be subject
to repurchase by DVS at any time, at DVS's sole discretion, for
an agreement amount equal to 100 RMB.
3. Panyu Kembo agrees that the date of this agreement until such
time as DVS has recovered all of its contributed capital from the
Joint Venture (in addition to any profits from operation). DVS
shall receive all profits from the operation of and capital
distribution from the Joint Venture including (a) profits that
would otherwise be payable to Panyu Kembo as a return on his 10%
interest in the Joint Venture and (b) any return of Panyu
Kembo's capital contributed to the Joint Venture (which shall be
the capital contributed by Tian Le).
4. Panyu Kembo shall assist DVS in obtaining any required
governmental approvals necessary to complete the substitution of
Panyu Kembo for Tian Le as DVS's new Joint Venture Partner.
5. DVS shall be entitled to designate all of the directors, the
General Manager and all other personnel for the Joint Venture and
to otherwise direct the management of the Joint Venture.
6. Dr. An and Yu Ling Koo are the sole owner of Panyu Kembo, which
is serving as a Joint Venture partner, and shall not transfer any
of their ownership interest in Panyu Kembo without the prior
written consent of DVS. Dr. An shall be appointed the General
Counsel for the Joint Venture during the period that he and Yu
Ling Koo are the Joint Venture Partner. Dr. An shall not receive
any special compensation for his service as General Counsel, but
he shall be entitled to be compensated for his legal services
provided to the Joint Venture at his usual and customary rate or
as otherwise agreed to by Dr. An and the Joint Venture.
7. DVS agrees to pay the costs of completing the substitution of
Panyu Kembo for Tian Le.
8. DVS agrees to hold Panyu Kembo harmless and free of any
obligations, contingent liabilities, or other costs resulting
from any obligations or liabilities which have accrued, or may
accrue from the Joint Venture and its operations in connection
with Panyu Kembo's acquisition of the 10% interest in the Joint
Venture formerly held by Tian Le, including without limitation,
for the payment of taxes, legal fees or other costs resulting
from such acquisition. Panyu Kembo agrees to act in good faith
and in a timely manner to make all filings and obtain all
consents required to be filed or obtained by the Joint Venture or
Panyu Kembo in connection with Panyu Kembo's acquisition of the
10% interest in the Joint Venture.
9. Following the substitution of Dr. An's company Panyu Kembo for
Tian Le as a 10% holder in the Joint Venture, the Joint Venture
shall maintain its current form of organization as a limited
liability company and equity joint venture in accordance with the
Law of the People's Republic of China on Sino Foreign Equity
Joint Ventures and other relevant laws and regulations of China
and the province of Guangdong.
10. All issues not expressly covered by this agreement shall be
resolved by good faith negotiations between the parties. If
negotiations are unsuccessful, any dispute shall be submitted to
the China International Economic and Trade Arbitration Commission
for arbitration according to its provisional rules of arbitration
procedure. The arbitration award shall be final and binding on
both parties. The costs of such arbitration's (including
reasonable legal fees) shall be borne the DVS party. During the
arbitration proceeding, this agreement shall continue to be
performed except for the portion which is subject to the dispute
under arbitration.
11. All disputes arising in connection with this agreement shall
apply the rule of laws of China.
12. This agreement has been memorialized in both Chinese and English,
and each such version, when duly executed, shall be a valid and
binding legal document. There are two (2) original copies of
each version, and each party shall keep a copy of both the
Chinese and the English version.
13. This agreement is binding upon signing by the legal
representatives of both parties.
MAJORITY JOINT VENTURE PARTNER: MINORITY JOINT VENTURE PARTNER:
D.V.S. H.K. Limited Panyu Kembo Electrical
Manufacturing Co; Ltd.
By: /s/ Dr.Edmund Sun By: /s/ Yu Ling Koo
Name: Dr.Edmund Sun Name: Yu Ling Koo
Title: Chairman Title: General Manager
Dated: January 31, 1998 Dated: January 31, 1998
EXHIBIT 10.38
March 26, 1998
Digital Video Systems, Inc.
160 Knowles Drive
Los Gatos, California 95032
Arris Interactive L.L.C.
David Potts, Chief Financial Officer
3871 Lakefield Drive
Suwanee, Georgia 30174
Re: Release of Shares; Termination of Earn Out, Etc.
Dear Mr. Potts:
We make reference to that certain Asset Purchase Agreement dated
as of July 25, 1997 by and between Digital Video Systems, Inc. ("DVS")
and Arris Interactive L.L.C. ("Arris"), as amended by Amendment No. 1
thereto dated as of August 1, 1997 (the "Asset Purchase Agreement"),
and that certain Escrow Agreement dated as of August 1, 1997 by and
between DVS and Arris (the "Escrow Agreement"). Capitalized terms used
herein and not otherwise defined shall have the meaning given to such
terms in the Asset Purchase Agreement.
Subject to the covenants and representations of Arris set forth
below:
1. DVS shall immediately release the 300,000 shares of DVS's
common stock escrowed pursuant to the Escrow Agreement (the
"Shares") in connection with the purchase of certain assets by
DVS from Arris;
2. DVS agrees that the restriction on sales of the Shares by
Arris contained in subsection 1.2(a)(iii) of the Asset
Purchase Agreement in hereby terminated and without further
force and effect; and
3. DVS agrees that Arris is hereby released from any obligation
under Article 10 of the Asset Purchase Agreement to indemnify
DVS for breaches of the representations and warranties
contained in Section 2.7(c) of the Asset Purchase Agreement
relating to Proprietary Technology.
Arris Interactive L.L.C.
March 26, 1998
Page 2
Arris makes the following representation and agrees to set forth
below:
1. As of the date hereof, the earn out and funding provisions set
forth in subsections 1.2(b)(I), (ii) and (iii) of the Asset
Purchase Agreement are hereby terminated and without further
force and effect;
2. Arris covenants that it will make any sales of the Shares in
compliance with the applicable requirements of the Securities
Act of 1933, as amended, and any applicable state securities
laws, rules and regulations;
3. Arris represents and warrants to DVS that no claim, action,
suit, proceeding, inquiry, hearing, arbitration,
administrative proceeding, or investigation is pending, or, to
Arris's best knowledge threatened in connection with the
Proprietary Technology. Arris knows of no facts that could
reasonably be expected to serve as the basis for litigation
against DVS affecting, involving, or relating to the
Proprietary Technology; and
4. Arris acknowledges and agrees that as of the date hereof, no
amounts are owned to Arris by DVS in connection with any of
the provisions of or transactions provided for the Asset
Purchase Agreement.
Please acknowledge your agreement to the above by signing below
and returning your signed letter to the attention of Thomas R.
Parkinson, President of DVS, by facsimile at (408) 871-8222 and sending
the original to the attention of Mr. Parkinson by overnight courier at
the address set forth above.
Very Truly Yours,
/s/ Thomas R. Parkinson
Thomas R. Parkinson
President and COO
Digital Video Systems, Inc.
ACKNOWLEDGED AND AGREED
BY ARRIS INTERACTIVE L.L.C.
By: /s/ David B. Potts
Name: David B. Potts
Title:Vice President of Finance
Exhibit 21
DVS - Hong Kong Hong Kong
DVS - Vicomp Technology United States
Exhibit 23.01
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8) pertaining to the 1993 stock Option Plan and
1997 Employees Stock Purchase Plan of Digital Video Systems, Inc.
of our report dated July 9, 1998 with respect to the consolidated
financial statements and schedule of Digital Video Systems, Inc.
included in this annual report (Form 10-KSB) for the year ended
March 31, 1998.
Ernst & Young LLP
San Jose, California
July 9, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted
from the Balance Sheet and Statement of Operations included in the
Company's Form 10-K for the year ended March 31, 1998 and is
qualified in its entirety by reference to such Financial Statements.
</LEGEND>
<MULTIPLIER>1000
<S> <C>
<FISCAL-YEAR-END> Mar-31-1998
<PERIOD-START> Apr-01-1997
<PERIOD-END> Mar-31-1998
<PERIOD-TYPE> 12-MOS
<CASH> 5,915
<SECURITIES> 1,033
<RECEIVABLES> 2,701
<ALLOWANCES> 1,562
<INVENTORY> 5,002
<CURRENT-ASSETS> 13,881
<PP&E> 2,788
<DEPRECIATION> 1,671
<TOTAL-ASSETS> 15,728
<CURRENT-LIABILITIES> 5,552
<BONDS> 0
0
0
<COMMON> 3
<OTHER-SE> 10,173
<TOTAL-LIABILITY-AND-EQUITY> 15,728
<SALES> 17,638
<TOTAL-REVENUES> 17,638
<CGS> 20,528
<TOTAL-COSTS> 20,528
<OTHER-EXPENSES> 23,917
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (25,718)
<INCOME-TAX> 0
<INCOME-CONTINUING> (25,718)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (25,718)
<EPS-PRIMARY> ($2.09)
<EPS-DILUTED> ($2.09)
</TABLE>
EXHIBIT 99.1
Other Considerations
Documents and press releases prepared by the Company, including
this report on Form 10-KSB may from time to time contain forward looking
statements. The Company, its assets, operations, and financial condition
and such forward looking statements made by the Company are subject to
various risks and uncertainties, including without limitation, the
following:
ABILITY TO CONTINUE AS A GOING CONCERN. As a result of the
Company's net losses and negative cash flow from operating activities in
recent periods, the Company's independent auditors have included in
their report on the Company's March 31, 1998 financial statements an
explanatory paragraph regarding the ability of the Company to continue
as a going concern. The Company is seeking additional debt and equity
funds, in one or more private placements transactions, in order to
obtain the funds necessary to meet its immediate working capital needs.
There can be no assurance that the Company will be able to successfully
complete the private placements or loan transactions or otherwise obtain
the necessary funds to continue the Company's operations.
LIQUIDITY. The Company's continuing operating losses and capital
commitments in connection with its acquisition of DVD-ROM manufacturing
capabilities and license of related DVD-ROM technology from Hyundai have
created a liquidity problem for the Company. As of March 31, 1998, the
Company had working capital of $10.4 million, as compared to working
capital of $32.7 million as of March 31, 1997, and the Company's working
capital has further declined since March 31, 1998. In June 1998, the
Company entered into an agreement with Dr. Edmund Y. Sun, the Company's
Chairman and Chief Technology Officer, pursuant to which Dr. Sun agreed to
purchase from the Company $1,000,000 of the Common Stock in July 1998.
Payment for these shares will be made by cancellation of $1,000,000 of
working capital loans made to the Company by Dr. Sun in June 1998.
Notwithstanding the private placement to Dr. Sun, the Company will need
to generate additional liquidity to meet its current obligations and
maintain its current level of operations or to finance any significant
future increase in revenues and is actively seeking additional financing
to meet those needs. The Company is currently negotiating equity
investments with several potential investors. However, there can be no
assurance that any such financings will ever be consummated, that such
financings if so consummated will be on terms favorable to the Company or
that such financings will be sufficient to meet the Company's immediate
needs. If adequate funds are not available to satisfy its capital
requirements, the Company may be required to curtail its operations
significantly or to obtain funds through arrangements with strategic
partners or others that may require the Company to relinquish material
rights to certain of its technologies or potential markets.
The Company has incurred operating losses since fiscal year 1994.
Even if the Company successfully completes the equity financings it is
currently attempting to consummate, if the Company continues to
experience operating losses in the future that result in a significant
utilization of its liquid resources, the Company's liquidity and its
ability over the long-term to sustain operations at current levels could
be materially adversely affected.
The Company may seek additional public or private financing to meet
its longer term capital needs if market conditions are favorable. If
additional funds are raised through the issuance of equity securities, it
is likely that the Company will be required to sell such securities at a
substantial discount to the current market price for the Company's Common
Stock, the percentage ownership of the then current shareholders of the
Company will be reduced, and such equity securities may have rights,
preferences or privileges senior to those of the holders of the Common
Stock. No assurance can be given that additional financing will be
available or that, if available, they will be available on terms
favorable to the Company or its shareholders. Any increase in the
outstanding number of shares of Common Stock or options and warrants to
acquire Common Stock may have an adverse effect on the market price of
the Common Stock and may hinder efforts to arrange future financing.
HISTORY OF LOSSES AND ACCUMULATED DEFICIT; EXPECTATION OF FUTURE
LOSSES. To date, the Company has incurred significant losses. At March
31, 1998 the Company had an accumulated deficit of approximately
$46,015,000. The Company incurred operating losses of approximately
$12,206,000 and $26,807,000 for the fiscal years ended March 31, 1997 and
March 31, 1998. Such losses resulted principally from limited revenues
from operations, price competition for the Company's products, including
pricing strategies implemented in order to penetrate certain markets and
significant costs associated with the development of the Company's
technologies. The Company expects to incur losses in the first half of
the fiscal year ending March 31, 1999 and until such future time, if
ever, as there is a substantial increase in product sales. There can be
no assurance that sales of the Company's products will ever generate
significant revenue, or that the Company will generate positive cash flow
from its operations or attain or thereafter sustain profitability in any
future period.
UNCERTAINTY OF MARKET ACCEPTANCE OF PRODUCTS; LACK OF ESTABLISHED
MARKET FOR CERTAIN PRODUCTS. The Company's business is dependent on
market acceptance of its digital video technology and the successful
commercialization of products utilizing this technology. In March 1997,
the next-generation CD product, known as DVD, was launched in its
home-video format by several large consumer electronics manufacturers in
the United States. A product for computer applications, known as the
DVD-ROM has recently entered the market as well. The Company believes a
number of factors should contribute to the long-term success of the DVD
player, including the movie industry's endorsement; the computer
industry's demand; and the general movement towards digital technology.
However, there can be no assurance that the DVD market will become a
significant one in the near term or at all.
In late 1996 the Company began the development of a DVD player and
related products for the home entertainment, business and computer
markets. In June 1998, the Company acquired a perpetual royalty-free
license to certain DVD-ROM technology from Hyundai and acquired certain
related manufacturing capabilities. The Company expects to commence
manufacturing DVD player, DVD Intelligent Loader, DVD Video Engine and
DVD-ROM products within the current calendar year. It is anticipated
that these products will be marketed to original equipment manufacturers
on a proprietary basis and will be available in both consumer and
commercial products. However, there can be no assurance that the Company
will be able to compete effectively in the market for products using the
new format or any different format. The Company's ability to
successfully market its DVD-ROM, DVD Intelligent Loader, DVD Video Engine
and/or DVD player products will depend in part on the willingness of
potential customers to incur the costs involved in purchasing products
and systems which contain a DVD-ROM, DVD Intelligent Loader, DVD Video
Engine and DVD players, which in turn will depend on the Company and
others convincing potential customers of the benefits of digital video.
The competition for DVD consumer players and DVD-ROM computer
devices is expected to be intense. Among the factors which may limit
widespread adoption of the current DVD player are a competing technology
player (DIVX) (short for "digital video express"), the inability of
current models to record, the limited number of software titles currently
available, the relatively high current retail price, and remaining
unresolved technical issues, including certain issues with respect to
copyright protection. Potential customers for the Company's products
utilizing the DVD format may be deterred from purchasing such products
due to the possibility that such products may become obsolete (as was the
case with beta video cassettes). Failure of the Company's products in
general (and its DVD-ROM, DVD Intelligent Loader, DVD Video Engine and
DVD player products in particular) to attain significant market
acceptance would have a material adverse effect on the Company's
business, financial condition and results of operations.
RISK OF PLANNED EXPANSION OF CETAIN OPEATIONS. The Company plans
to significantly expand its DVD player, DVD Intelligent Loader, DVD Video
Engine and DVD-ROM operations, which could place a significant strain on
its limited personnel, financial and other resources. The Company's
ability to manage this growth may require significant expansion of
certain of its product development, marketing and sales capabilities and
personnel. The contemplated sale and distribution of products to
licensees and subcontractors who will manufacture products incorporating
the Company's products in diverse markets and the requirements of such
manufacturers for design support will also place substantial demands on
the Company's product development, quality control and sales functions.
The failure of the Company's management to effectively expand or manage
these functions consistent with any growth which may occur could have a
materially adverse effect on the Company's business, financial condition
and results of operations.
DEPENDENCE ON LIMITED NUMBERS OF SUPPLIERS. The Company
anticipates that its DVD products will incorporate optical components
produced by a leading manufacturer. The Company has no contractual right
to obtain any specified number of optical components from the
manufactureand there can be no assurance that the Company will be able to
meet all of its future needs for such components through the
manufacturer. Should the Company's ability to obtain the requisite
number of such components be limited for any lengthy period of time or if
the cost of such manufacturer components increases, or if such components
are only available to the Company at prices substantially higher than
those paid by the Company's competitors for these optical components or
other functionally equivalent optical components, the Company's ability
to supply products to its customers on a competitive basis or at all
could be materially and adversely affected. The Company is currently
evaluating alternative sources of supply and anticipates that it will
begin the process of qualifying optical components made by other
suppliers to work with the Company's DVD products. However, the
qualification process may take from six to twelve months to complete.
There can be no assurance that the Company could successfully or
economically convert its video engines to a DVD format. The Company's
inability to obtain a sufficient quantity of optical components for its
DVD products or chips for its Video CD products at a competitive cost
would have a material adverse effect on the Company's business, financial
condition and results of operations.
RISKS ASSOCIATED WITH THE PANYU JOINT VENTURE. The Company entered
into the Panyu Joint Venture in August 1997 to manufacture Video CD
players and related products. Prior to that time the Company had no
experience doing business in China (other than marketing products there).
The Video CD market is highly competitive in China, with approximately
400 enterprises manufacturing and selling Video CD players there. The
Company believes that the five largest of these companies control
approximately 70% of the total Video CD player market share in China,
with the remaining companies, including the Company, competing for
approximately 30% of the market. This intense competition results in
ever-increasing downward pressure on the Company's gross margins on Video
CD players which are currently approaching approximately 5%, and the
Company believes that such downward pressure will continue.
Since its inception in August 1997, the Panyu Joint Venture has
incurred losses of approximately $5,100,000. In addition the Panyu Joint
Venture has ongoing liabilities which include an approximately $2,500,000
payable to a supplier of component parts, employee salaries and lease
payments on the joint venture's facilities. The Company has not been
able to achieve a breakeven level of Video CD player production at the
Panyu Joint Venture, and because of decreasing margins due to intense
competition, the Company does not expect this to continue production of
the Video CD player for the Chinese consumer market.
The Company believes that it may be possible for the Panyu Joint
Venture's manufacturing facility to produce the level and quality of
output required to compete effectively in the DVD player market.
However, this will require, among other things, upgrading certain parts
of the manufacturing facility's production capacity and process,
providing additional training to the work force, and instituting more
rigorous quality control measures. However, there can be no assurance
that the Panyu Joint Venture will be able to achieve quality and output
objectives in order to compete effectively in the DVD player market. In
addition, the actions necessary to increase the Panyu Joint Venture's
manufacturing capacity and to improve quality control at the Panyu Joint
Venture's manufacturing facility may require substantial expenditures
that may need to be funded by the Company in excess of its current
financial commitment to the Panyu Joint Venture.
In addition to intense competition, the Company has experienced
increasingly severe problems with its local Chinese partner (the "JV
Partner") in the Panyu Joint Venture. Based upon a recently completed
investigative audit of the Panyu Joint Venture, the Company believes that
the JV Partner diverted substantially all of the revenues generated by
the Panyu Joint Venture (approximately $2.1 million) in fiscal 1998. In
addition, the Company believes that the JV Partner removed substantial
amounts of inventory from the Panyu Joint Venture's premises without
authorization or payment. The Company has retained Chinese counsel to
provide advice on how to recover such losses and is currently
investigating available legal remedies. There can be no assurance,
however, that the Panyu Joint Venture will be able to recoup any of the
losses resulting from the improper conduct of the JV Partner.
If the Panyu Joint Venture does not achieve its cash flow
objectives within a reasonable period of time, the Company may be
compelled to choose between contributing additional resources to the
Panyu Joint Venture or risking the loss of its entire investment.
Transfer of an interest in a Chinese equity joint venture, such as the
Panyu Joint Venture, requires government approval and unanimous agreement
among the parties. In addition, the parties in an equity joint venture
may not reduce the amount of their registered capital until the
expiration of the term of the joint venture or its dissolution in
accordance with Chinese law. The term of the Panyu Joint Venture is 25
years.
RAPID TECHNOLOGICAL CHANGE AND OBSOLESCENCE; RISKS ASSOCIATED WITH
PRODUCT DEVELOPMENT, INTRODUCTIONS AND ANNOUNCEMENTS. The markets served
by the Company are characterized by rapid technological advances,
downward price pressure in the marketplace as technologies mature,
changes in customer requirements, frequent new product introductions and
enhancements, and price erosion. The Company's business requires
substantial ongoing research and development efforts and expenditures,
and its future success will depend on its ability to enhance its current
products, reduce product costs and develop and introduce new products
that both keep pace with technological developments in response to
evolving customer requirements and that also achieve market acceptance.
There can be no assurance that one or more of the Company's products will
not be rendered noncompetitive or obsolete by technological advances or
changing customer preferences. In addition, from time to time, the
Company or others may announce products, features or technologies that
have the potential to shorten the life cycle of or replace the Company's
then existing products, including the Company's products that only use
the MPEG-1 format. Such announcements could cause customers to defer the
decision to buy or determine not to buy the Company's products or cause
the Company's distributors to seek to return products to the Company, any
of which could cause the Company to write down some or all of its
inventory. Any such writedown could have a material adverse effect on
the Company's business, financial condition and results of operations.
The Company has from time to time experienced delays in introducing
new products and product enhancements, and there can be no assurance that
the Company will not experience difficulties that could delay or prevent
the successful development, introduction and marketing of new products or
product enhancements in the future. In 1996, the Company acquired all of
the outstanding capital stock of ViComp Technology, Inc. At that time
ViComp was engaged in the design and development of integrated circuits
to decode MPEG-1 signals. However, to date ViComp has been unable to
complete planned development of the ViComp MPEG-1 Chip for use in the
Company's Video CD players and since approximately December 1997 all such
development efforts at ViComp have been suspended. In order stay current
in a market of rapidly changing technologies, the Company will be
required to continue to invest in research and development to attempt to
maintain and enhance its existing technologies, and there can be no
assurance that it will have the funds available at such time as it will
be necessary to do so.
In addition to the difficulty of completing product development on
certain products, some of the products offered by the Company may contain
defects when they are first introduced or as new or enhanced versions are
released. The Company has in the past discovered defects in certain of
its new products, such as the karaoke jukebox, and in certain of its
product enhancements. These defects have required correction by the
Company, thereby resulting in delays in the marketing of such products or
product enhancements. There can be no assurance that, despite
significant quality control testing by the Company, defects will not be
found in new products and product enhancements after commencement of
commercial shipments, resulting in delays in or loss of market
acceptance.
The Company has identified and increased its product development
and sales efforts in certain market segments, including the DVD-ROM, DVD
Intelligent Loader, DVD Video Engine and DVD player segments, in which
the Company believes the demand for its products will increase in the
future. There can be no assurance that the Company's efforts in such
market segments will result in increased revenues or profitability in the
future. Moreover, there can be no assurance that the Company's
competitors will not introduce functionally similar products that could
render the Company's products obsolete. If the Company is unable to
develop new, or improve its current, products and technology in response
to changes in customer demand, the Company's operating results and
financial condition could be materially, adversely affected.
RISKS OF INTERNATIONAL OPERATIONS. Sales outside the United States
have accounted for approximately 79% of the Company's revenues from
inception through March 31, 1998 (with sales to Hong Kong, China and
Taiwan accounting for approximately 55%, 10% and 7%, respectively, of the
Company's revenues of $17,638,000 in fiscal 1998), and the Company
believes that foreign sales will continue to account for a significant
portion of its future revenues. The Company's four largest customers in
fiscal 1998 were Carnival Honour Development Limited, Starnet, Wanyan
Electronic Systems, Inc., and Serial Semiconductor Co., Ltd., which
accounted for 30.6%, 8.6%, 7.7% and 7.7%, respectively, of the Company's
revenues for that fiscal year. Moreover, the Company has been
manufacturing Video CD players and "Video Engine" (a commercial
application of its Video CD products) products utilizing subcontractors
in China and Taiwan to produce Video CD, Video Engine and
sub-assemblies. The Company has completed the process of shifting
assembly of Video CD products to the Panyu Joint Venture in China to
reduce manufacturing costs. The Company may establish manufacturing
operations in other countries to meet local demand for its products in
those markets when, if ever, such demand develops.
The Company will be subject to all of the risks inherent in
international operations in connection with its foreign operations,
including work stoppages, transportation delays and interruptions,
political instability in, or conflict between, countries in which the
Company is doing business, such as South Korea, China and Taiwan, foreign
currency fluctuations, economic disruptions, expropriation, the
imposition of tariffs and import and export controls, the payment of
significant customs duties to deliver products into markets such as China
where the smuggling of competing products into such markets without the
payment of duties may be widespread, changes in governmental policies
(including United States trade policy toward certain countries such as
China and Japan) and other factors which could have a material adverse
effect on the Company's business, financial condition and results of
operations. The recent currency and financial turmoil in a number of
Asian countries has adversely impacted consumer demand for various
products in certain of those countries. A prolonged or deepening crisis
in these countries could have a material adverse effect on demand for the
Company's products in these countries.
The Company will also be subject to the burdens of complying with a
wide variety of foreign laws and regulations. These international trade
factors may, under certain circumstances, materially and adversely impact
demand for the Company's products or the Company's ability to deliver its
products in a timely manner, which in turn may have an adverse impact on
the Company's relationships with its customers. In order to manufacture
or market its products in foreign countries such as China, the Company
may be required or deem it advisable to conduct these operations through
joint ventures with local partners, which could expose the Company to
various risks, including potentially reduced profitability of these
operations for the Company and the need to share management control with
such local partners. The Company's success will depend in part upon its
ability to manage international marketing and sales operations and
manufacturing relationships, which are generally more complex than
domestic marketing and sales operations or manufacturing relationships.
Should the Company substantially increase its product sales in
South Korea or China or other countries, the Company anticipates that it
will be required to significantly increase the amount of credit it
extends to purchasers in these markets. The Company has had only limited
experience in extending credit to foreign customers and will encounter
increased risks in extending credit to new customers in these markets,
including the creditworthiness of such customers and the difficulty of
collecting accounts receivable in these countries. While the Company
sells certain of its products in international markets and buys limited
quantities of certain items incorporated into its products in currencies
other than the U.S. dollar, the Company does not currently hedge its
exposure to foreign currency fluctuations. As a result, currency
fluctuations could have a material adverse effect on the Company's
business and results of operations. With respect to international sales
that are denominated in U.S. dollars, an increase in the value of the
U.S. dollar relative to foreign currencies could increase the effective
price of, and reduce demand for, the Company's products relative to
competitive products priced in the local currency.
RISKS ASSOCIATED WITH MERGERS, ACQUISITIONS, DIVESTITURES AND JOINT
VENTURES. An element of the Company's strategy is to pursue mergers,
acquisitions, divestitures and joint ventures that would complement its
existing range of products, augment its market coverage or enhance its
technological capabilities or that may otherwise offer growth
opportunities. Acquisitions and joint ventures made to date have failed
to meet the Company's objectives for such operations and have contributed
to the Company's substantial operating losses, and there can be no
assurance that the Company's acquisition of DVD-ROM manufacturing
capabilities and related license of DVD-ROM technology from Hyundai will
meet the Company's business objectives. Any future mergers, acquisitions
or joint ventures by the Company could result in potentially dilutive
issuances of equity securities, the incurrence of debt and contingent
liabilities, and the amortization of expenses related to goodwill and
other intangible assets, any of which could have a material adverse
effect on the Company's business, financial condition and results of
operations. Mergers, acquisitions and joint ventures entail numerous
risks, including difficulties in the assimilation of acquired operations,
technologies and products, diversion of management's attention to other
business concerns, risks of entering markets in which the Company has no,
or limited, prior experience, the potential loss of key employees of
acquired organizations or joint ventures and the need to share managerial
control of joint ventures with one or more joint venture partners. No
assurance can be given as to the ability of the Company to successfully
integrate any acquired business, product, technology or personnel with
the operations of the Company, and the failure of the Company to do so
could have a material adverse effect on the Company's business, financial
condition and results of operations.
EFFECT OF TRADE DISPUTES. The United States has had disputes with
China relating to trade and human rights issues and has considered trade
sanctions against China and Japan. If trade sanctions were imposed,
China or Japan could enact trade sanctions in response which, if imposed,
could have a material adverse effect on the Company's business, financial
condition and results of operations because of the proportion of the
Company's business in those countries. Similarly, protectionist trade
legislation could have a material adverse effect on the Company's ability
to import and/or export products and to manufacture or to sell its
products in foreign markets.
RISKS ASSOCIATED WITH CONDUCTING BUSINESS IN CHINA. General
economic conditions in China could have a significant impact on the
business prospects of the Company. The economy of China differs from the
economies of most countries belonging to the Organization for Economic
Co-operation and Development in such respects as structure, government
involvement, level of development, growth rate, capital reinvestment,
allocation of resources, self- sufficiency, rate of inflation and balance
of payments position, among others. For over 40 years, the economy of
China has been primarily a planned economy characterized by state
ownership and control of productive assets and the management of such
assets through a series of economic and social development plans.
However, the adoption of economic reform policies since 1978 has resulted
in a gradual reduction in the role of state economic plans in the
allocation of resources, pricing and management of productive assets, an
increased emphasis on the utilization of market forces, and rapid growth
in the Chinese economy. At times, the economic reform measures adopted
by the Chinese government may be inconsistent or ineffectual, and
therefore the Company may not be able to enjoy the potential benefits of
such reforms.
The Company may also be adversely affected by changes in the
political and social conditions in China, and by changes in governmental
policies with respect to such matters as laws and regulations, methods to
address inflation (including austerity measures that could adversely
affect consumer demand for products such as DVD players and Video CD
players), currency conversion and rates and methods of taxation.
To date, a substantial portion of the revenues generated by the
Company in China have been earned in Renminbi (the Chinese currency) and
the Company expects that this will continue to be the case. Renminbi
earnings must be converted to pay dividends or make other payments to the
Company in U.S. dollars or other freely convertible currencies. As of
December 1, 1996, the Renminbi became fully convertible for current
account items, including profit distributions, interest payments and
receipts and expenditures from trade. Certain ministerial approvals are
needed to acquire foreign exchange for a current account transaction.
Strict foreign exchange controls continue for capital account
transactions (including repayment of loan principal and return of direct
capital investments and transactions in investments in negotiable
securities). In the past, there have been shortages of U.S. dollars or
other foreign currency available for conversion of Renminbi, and it is
possible such shortages could recur, or that restrictions on conversion
could be reimposed, in the future at times when the Company is seeking to
convert Renminbi. Prior to 1994, the Renminbi experienced a significant
net devaluation against most major currencies, and during certain
periods, significant volatility in the market-based exchange rate. In
early 1994, the Renminbi experienced an approximately 35% devaluation
against most major currencies, and the Renminbi to U.S. dollar exchange
rate has largely stabilized since that time. However, China's finance
minister has recently stated that a failure to attain China's target 8%
growth in 1998 could affect the stability of the Renminbi. Given the
current Asian financial crisis, there can be no assurance that the
Renminbi to U.S. dollar exchange rate will remain stable or that the
Company will continue to be able to remit foreign currency abroad.
China's current legal system is relatively new, and the government
is still in the process of developing a comprehensive system of laws.
While considerable progress has been made in the promulgation of laws and
regulations dealing with economic matters such as corporate organization
and governance, foreign investment, commerce, taxation and trade, foreign
investors may be adversely affected by new laws, changes to existing laws
(or interpretations thereof) and preemption of provincial or local
regulations by national laws or regulations. Moreover, experience with
respect to the implementation, interpretation and enforcement of such
laws and regulations is limited. Administrative and judicial
interpretation and implementation and the enforcement of commercial
claims and resolution of commercial disputes may be subject (as has
recently been asserted by a number of American corporations doing
business in China) to the exercise of considerable discretion by both
administrative and judicial organs and may be influenced by external
forces unrelated to the legal merits of a particular matter or dispute.
Even where adequate laws exist and contractual terms are clearly stated,
there can be no assurance that the Company will obtain swift and
equitable enforcement of its rights under Chinese law.
EXPROPRIATION. The Chinese government has, in the past, renounced
various debt obligations incurred by predecessor governments, which
obligations remain in default, and expropriated assets without
compensation. There can be no assurance that Chinese government will not
in the future expropriate or nationalize assets which may relate to any
current or prospective business operations of the Company.
RELIANCE ON STATISTICS. Statistics relating to economic,
demographic, and general business data are not widely disseminated within
or outside of China. Further, certain Chinese statistics may not be
compiled in accordance with, or may not be subject to, Western standards
of accuracy. The resultant imperfect information naturally hinders the
performance of the Company's business planning or investment analysis and
introduces risks in conducting business in China.
RISKS ASSOCIATED WITH CONDUCTING BUSINESS IN SOUTH KOREA. As the
Company expands its DVD-ROM operations in South Korea, general economic
conditions in South Korea could have a significant impact on the business
prospects of the Company and its operations there. South Korea has
experienced severe economic problems in the last 12 months, including a
slowing of GDP growth and export growth, currency devaluation and rising
unemployment. In December 1997, the International Monetary Fund ("IMF")
outlined and began to implement a reform program designed to stabilize to
economy. The IMF monetary reforms include limiting money growth during
1998 to a rate consistent with 5% percent inflation and maintaining a
flexible exchange rate policy. IMF fiscal reforms include the
elimination of certain tax incentives and exemptions for corporations and
an increase in value added tax, excise tax and transportation taxes,
among others. There can be no assurance that such reforms, or that any
future reforms, will not have a material adverse effect on the Company's
operations in South Korea, and thereby have a material adverse effect on
the Company's business, operations, prospects and financial results.
The Company may also be adversely affected by changes in the
political and social conditions in South Korea, and by changes in
governmental policies with respect to such matters as laws and
regulations, methods to address inflation (including austerity measures
that could adversely affect consumer demand for products such as DVD
products), currency conversion and rates and methods of taxation.
In early 1998, the South Korean currency, the Won, reached its
lowest exchange rate against the U.S. dollar in a decade. Given the
current Asian financial crisis, there can be no assurance that the Won to
U.S. dollar exchange rate will not decline further. Although the IMF
policy has stated that Korea will maintain a flexible exchange rate,
there can be no assurance that the Company will be able to obtain
sufficient dollars for conversion of Won, or that the IMF or the South
Korean government will not restrict the Company's ability to remit
foreign currency earnings to the United States. It is possible shortages
of the Won could occur, or that restrictions on conversion could be
imposed in the future at times when the Company is seeking to convert
Won. Any such restrictions could have a material adverse effect on the
Company's business, operations, prospects and financial results.
DEPENDENCE ON KEY PERSONNEL AND NEED FOR ADDITIONAL MANAGEMENT
PERSONNEL. The Company's operations to date have depended in large part
on the skills and efforts of Dr. Edmund Y. Sun, the Company's founder,
Chairman and former Chief Executive Officer and, to a lesser extent,
Thomas R. Parkinson, the Company's former President and Chief Executive
Officer. The Company's operations also depend to a significant extent on
the performance and continued service of certain other key employees,
including Edward M. Miller, Jr., who was appointed the Company's Chief
Executive Officer in June 1998 after previously serving as the Company's
Chief Financial Officer, and Bob Werbicki, the Company's Vice President
of Engineering. Competition for highly-skilled business, product
development, technical and other personnel is intense, and there can be
no assurance that the Company will be successful in recruiting new
personnel as needed or in retaining any of its existing personnel. The
Company may experience increased costs in order to retain and attract
skilled employees. The Company's failure to attract additional qualified
employees as needed or to retain the services of key personnel could have
a material adverse effect on the Company's business, financial condition
and results of operations.
COMPETITION IN THE VIDEO CD PRODUCT AND DVD PRODUCT MARKETS. The
Company's Video CD products currently compete with, and the Company's DVD
products, when introduced, will compete with, products marketed by other
manufacturers of Video CD players, subassemblies and components and DVD
products, respectively, as well as with alternative methods of displaying
audio and video such as video cassette players, laser discs, multimedia
computers and game machines, as well as with other companies' products
that use similar technologies. The large video entertainment markets of
the United States and other industrial nations are currently served
primarily by VHS video cassettes and laser discs, and there can be no
assurance that DVD formats will be able to effectively compete for these
markets in the future. A number of major electronics manufacturers have
entered the DVD consumer entertainment market and many other major
electronics manufacturers are expected to compete for this market should
it expand significantly. In September 1997, a large U.S. consumer
electronics retailer announced plans to back DIVX an alternative
competing format called "DIVX," short for "digital video express." DIVX
disks are designed to be viewable only a limited number of times. Unlike
rented video cassette tapes, DIVX disks need not be returned to the
retailer. It is possible that these two competing, but similar,
technologies may create confusion in the minds of consumers that will
result in consumers being hesitant to invest in DVD players until a
dominant technology emerges. Most of the Company's competitors and
potential competitors are substantially larger in size and have far
greater financial, technical, marketing, customer service and other
resources than the Company. Certain of the Company's potential
competitors may have technological capabilities or other resources that
would allow them to develop alternative products which could compete with
the Company's products.
Potential competitors may begin operations or expand their existing
operations into the Company's proposed markets before the Company is able
to successfully market its products. The Company's ability to
effectively compete may be adversely affected by the ability of these
competitors to offer their products at lower prices than the price of the
Company's products and to devote greater resources to the sales and
marketing of their products than are available to the Company.
Competition in the Video CD market generally occurs on the basis of price
and features. To date, the Company has been unable to offer its
customers products that are as competitively priced or as feature rich as
its larger competitors and there can be no assurance that the Company
will be able to do so in the future. Moreover, manufacturers of Video CD
player sub-assemblies and components have substantially reduced the
selling prices of these items and further reductions in those prices can
be expected, which will require the Company to reduce its production
costs in order to remain competitive in the Video CD player, sub-assembly
and component markets. Although the Company has been reducing its costs
of production for these products and is now focusing its efforts in the
commercial Video CD business rather than the more competitive consumer
Video CD business, there can be no assurance that it will be able to
remain competitive or that its operations will not be materially
adversely affected should competitors substantially reduce their prices
in the future. There can be no assurance that future technological
advances will not result in improved products or services that could
adversely affect the Company's business. Competition in the electronics
industry also extends to attracting and retaining qualified technical and
marketing personnel, and there can be no assurance that the Company will
be successful in attracting and retaining such qualified personnel.
COMPETITION IN DIGITAL AD INSERTION MARKET. Since August 1997, the
Company, through its New Media Division, has competed against other
suppliers of digital advertisement insertion systems, which provide cable
television operators with the ability to selectively insert local and
regional advertising into cable channel video streams. The digital ad
insertion market is highly competitive and is currently dominated by two
suppliers, SeaChange International Inc. and SkyConnect, Inc. Based on
its experience to date, and the substantial cash drain created by the New
Media Division, the Company does not believes that it can compete
effectively in the digital ad insertion market. Thus, the Company has
decided to exit the digital ad insertion business. The Company is
currently exploring various options to ensure an orderly liquidation of
assets remaining in the New Media Division.
DEPENDENCE ON NONAFFILIATED AND FOREIGN MANUFACTURERS. To date,
the Company has primarily relied on subcontractors and licensees, most of
whom have been located in China or Taiwan, to manufacture its products or
products incorporating the Company's products. None of these
manufacturers are contractually obligated to meet the long-term
production requirements of the Company. There can be no assurance that
the Company will be successful in entering into any such future
manufacturing arrangements with third parties on terms acceptable to the
Company, or at all. As the Company begins to manufacture DVD products in
South Korea, the Company may rely on subcontractors and/or licensees.
The Company's arrangements with manufacturers in South Korea or elsewhere
may not prevent these manufacturers from entering into similar
arrangements with competitors of the Company or competing directly with
the Company. The Company's reliance on third parties for manufacturing
components of its products reduces the Company's control over the
manufacture of its products and makes the Company substantially dependent
upon such third parties to deliver its products in a timely manner, with
satisfactory quality controls and on a competitive basis. On several
occasions, the Company has had a number of its products manufactured in
Taiwan returned to it by customers due to quality control problems.
There can be no assurance that the Company will not experience quality
control problems or require product recalls in the future in its foreign
manufacturing operations that could have a material adverse effect on the
Company's business, financial condition and results of operations.
Further, foreign manufacturing is subject to a number of risks inherent
in foreign operations, including risks associated with the availability
of and time required for the transportation of products from such foreign
countries and increased risks of theft by personnel of source codes and
other proprietary product information in countries where intellectual
property is not well protected by law. Although the Company has
experienced certain quality control problems in connection with the Panyu
Joint Venture's initial production of Video CD players, the Company
believes that manufacturing Video CD players and other products through
the Panyu Joint Venture ultimately will enable the Company to exercise
greater control over the quality of such products and the manufacturing
capacity required to make such products.
LIMITED SALES AND MARKETING EXPERIENCE. The Company's operating
results will depend to a large extent on its ability to successfully sell
and market its Video CD products, DVD products and network video
products. The Company currently has limited marketing capabilities.
There can be no assurance that the Company will be able to recruit, train
or retain qualified personnel to market and sell its products or that it
will develop a successful sales and marketing strategy. The Company also
has very limited marketing experience. There can be no assurance that
any marketing efforts undertaken by the Company will be successful or
will result in any significant sales of its products.
RISKS OF LIMITED PROTECTION FOR COMPANY'S INTELLECTUAL PROPERTY AND
PROPRIETARY RIGHTS AND INFRINGEMENT OF THIRD PARTIES' RIGHTS. The
Company regards its products as proprietary and relies primarily on a
combination of patent, trademark, copyright and trade secret laws and
employee and third-party nondisclosure agreements to protect its
proprietary rights. The Company possesses certain patent rights which
may limit competition against it in certain areas of the digital ad
insertion market, and has applied for patent protection in the United
States and certain other countries covering certain of the technologies
that relate to its digital ad insertion systems and network video
systems. There are few barriers to entry into the market for many of the
Company's products, and there can be no assurance that any patents
applied for by the Company will be granted for any of these technologies
or that the scope of any patent claims allowed will be sufficiently broad
to protect against the use of similar technologies by the Company's
competitors. There can be no assurance, therefore, that any of the
Company's competitors, many of whom have far greater resources than the
Company, will not independently develop technologies that are
substantially equivalent or superior to the Company's technology.
Further, the Company distributes certain of its products in countries
where intellectual property laws are not well developed or are poorly
enforced. Legal protection of the Company's rights may be ineffective in
such countries, and software developed in such countries may not be
protectable in jurisdictions where protection is ordinarily available.
Software piracy and ineffective legal protection of the Company's
software in foreign jurisdictions may cause substantial losses of sales
by the Company, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
There can also be no assurance that third parties will not assert
infringement claims against the Company in the future with respect to
current or future products. If infringement is alleged, the Company
could be required to discontinue the use of certain software codes or
processes, to cease the manufacture, use and sale of infringing products,
to incur significant litigation costs and expenses and to develop
non-infringing technology or to obtain licenses to the alleged infringing
technology. There can be no assurance that the Company would be able to
develop alternative technologies or to obtain such licenses or, if a
license were obtainable, that the terms would be commercially acceptable
to the Company.
The Company may be involved from time to time in litigation to
determine the enforceability, scope and validity of any proprietary
rights of the Company or of third parties asserting infringement claims
against the Company. Any such litigation could result in substantial
costs to the Company and diversion of efforts by the Company's management
and technical personnel.
CONTROL BY INSIDERS. The Company's directors and officers,
together with Hyundai (a principal shareholder of the Company),
beneficially own shares of the Company's capital stock representing in
excess of 50% of the total voting power of the Company. Accordingly, it
is likely that they will continue to be able to elect at least a majority
of the Company's directors and thereby direct the policies of the Company
for the foreseeable future.
CHARGE TO INCOME IN THE EVENT OF RELEASE OF ESCROWED SECURITIES.
In the event that certain shares of Common Stock and certain options to
purchase Common Stock which were deposited into an escrow in connection
with the IPO ("Escrow Securities") owned by securityholders of the
Company who are officers, directors, consultants or employees of the
Company, or 140,760 shares received by Dr. Edmund Y. Sun in the ViComp
Acquisition that were escrowed in connection with the Company's follow-on
offering are released from escrow (the "Escrow Acquisition Shares"),
compensation expense will be recorded for financial reporting purposes.
Therefore, in the event the Company attains any of the earnings or stock
price thresholds required for the release of the Escrow Securities and
the foregoing Escrow Acquisition Shares owned by Dr. Sun, the release
will be treated, for financial reporting purposes, as expense of the
Company. Accordingly, the Company will, in the event of the release of
the Escrow Securities or Dr. Sun's Escrow Acquisition Shares, recognize,
during the period that the conditions for such release are met, a
substantial non-cash charge to earnings that would increase the Company's
loss or reduce or eliminate earnings, if any, at such time. The amount
of those charges will be equal to the aggregate market price of such
Escrow Securities or Escrow Acquisition Shares at the time of release
from escrow. Although the amount of expense recognized by the Company
will not affect the Company's total shareholders' equity or cash flow, it
may depress the market price of the Company's securities.
EFFECT OF OUTSTANDING OPTIONS AND WARRANTS. The Company previously
has issued or granted warrants and stock options, some of which are
currently exercisable, for a substantial number of shares of the
Company's common stock. Holders of such options and warrants may
exercise them at a time when the Company would otherwise be able to
obtain additional equity capital on terms more favorable to the Company.
Moreover, while these options and warrants are outstanding, the
Company's ability to obtain financing on favorable terms may be adversely
affected. If the trading price of the Company's common stock at the time
of exercise of any such options or warrants exceeds the exercise price,
as the Company anticipates it will, such exercise will have a dilutive
effect on the Company's shareholders.
POSSIBLE ADVERSE EFFECTS OF AUTHORIZATION OF PREFERRED STOCK;
POTENTIAL ANTI-TAKEOVER PROVISIONS. The Company's Amended and Restated
Certificate of Incorporation authorizes the issuance of a maximum of
5,000,000 shares of Preferred Stock on terms which may be fixed by the
Company's Board of Directors without further shareholder action. The
terms of any series of preferred stock, which may include priority claims
to assets and dividends and special voting rights, could adversely affect
the rights of holders of the Common Stock and thereby reduce the value of
the Common Stock. The issuance of preferred stock could make the
possible takeover of the Company or the removal of management of the
Company more difficult, discourage hostile bids for control of the
Company in which shareholders may receive premiums for their shares of
Common Stock or otherwise dilute the rights of holders of Common Stock.
In addition, the agreement governing the Escrow Securities contains
certain procedures that may make a possible takeover of the Company more
difficult.
POSSIBLE VOLATILITY OF PRICE OF SECURITIES. The Company believes
factors such as quarterly fluctuations in financial results and
announcements of new technology in the entertainment industry may cause
the market price of the Company's securities to fluctuate, perhaps
substantially. These fluctuations, as well as general economic
conditions, such as recessions or high interest rates, may adversely
affect the market price of the securities.
